I. INTRODUCTION
The Home Equity Loan Consumer Protection Act (the “Act”), enacted November 23, 1988, imposes additional disclosure requirements upon lenders in connection with home equity loans. The Federal Reserve Board of Governors has issued the implementing regulations which cover open-end credit lines which are secured by the consumer’s principal dwelling or any second or vacation home. Compliance with these regulations became mandatory, on November 7, 1989.
II. COVERAGE
The Act applies not only to a home equity line of credit secured by the consumer’s principal dwelling, but also if secured by any second or vacation home.
III. GENERAL DISCLOSURE REQUIREMENTS
Preliminary Disclosures
Lenders must provide consumers with a set of detailed “segregated” disclosures, a brochure describing HELOC’s (a Home Equity brochure published by the Federal Reserve Board or a suitable substitute) and variable rate information (if variable rate information is applicable). These “preliminary disclosures” and materials must be given to the consumer with the application for such a line of credit. The “preliminary disclosures” generally must be grouped together and separated from any unrelated information. The brochure and variable rate information may either be provided with or separately from the preliminary disclosures. There is no requirement that the preliminary disclosures be in a form that the consumer may keep, but they must be in writing. As a result, these disclosures could be placed on the application form that the consumer returns to the creditor to apply for the equity line.
Secondary Disclosures
A second set of disclosures (“secondary disclosures”) must also be provided to the consumer. These disclosures must be given to the consumer prior to the first transaction under the HELOC plan and must be provided in a form that the consumer can retain. The secondary disclosures combine the information provided in the preliminary disclosures with information currently required by Regulation Z.
IV. TIMING OF DISCLOSURES
The preliminary disclosures and brochure are required to be given at the time the application is provided to the consumer. If applications are taken over the telephone or received by mail through an intermediary, the preliminary disclosures and brochure must be mailed or delivered to the consumer within three (3) business days of receipt of the application.
The secondary disclosures are required to be given to the consumer prior to the first transaction under the HELOC plan.
V. CONTENT OF DISCLOSURES
To the extent applicable to the particular HELOC, the preliminary disclosures must contain the following information:
A. Retention of Information
Since the preliminary disclosures need not be in a form which the consumer can retain, the consumer must be advised to make and retain a copy of the disclosures. This statement is not required if the disclosures are in a form which the consumer may retain (e.g., disclosures are not a part of the application which is returned to the lender).
B. Conditions for Disclosed Terms
Creditors must also include a statement of the time by which an application must be submitted to obtain the specific terms disclosed. Any disclosed terms which are subject to change prior to opening the plan must also be identified.
The creditor must also notify the consumer of the right to a refund of all fees paid in connection with the application if any disclosed term (other than changes resulting from fluctuations in the index value in a variable-rate plan) changes prior to opening the plan and as a result the consumer chooses not to enter into the plan.
C. Security Interest and Risk to Home
Creditors must disclose that a security interest is being taken in the consumer’s dwelling and that the consumer could lose the home in the event of default.
D. Possible Actions by Creditor
1. A statement must be provided that, under certain circumstances, a creditor may terminate the plan and accelerate any outstanding balance, prohibit additional advances or reduce the credit limit or, as set forth in the initial agreement, implement modifications to the original terms of the plan. The creditor must also state if fees may be imposed upon termination of the account.
2. A statement that the consumer can receive, upon request, a list of the conditions that permit the creditor to terminate the plan, prohibit additional advances or reduce the credit limit and implement modifications during the term of the plan. Upon receiving such a request, creditors must provide this information in writing in a form which the consumer can keep.
3. In lieu of providing the information referred to under paragraph 4(b) above, the creditor may provide the lists of conditions with the preliminary disclosures. These disclosures must be distinguished in some fashion from other information contained in the document (e.g., use of a cover sheet specifically pointing out which contract provisions contain this information or by marking the relevant items).
E. Payment Terms
The creditor must describe the payment terms of the plan, including:
1. The length of the draw period and any repayment period;
2. All payment options under the plan must be stated, including any different payment terms that may exist during the draw period or during any repayment period, as well as any differences that may apply within either period;
3. Information regarding the consumer’s ability to convert any of the loan balance to a fixed term loan, if the plan permits such an option;
4. An explanation of how the minimum periodic payment is determined, the frequency of payments and whether making only the minimum payments would not repay any or all of the principal balance during the draw and repayment periods. In addition, if a balloon payment is required under the plan, this fact must be disclosed to the consumer;
5. Creditors must disclose an example, based on a $10,000 outstanding balance and a recent Annual Percentage Rate (APR), showing the minimum periodic payment and any balloon payment and the time it would take to pay off the balance if the consumer made only these payments;
F. Annual Percentage Rate for Fixed Rate Plans
A recent APR would have to be provided and consumers must be told that the APR does not include costs other than interest.
G. Fees Imposed by Creditor
Creditors must provide a description and the amount of charges required to open and use the account and a statement of when the consumer must pay the charges. These charges may be stated as an estimated dollar amount for each fee or as a percentage of a hypothetical amount of credit. These fees include items such as; application fees, points, annual fees and transaction fees.
H. Fees Imposed by Third Parties
A good faith estimate of fees imposed by third parties must be provided to the consumer. These fees may be stated as a single dollar amount or range. The consumer must also receive a statement that the consumer may request more specific information about such fees from the creditor.
