A. Section 226.19 Revisions

Under the current version of Regulation Z, for most kinds of closed-end mortgage transactions the disclosures required by 12 C.F.R. Section 226.18 (e.g., the finance charge, amount financed, APR, etc.) need only be given at some point prior to consummation.⁶ However, in the case of a “residential mortgage transaction” (i.e., a mortgage loan to acquire or initially construct the consumer’s principal dwelling) subject to the Real Estate Settlement Procedures Act (“RESPA”), Regulation Z, Section 226.19(a) requires that good faith estimates of the Section 226.18 disclosures be provided before consummation or within three business days after the lender receives the application, whichever is earlier.⁷

The Final Rule amends Section 226.19(a)(1) to require that early disclosures be provided not just for a TILA “residential mortgage transaction,” but for any closed-end mortgage transaction subject to RESPA and secured by the consumer’s principal dwelling (e.g., home equity loans, refinancings, etc.). The Fed left the timing requirement unchanged.

In addition, other than a bona fide and reasonable credit report fee, neither the lender “nor any other person” may impose a fee on the consumer until the consumer has received the early disclosures (if mailed, a consumer is considered to have received the early disclosures three business days after they are mailed).⁸

But that is not the end of the story. HERA upends the Fed’s early disclosure revisions to Regulation Z by amending the statute–Section 128 of TILA–on which Section 226.19 is based, to further expand the scope of mortgage loans subject to early disclosure, alter the timing requirements, and add additional disclosures.

B. HERA Amendments

HERA expands the scope of mortgage loans subject to early disclosure beyond those set forth in amended Section 226.19(a)(1) (i.e., closed-end mortgage loans that are subject to RESPA and secured by the consumer’s principal dwelling). Specifically, Section 2502 of HERA deletes from Section 128(b)(2) of TILA the phrase “In the case of a residential mortgage transaction” and replaces it with “in the case of any extension of credit that is secured by the dwelling of a consumer.” One of the intents of this language was to expand the early disclosure requirement to loans other than those used to acquire or initially construct the consumer’s dwelling, which, as discussed above, is consistent with the Fed’s amendment to Section 226.19. However, this language is more expansive than the Final Rule, in that it also covers closed-end mortgage loans that are secured by dwellings that are not necessarily the consumer’s principal dwelling (such as a vacation home).

HERA also adds a seven business day waiting period before such loans may close. Under the current version of Section 128(b)(2), the early disclosures must be provided before credit is extended or within three business days after the lender receives the application, whichever is earlier.

Under the HERA amendments, the early disclosures must be “delivered or placed in the mail not later than three business days after the creditor receives the consumer’s written application, which shall be at least seven business days before consummation of the transaction.” The seven day period may also be waived in the event of a bona fide personal emergency. However, like rescission waivers, lenders should be cautious of permitting waivers of this new timing requirement.

The requirement to re-disclose if the APR given in the early disclosures changes beyond specified tolerances has also been changed by HERA to require that the consumer receive new disclosures not later than three business days before closing (the current rule permits new disclosures to be provided at closing).

HERA also requires that the early disclosures contain the following statement: “You are not required to complete this agreement merely because you have received these disclosures or signed a loan application.” This disclosure also needs to be included in any corrected disclosures.

In addition, for variable rate or payment transactions, the payment schedule must be labeled to note that payments will vary based on interest rate changes; after consumer testing, the Fed must publish regulations providing rules for disclosing examples of how a consumer’s payment may change based on interest rate changes.

C. The Proposed Rule and Earlier Effective Dates

The Fed’s Proposed Rule, released on December 5, proposes to further amend Regulation Z (including certain sections amended by the Final Rule) to conform it to the HERA amendments discussed above. Comments to the Proposed Rule are due by January 23, 2009.

Proposed revisions include:

• eliminating the reference to “principal” dwelling in new Section 226.19(a)(1)(i), to clarify that the early disclosure requirement applies to all closed-end, dwelling-secured loans subject to RESPA;
• requiring that the early disclosures be delivered or placed in the mail at least seven business days before closing;
• providing that any required re-disclosure be received by the consumer no later than three business days before closing; and
• adding separate early disclosure requirements for timeshare plans.⁹

Finally, in order to reconcile a July 30, 2009 effective date for most of HERA’s TILA Section 128 amendments and the October 1, 2009 effective date for most provisions of the Final Rule, the Proposed Rule plans to move up the effective date for the Section 226.19 amendments and related provisions to July 30, 2009.¹⁰

III. “Higher-Priced” Mortgage Loans

Lenders are by now well familiar with the “high cost” loan provisions added to TILA by HOEPA in 1994.¹¹ Largely because of the punitive penalties that attach to compliance violations for high-cost loans, as well as the more expansive assignee liability, the market for high-cost loans has been largely non-existent (and is even more so today in light of the crisis in the credit markets). In fact, lenders generally pay little attention to HOEPA’s substantive restrictions on high-cost loans, and instead focus on ensuring that their loans do not trip either the “points and fees” or APR triggers. A similar result has been found in the large number of states that have enacted “me too” laws, which in many cases include lower coverage triggers than under HOEPA.

The Fed’s new rules for “higher-priced” mortgage loans are, despite the name, intended to capture loans between prime-priced mortgage loans and HOEPA high-cost loans. In effect, the new rules will cover all subprime loans, as well as at least some “Alt-A” loans. While the market for both subprime and Alt-A paper has substantially contracted, these new rules will require lenders to make system changes going forward so that they will know when the requirements for such loans will be in play.

Like high-cost loans, higher-priced mortgage loans are closed-end mortgage loans that are secured by the consumer’s principal dwelling.¹² However, while loans to both purchase and initially construct the consumer’s principal dwelling are excluded from HOEPA coverage, the new higher-priced loan category covers home purchase loans (but not initial construction loans).¹³

In addition, the test for determining whether a loan is “higher-priced” is substantially different from the high-cost loan test. There is no points and fees test, and while there is an annual percentage rate test, it is not based on Treasury security yields. Instead, the measuring stick is the “average prime offer rate,” which is defined in the Final Rule as an annual percentage rate derived from average interest rates, points and other loan pricing terms that are currently offered to consumers by a representative sample of lenders for mortgage transactions that have low-risk pricing characteristics.¹⁴ At least initially, the Fed will use information derived from Freddie Mac’s Primary Mortgage Market Survey (“PMMS”), but may eventually develop its own tables. The average prime offer rate for both fixed and adjustable rate loans will be published in a table and updated at least weekly.

A loan is considered higher-priced if its APR exceeds the applicable average prime offer rate by 1.5 percentage points or more for first lien loans and 3.5 percentage points or more for junior lien loans.¹⁵ Unlike the HOEPA APR test, which compares the loan’s APR to the applicable Treasury security yield as of the 15th day of the month immediately preceding the month in which the application is received, the Final Rule requires that the loan’s APR be measured against the applicable average prime offer rate “as of the date the interest rate is set.”¹⁶ The Official Staff Commentary clarifies that if a loan’s rate is initially set at one level but then changed prior to closing, a lender must use the last date the interest rate is set before closing.¹⁷

If a loan meets the definition of a “higher-priced” mortgage loan, the Final Rule imposes three basic requirements or restrictions: a ban on extending credit without adequately considering and verifying repayment ability; limits or prohibitions on prepayment penalties; and a requirement for escrow accounts for first lien loans.¹⁸

A. Repayment Ability

The new rules regarding consideration and verification of a consumer’s repayment ability for a higher-priced loan represent, of all the new requirements, arguably the greatest potential litigation risk for lenders. Higher-priced loans are subject to the same repayment ability rules as high-cost loans.¹⁹ However, those rules have now been dramatically altered by the Fed.