I. Negative Amortization
A statement must be provided indicating that negative amortization may occur and that such negative amortization increases the principal balance and reduces the consumer’s equity in the dwelling.
J. Transaction Requirements
Creditors must state any limitations on the number of extensions or amount of credit that can be obtained during any time period as well as any minimum draw or minimum outstanding balance requirement stated as a dollar amount or as a percentage.
K. Tax Implications
Consumers must be advised to consult a tax advisor regarding the deductibility of interest and charges under the plan.
L. Variable Rate Disclosures
For a plan in which the APR is variable, the following disclosures, as applicable, must be provided:
1. The fact that the APR may change and that the payment or term may change due to the fact that the APR is variable.
2. The frequency of changes in the APR.
3. Identification of the index used to determine rate adjustments and a source of information about the index.
4. Description of how the APR will be determined, including an explanation of how the index is adjusted, such as by the addition of a margin.
5. Consumers must be advised to “ask about” the current index value, margin and APR.
6. Any rules relating to changes in the index values, resulting changes in the APR and resulting changes in the payment amount, including for example, a preferred rate provision where the rate will increase upon the occurrence of some event, such as an employee leaving the creditor’s employ.
7. An explanation if the plan permits the consumer to convert from a variable rate plan to a fixed rate.
8. A statement of any annual or more frequent periodic limitations on changes in the APR (or a statement that no annual limitation exists), as well as a statement of the maximum APR that may be imposed under each payment option.
9. Creditors must show the minimum periodic payment based on any $10,000 outstanding balance, if the maximum rate is in effect, and a statement of the earliest date or time the maximum rate may be imposed.
10. The consumer must be provided with an historical example, based on an assumed $10,000 extension of credit, showing how APR and payments would have been effected by the index value changes under the terms of the plan. The historical example shall be based on the most recent fifteen years of index values (selected for the same time period each year) unless values for an index have not been available for fifteen years, in which event, creditors would need only go back as far as the values have been available. The historical example must reflect all significant loan program terms, such as rate and payment caps, a discounted APR, negative amortization and interest carryover.
11. A statement that rate information will be provided on or with each periodic statement.
VI. LIMITATIONS ON CREDITORS
Creditors must be aware that the new Act and regulations limit the creditor’s ability to change the APR, terminate an HELOC plan or change the terms of the HELOC plan.
A. A creditor may not change the Annual Percentage rate unless: (a) The change is based on an index outside the creditor’s control; and (b) Such index is available to the general public.
B. A creditor may not terminate a plan and accelerate payment of the outstanding balance prior to the scheduled expiration of the plan unless: (a) There has been fraud or material misrepresentation by the consumer in connection with the plan; (b) The consumer has failed to meet the repayment terms of the agreement; or (c) The consumer acts or fails to act in a way that adversely effects the creditor’s security interest.
C. The creditor may not unilaterally change the terms under the plan after the account has been opened unless: (a) The initial agreement provides that specified changes will occur if specific events take place (e.g., the contract provides that a specified higher rate will apply if the borrower’s employment ends); (b) The specific changes are agreed to by mutual written agreement; (c) Changes are made to “insignificant terms” of the plan; (d) The creditor may change the index and margin used under the plan if original index becomes unavailable, as long as historical fluctuations in the two indices were substantially similar and as long as the new index and margin would have resulted in a rate similar to the rate that was in effect at the time the original index became unavailable; or (e) Changes are made which “unequivocally benefit” the consumer throughout the remainder of the plan.
D. The creditor may prohibit additional extensions of credit or reduce the credit limit in the following circumstances: (a) The value of the dwelling that secures the plan declines significantly below the property’s appraised value for purposes of the plan; (b) The creditor reasonably believes the consumer will be unable to fulfill the repayment obligations under the plan due to a material change in the consumer’s financial circumstances; (c) The consumer is in default of any material obligation under the agreement; (d) Action by a governmental body either precludes the creditor from imposing the agreed upon APR or adversely effects the priority of the creditor’s security interest to the extent that the value of the security is less than 120% of the amount of the credit line; (e) A regulatory agency has notified the creditor that continued advances would constitute an unsafe and unsound practice; and (f) The maximum APR is reached. (Provided that initial agreement allows the creditor to prohibit additional extensions of credit or reduce the credit limit under this circumstance.)
VII. PRECEDENCE OF DISCLOSURES
Certain preliminary disclosures, if applicable, must be highlighted by requiring them to proceed the other disclosures. The disclosure statements which must be given “precedence” in the preliminary disclosures are as follows:
A. A warning to the consumer to keep a copy of the disclosures;
B. The right of the consumer to obtain a refund of fees if any terms change and they decide not to enter into the contract as a result;
C. The risk of loss of the dwelling in the event of a default of the consumer; and
D. The right of a creditor to terminate a plan or suspend future advances under certain circumstances.
The “precedence rule” set forth above applies only to the preliminary disclosures and is not required when making the secondary disclosures.
VIII. CONCLUSION
As you can tell from the foregoing information, the disclosure requirements for HELOCs have become more complicated with passage of the 1988 Act. For your assistance in complying with these disclosure requirements, the model forms and clauses can be found by going to the CFPB website (www.consumerfinance.gov) and searching for "Appendix G to Part 1026."