Of greatest significance, the Fed has eliminated the “pattern or practice” language previously found in Section 226.34(a)(4). Now, an individual borrower can establish a violation of the repayment ability provision for both higher-priced and HOEPA high-cost loans, without having to prove that the lender has a pattern or practice of not considering repayment ability. What makes this change so striking is that the pattern or practice language was not the Fed’s creation. Rather, Congress included the language in HOEPA.²⁰ The Fed thus effectively eliminated a statutory predicate that a borrower heretofore had to meet in order to establish liability. The Fed apparently believes that it has the authority to do this under Section 129(l)(2), which permits the Fed to prohibit acts or practices in connection with mortgage loans that it deems unfair or deceptive.²¹

In addition, under the current version of Section 226.34(a)(4), if the lender has a pattern or practice of not verifying repayment ability (assuming the lender is making high-cost loans at all), it creates only a rebuttable presumption of noncompliance. However, under the Final Rule, a lender has an affirmative obligation for both high-cost and higher-priced loans to verify repayment ability, and receives a rebuttable presumption of compliance with Section 226.34(a)(4) if it:

• verifies repayment ability in the manner set forth in the regulation;
• determines repayment ability by using the largest payment of principal and interest scheduled during the first seven years of the loan and taking into account current obligations and mortgage-related obligations; and
• uses in its assessment of repayment ability either a debt-to-income calculation or a residual income calculation.²²

The Final Rule also gives more specific instructions on how repayment ability must be verified in order for the lender to receive a presumption of compliance. Income and assets must be verified by use of IRS records, payroll receipts, financial institution records or other third-party documents (the Fed specifically rejected calls to exempt loans to self-employed individuals).²³ Current obligations must also be verified.²⁴ The Fed also provides a very narrow affirmative defense for a lender that did not properly verify income and assets, but can show that it used income and asset figures that were not “materially greater” than those that would have been used had such information been properly verified.²⁵

The Official Staff Commentary to Section 226.34 has also been extensively amended to provide additional information on how repayment ability may be verified, and should be carefully consulted. That being said, these new rules raise several unanswered questions about the extent to which a lender’s assessment of repayment ability will suffice in any particular case, which, in turn, increases litigation risk. For instance, while a lender must consider either the debt-to-income ratio or the amount of residual income in order to obtain the presumption of compliance, the Fed does not offer any guidance on what appropriate debt-to-income and residual income guidelines would look like. Presumably, a borrower can rebut the presumption by arguing that the lender’s debt-to-income ratio or residual income guidelines were too high.

Further, because the Fed has used its authority under Section 129(l) of TILA to promulgate its repayment ability rule, it appears that a violation will subject a lender both to the normal statutory penalty applicable to closed-end mortgage loans (as now increased by HERA), as well as the enhanced HOEPA penalty equal to the sum of all finance charges and fees paid by the consumer.²⁶ If there is any bright side to the new repayment ability rule it is that, like the former rule, it does not create an extended rescission right for a violation.

B. Prepayment Penalties

1. New Prepayment Penalty Restrictions

The Final Rule also amends the existing prepayment penalty restrictions for high-cost loans and adds new restrictions for higher-priced loans. For high-cost loans, the maximum duration for which a prepayment penalty can be in effect has been reduced from five years to two years after consummation.²⁷ In addition, a new restriction has been added which prohibits a high-cost loan from having a prepayment penalty if the amount of the periodic payment of principal, interest, or both can change at any time during the first four years following consummation.²⁸

As with high-cost loans, for a higher-priced loan the maximum duration for which a prepayment penalty can be in effect is limited to two years after consummation, and no prepayment penalty can be charged if the amount of the periodic payment of principal, interest, or both can change at any time during the first four years following consummation. Also like high-cost loans, a prepayment penalty in connection with a higher-priced loan may not be charged if the source of the prepayment funds is a refinancing by the lender or the lender’s affiliate.²⁹ The Fed declined to extend to higher-priced loans the high-cost loan prohibition on charging a prepayment penalty in cases where the consumer’s debt-to-income ratio exceeds 50%. However, given the new repayment ability rules, use of ratios above 50% may cause other problems for lenders making higher-priced loans.

2. Expanded Rescission Right

The Fed also amended footnote 48 of Section 226.23 to provide that a higher-priced loan that does not comply with the prepayment penalty provisions in Section 226.35 is subject to the extended right of rescission. However, the Fed was careful to note that this language is not intended to expand the universe of loans subject to rescission (e.g., while a higher-priced purchase money loan secured by the consumer’s principal dwelling is subject to Section 226.35, it is not subject to rescission under Section 226.23).³⁰ As with the repayment ability rules, the prepayment penalty rules are promulgated under the Fed’s authority in Section 129(l). Thus, a violation will appear to subject a lender both to the normal statutory penalty applicable to closed-end mortgage loans, as well as the enhanced HOEPA penalty equal to the sum of all finance charges and fees paid by the consumer.

Given the risk of both rescission and a potentially substantial financial penalty, there is a potential trap for lenders that bears mention. The limitations on when a higher-priced loan may contain a prepayment penalty are prefaced in the regulation by the phrase “[u]nder the terms of the loan.”³¹ While this same phrase is found in the high-cost loan prepayment penalty restrictions in Section 226.32(d)(7), it has been paid little attention, as most lenders have studiously avoided making high-cost loans.

Now, with the higher-priced loan triggers likely to capture all subprime and many alternative-A loans, this phrase merits closer attention. The terms of the loan documents will clearly reveal two of the three requirements allowing a higher-priced loan to have a prepayment penalty–that the penalty be in effect only for the first two years of the loan and that the loan payments be fixed for at least the first four years. However, given the phrase “under the terms of the loan,” it would seem that the third requirement must also be specifically disclosed–that the borrower will not have to pay the prepayment penalty if, during the first two years, the loan is refinanced with the same lender or the lender’s affiliate.

C. Escrow Accounts

The final requirement in Section 226.35 applies only to first lien higher-priced loans and requires that an escrow account be established for property taxes and premiums for mortgage-related insurance required by the lender, such as hazard, liability and credit insurance.³² Keep in mind that while the definition of a higher-priced loan is limited to a loan that secures the consumer’s principal dwelling, the term “dwelling” includes structures that may be considered personal property under state law, such as mobile homes, boats and trailers when used as the consumer’s principal dwelling.³³

Note also that the escrow requirement applies only to mortgage-related insurance that is “required” by the lender. Thus, premiums for optional insurance products obtained by the consumer need not be escrowed.³⁴ The Fed has also exempted from the escrow requirements loans secured by shares in a cooperative. In addition, for loans secured by condominiums, insurance premiums need not be escrowed where the condominium association has an obligation to maintain a master policy to insure the units. A lender or servicer may allow a consumer to cancel an escrow account, but only by a dated written request that is received by the lender or servicer no earlier than 365 days after closing.³⁵

This provision was also promulgated under Section 129(l) of TILA; therefore, a violation would appear to subject a lender to liability for the enhanced HOEPA penalties. However, a violation will not extend the rescission period.

The escrow requirements are effective for applications received on or after April 1, 2010, with an additional delayed effective date of October 1, 2010 for applications for loans secured by manufactured housing.³⁶

IV. Appraisal and Servicing Practices

The Fed has added a new Section 226.36 to address perceived abuses in mortgage loan servicing and the appraisal process. The prohibitions in this section apply to any closed-end mortgage loan subject to TILA and secured by the consumer’s principal dwelling, regardless of pricing or loan purpose. Each of the prohibitions described below are established pursuant to the Fed’s authority under Section 129 of TILA to prohibit unfair or deceptive mortgage loan practices. Thus, a lender that violates any of these provisions may be subject to both a statutory penalty and the enhanced HOEPA damages. But note that other parties that violate these rules (such as brokers and servicers) are not subject to TILA’s private right of action provisions, although state and federal authorities may seek penalties.

Section 226.36(b) prohibits any lender, mortgage broker or affiliate of a lender or mortgage broker from coercing, influencing or encouraging an appraiser to misstate the value of the dwelling. The regulation gives several examples of conduct permitted and prohibited by the regulation.³⁷ For instance, an appraiser may not be excluded from consideration for future engagements because the appraiser reports a value that does not meet or exceed a minimum threshold. However, it is not a violation to ask an appraiser to consider additional information about the dwelling or comparable properties or to asking an appraiser to correct factual errors.

In addition, a lender cannot extend credit if the lender knows, at or before closing, that improper coercion has occurred (either by a broker or the lender’s employees or an affiliate of either) unless the lender can document that it has acted with reasonable diligence to determine that the appraisal does not materially misstate or misrepresent the dwelling’s value.

Section 226.36(c)(1) also prohibits several servicing practices. First, a servicer must credit a payment as of the date of receipt, unless the delay results in no adverse consequences to the consumer (e.g., no negative reporting to a consumer reporting agency). However, if a servicer specifies payment requirements in writing, such as cut-off times or a specific address for payments, but accepts a nonconforming payment, the servicer must credit the payment as of five days after receipt.

Several industry commenters on the proposed rule asked the Fed not to require the crediting of partial payments because it would contradict the terms of uniform loan documents currently in use. For instance, under the terms of the standard Fannie Mae mortgage, a lender has the option to apply or return a partial payment. To allay industry concerns, the Fed added Comment 2 to 226.36(c)(1)(i), which clarifies that payments should be credited in accordance with the legal obligation between the lender and the consumer.³⁸

Second, pyramiding of late fees is prohibited. This is similar to the existing “Credit Practices Rule” under the FTC Act, 15 U.S.C. § 45. However, the Fed believed that exercising its authority under Section 129 of TILA to promulgate a parallel provision in Regulation Z was important because it allows state attorneys general to bring enforcement actions.³⁹

Finally, Section 226.36(c)(1) requires a servicer to provide, within a reasonable period of time, statements showing the payoff amounts as of a specified date in time.

V. Advertising

The Final Rule also makes certain amendments to the advertising disclosures, most of which specifically target home equity lines of credit (“HELOCs”) and closed-end mortgage loans. In addition, the Final Rule prohibits seven different practices in connection with all closed-end (but not open-end) mortgage loans subject to TILA.

A. HELOC Advertising

1. Balloon Payments

The existing balloon payment disclosure for HELOC advertisements has been clarified. First, if a disclosed minimum periodic payment could result in a balloon if only the minimum payment were made, the advertisement must state with equal prominence and in close proximity to the disclosed minimum payment that a balloon may result. Second, the amendments clarify that a balloon payment results in any case where paying the minimum payment does not fully amortize the outstanding balance by a specified time, and the consumer is required to repay the outstanding balance at that time. Finally, existing language in the Commentary has been moved to the regulation to the effect that if a balloon payment is certain to occur if the consumer makes only the minimum payment and a minimum payment is stated in the advertisement, it must be disclosed with equal prominence and in close proximity to the disclosed minimum payment that a balloon will (rather than may) result, and the advertisement must also state the amount and timing of the balloon payment that will result if the consumer makes only the minimum payments for the maximum period of time allowed.⁴⁰

2. Promotional Rates and Payments

The Fed has also increased the disclosure requirements for HELOC advertisements that contain promotional rates or payments by adding a new Section 226.16(d)(6). A “promotional rate” in a variable rate plan is any APR that is not based on the index and margin that will be used to make rate adjustments under the plan, provided that that rate is less than a reasonably current APR that would be in effect under the index and margin that will be used to make adjustments.⁴¹ A “promotional payment” in the case of a variable rate plan is any minimum payment applicable to a promotional period that is not derived by applying to the balance the index and margin that will be used to determine other minimum payments and is less than other minimum payments derived by applying a reasonably current index and margin that will be used to determine the amount of such payments, given an assumed balance. For a fixed-rate plan, a promotional payment is any minimum payment applicable for a promotional period that is less than other payments required under the plan given an assumed balance.

If a HELOC advertisement (other than television or radio advertisements) states a promotional rate and/or a promotional payment, the following information must be disclosed in a clear and conspicuous manner and with equal prominence and in close proximity to each listing of the promotional rate or payment:

• the period of time during which the promotional rate or payment will apply;
• in the case of a promotional rate, any APR that will apply under the plan; and
• in the case of a promotional payment, the amounts and time periods of any payments that will apply under the plan (this could require disclosure of several payment amounts).⁴²

B. Closed-End Mortgage Advertising Changes

1. Rate or Payment Amounts

Similarly, the Fed has added a new Section 226.24(f) which applies to advertisements (other than television or radio advertisements) for closed-end credit secured by the consumer’s dwelling. However, you will note that this provision applies whenever specific rate or payment amounts are advertised. They need not be promotional rates or payments, as under Section 226.16(d)(6). If an advertisement for a closed-end mortgage loan states a simple annual rate of interest and more than one rate will apply over the term of the loan, the advertisement must also disclose with equal prominence and in close proximity to the advertised rate:

• each simple annual rate of interest that will apply (in a variable-rate transaction a reasonably current index and margin must be used.);
• the period of time during which each simple annual rate of interest will apply; and
• the APR for the loan.⁴³

If the advertisement states the amount of any payment, the advertisement must also state with equal prominence and in close proximity to such payment:

• the amount of each payment that will apply over the term of the loan, including any balloon payment (In a variable rate transaction a reasonably current index and margin must be used.); and
• the period of time during which each payment will apply.⁴⁴

In addition, an advertisement for a first lien mortgage loan that states the amount of any payment must also state prominently (but not with equal prominence) and in close proximity to the advertised payment that the payments do not include amounts for taxes and insurance, if applicable, and that the actual payment amount will be higher.⁴⁵

2. Additional Restrictions on Closed-End Mortgage Advertisements

The Final Rule also adds a new Section 226.24(i), which prohibits certain advertising practices in connection with closed-end mortgage loans (but not HELOCs). Significantly, unlike the advertising disclosure amendments discussed above, the prohibitions in Section 226.24(i) are promulgated pursuant to the Fed’s authority under Section 129(l) of TILA.⁴⁶ Thus, a violation of these rules would appear to subject a lender to the enhanced HOEPA damages.

a. Use of the Term “Fixed”

Section 226.24(i)(1) sets rules for using the term “fixed” to refer to rates, payments or the credit transaction in any advertisement for a variable-rate transaction or other transaction where the payments will increase. In an advertisement solely for a variable-rate transaction, the terms “Adjustable-Rate Mortgage,” “Variable-Rate Mortgage,” or “ARM” must appear before the first use of the word “fixed” and must be at least as conspicuous, and each use of the word “fixed” to refer to a rate or payment must be accompanied by an equally prominent and closely proximate statement of the time period for which the rate or payment is fixed and that the rate can vary or the payment can increase after that period.

Similarly, in an advertisement solely for a non-variable rate transaction where the payment will increase, each use of the word “fixed” to refer to the payment must be accompanied by an equally prominent and closely proximate statement of the time period for which the payment is fixed and that the payment can increase after that period.

Finally, for advertisements that promote both variable-rate and non-variable-rate transactions in the same advertisement, the terms “Adjustable-Rate Mortgage,” “Variable-Rate Mortgage,” or “ARM” must appear with equal prominence as any use of the term “fixed,” “Fixed-Rate Mortgage” or similar. In addition, any use of the term “fixed” to refer to a rate, payment or the transaction must clearly refer only to the transactions for which rates are fixed, and, if used to refer to a payment, is accompanied by an equally prominent and closely proximate statement of the time period for which the payment is fixed and that the payment can increase after that period. Similarly, if the term “fixed” refers to a variable rate transaction it must be accompanied by an equally prominent and closely proximate statement of the time period for which the rate or payment is fixed, and that the rate can vary or the payment can increase after that period.

b. Payment and Rate Comparisons

Section 226.24(i)(2) prohibits an advertisement from making any comparison between actual or hypothetical payments or rates and a “teaser” payment or simple annual rate that will be available for the advertised product unless:

• the advertisement includes a clear and conspicuous comparison to the information required to be disclosed under Section 226.24(f)(2) and (3), discussed above; and
• for a variable rate transaction where the advertised payment or simple annual rate is based on the index and margin used to make subsequent rate or payment adjustments, the advertisement includes an equally prominent statement in close proximity to the payment or rate that the payment or rate is subject to adjustment and the time period when the first adjustment will occur.

c. Other Prohibitions

Finally, new Sections 226.24(i)(3)-(7) prohibit: misrepresentations about a loan product being government endorsed; any misleading use of the current lender’s name in the advertisement; misleading claims of debt elimination; using the term “counselor” in any advertisement to refer to a for-profit mortgage broker or lender; and, for a foreign language advertisement, providing information about some trigger terms or required disclosures in a foreign language, while providing information about other trigger terms or required disclosures only in English.

C. Other Advertising Changes

The Fed has amended the Official Staff Commentary to both Section 226.16 and Section 226.24 to give examples of how the general “clear and conspicuous” standard can be met in certain contexts, such as for internet, television and oral advertisements.⁴⁷ In addition, recognizing the time constraints inherent in television and radio advertisements, the Fed has added provisions permitting more limited advertising disclosures, so long as the disclosures are accompanied by a telephone number that the consumer may call to obtain additional cost information.⁴⁸

For both HELOCs and closed-end mortgage loans secured by the consumer’s principal dwelling, the Fed has also added provisions implementing one of the amendments to TILA made by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. In the case of a paper or internet advertisement (but not radio or television ads) for a HELOC or closed-end loan secured by the consumer’s principal dwelling in which the advertisement states (and not just implies) that the credit may exceed the fair market value of the dwelling, the advertisement must clearly and conspicuously state that the interest on the portion of the credit extension that is greater than the fair market value of the dwelling is not tax deductible and that the consumer should consult a tax advisor.⁴⁹

VI. Conclusion

With the HERA and Final Rule effective dates on the horizon (as well as expected final regulations coming out of the Proposed Rule), lenders now should be focusing of how they can come into (and remain in) compliance with the new requirements. Prudent steps include:

• making sure that your origination platform can generate early TILA disclosures for a broader class of closed-end mortgage loans than currently required;
• discussing with your vendor for high-cost loan compliance whether it will provide a similar service for “higher-priced” mortgage loans;
• making sure that you have the systems in place to comply with the requirements for “higher-priced” mortgage loans (i.e., repayment ability verification, prepayment penalty restrictions, and escrow accounts for most first lien loans);
• understanding what activities may violate the prohibition on appraisal coercion;
• if servicing closed-end mortgage loans, assessing your servicing practices to make sure that they are compliant with the new servicer rules;
• carefully reviewing the new advertising rules for both HELOCs and closed-end mortgage loans, which impose significant new disclosure requirements where the advertisement states certain key loan terms; and
• ensuring that your advertisements for closed-end mortgage loans do not violate any of the new prohibited acts or practices (e.g., misleading rate or payment comparisons, misleading use of the term “fixed,” etc.).

We regularly advise clients on TILA, HOEPA and Regulation Z compliance. Please call us if we can assist you in implementing the policies, procedures and system changes that will be needed under these new rules.

1. See 73 Fed. Reg. 44522 (July 30, 2008).
2. Pub. L. No. 110-289, 122 Stat. 2654.
3. On December 5, 2008 the Fed announced proposed changes to Regulation Z that would conform it to the HERA amendments (“Proposed Rule”). As of this writing, the Proposed Rule is not available in the Federal Register but can be obtained on the Fed’s website.
4. HOEPA is the 1994 amendment to TILA which added the “high-cost” mortgage provisions. Section 129 permits the Fed to prohibit unfair or deceptive mortgage loan practices. See 15 U.S.C. § 1639(l)(2).
5. See 15 U.S.C. § 1640(a)(4).
6. See 12 C.F.R. § 226.17(b).
7. Similarly, Section 226.19(b) requires that a consumer receive early program disclosures for a variable-rate mortgage loan secured by the consumer’s principal dwelling.
8. See 12 C.F.R. § 226.19(a)(1)(ii), (iii).
9. This last change was required by an amendment to HERA contained in the Emergency Economic Stabilization Act of 2008, which was enacted in October, 2008.
10. But note that HERA’s provisions for variable rate and payment transactions do not become effective until a compliance date specified by the Fed or January 30, 2011, whichever is earlier.
11. See, e.g., 15 U.S.C. § 1639 and 12 C.F.R. §§ 226.31, 226.32 and 226.34.
12. Compare 12 C.F.R. § 226.35(a)(1) with 12 C.F.R. § 226.32(a)(1).
13. See 12 C.F.R. § 226.35(a)(3); see also 73 Fed. Reg. at 44537-39.
14. See 12 C.F.R. § 226.35(a)(2).
15. On October 24, 2008, the Fed also finalized amendments to Regulation C under the Home Mortgage Disclosure Act, under which the same standard will be used to determine whether a loan’s rate spread must be reported on a financial institution’s Loan Application Register. See 73 Fed. Reg. 63329 (Oct. 24, 2008).
16. See 12 C.F.R. § 226.35(a)(1).
17. See Official Staff Commentary, § 226.35(a)(2)-3.
18. See 12 C.F.R. § 226.35(b).
19. See 12 C.F.R. §§ 226.35(b)(1) and 226.34(a)(4). Note also that, virtually by definition, any loan that trips one or both of the “high cost” triggers will almost certainly trip the applicable “higher-priced” trigger.
20. See 15 U.S.C. § 1639(h).
21. See 15 U.S.C. § 1639(l)(2).
22. See 12 C.F.R. § 226.34(a)(4)(iii). However, two types of loans may not take advantage of the presumption of compliance – loans where the regular payment for the first seven years would cause the principal balance to increase and loans where the term is less than seven years and the regular periodic payments when aggregated do not fully amortize the outstanding principal balance. See 12 C.F.R. § 226.34(a)(4)(iv).
23. See 73 Fed. Reg. at 44547-48).
24. See 12 C.F.R. § 226.34(a)(4)(ii)(A), (C).
25. See 12 C.F.R. § 226.34(a)(4)(ii)(B).
26. See 15 U.S.C. § 1640(a)(2), (4).
27. This is another example of the Fed imposing a more restrictive standard than is found in the statute. See 15 U.S.C. § 1639(c)(2)(C).
28. See 12 C.F.R. § 226.32(d)(7)(i), (iv).
29. See 12 C.F.R. § 226.35(b)(2)(ii).
30. See 73 Fed. Reg. at 44551.
31. 12 C.F.R. § 226.35(b)(2)(ii).
32. See 12 C.F.R. § 226.35(b)(3).
33. See, e.g., Official Staff Commentary, § 226.35(b)(3)(i)-1.
34. See Official Staff Commentary, § 226.35(b)(3)(i)-3.
35. See 12 C.F.R. § 226.35(b)(3)(ii), (iii).
36. See Official Staff Commentary, § 226.1(d)(5)-1.
37. See 12 C.F.R. § 226.36(b).
38. See 73 Fed. Reg. at 44571-72.
39. See id. at 44572; see also 15 U.S.C. § 1640(e).
40. See 12 C.F.R. § 226.16(d)(3).
41. In the Supplemental Information the Fed notes that a promotional rate under Section 226.16(d)(6) may also be a discounted “initial rate” under Section 226.16(d)(2) when it is the first rate in effect. However, the term “promotional rate” can also cover a rate used at a later point in the plan. See 73 Fed. Reg. at 44577.
42. See 12 C.F.R. § 226.16(d)(6)(ii).
43. See 12 C.F.R. § 226.24(f)(2).
44. See 12 C.F.R. § 226.24(f)(3).
45. See id.
46. See 73 Fed. Reg. at 44586.
47. See Official Staff Commentary §§ 226.16-2 through 5 and 226.24(b)-2 through 5.
48. See 12 C.F.R. §§ 226.16(e) and 226.24(g). Section 226.24(g) applies to all closed-end credit advertisements, and not just mortgage advertisements. Section 226.16(e) applies only to HELOCs; however, the Fed intends to enact a similar rule for other kinds of open-end credit advertisements. See 73 Fed. Reg. at 44579.
49. See 12 C.F.R. §§ 226.16(d)(4) and 226.24(h).

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