I. INTRODUCTION
The Federal Reserve Board (“Board”) has issued an interim rule requiring lenders to disclose how borrowers’ closed-end mortgage loan payments can change due to adjustable rates, features like balloon payments or other variables, such as making only the minimum payment.
The rule, which implements provisions of the Mortgage Disclosure Improvement Act, requires lenders extending consumer credit secured by real property or a dwelling, other than a transaction secured by a consumer’s interest in a time share plan, to include certain information in a tabular format. The compliance date for the interim rule was January 30, 2011. Compliance with its provisions was optional, however, for transactions for which an application for credit was received by the creditor before October 1, 2011.
II. MORTGAGE PAYMENT DISCLOSURES
Under this interim rule, creditors will be required to disclose in a tabular format the contract interest rate together with the corresponding monthly payment, including any escrows for taxes and property and/or mortgage insurance. Special disclosure requirements are imposed for adjustable-rate or step-rate loans to show the interest rate and payment at consummation, the maximum interest rate and payment at any time during the first five years after consummation, and the maximum interest rate and payment possible during the life of the loan. Additional special disclosures are required for loans with negatively-amortizing payment options, introductory interest rates, interest-only payments, and balloon payments. Finally, the interim rule requires the disclosure of a statement that there is no guarantee the consumer will be able to refinance the loan with a new transaction in the future.
A. Interest Rate and Payment Summary Tables
The information required to be disclosed (contract interest rate and the periodic payment) must be in the form of a table, substantially similar to Model Clauses H-4(E)-(H) in Appendix H. Comments to the interim rule clarify that a disclosure that does not include the shading shown in a model clause but otherwise follows the model clause’s headings and format is substantially similar to that model clause.
Specifically, creditors must provide “examples of adjustments to the regular required payment on the extension of credit based on the change in the interest rates specified by the contract for such extension of credit."
Among the examples required . . . "is an example that reflects the maximum payment amount of the regular required payments on the extension of credit, based on the maximum interest rate allowed under the contract . . .”
These examples must be in conspicuous type size and format and the payment schedule must be labeled “Interest Rate and Payment Summary.”
The interim final rule requires creditors to disclose the contract interest rate, regular periodic payment, and balloon payment if applicable. For adjustable-rate or step-rate amortizing loans, up to three interest rates and corresponding periodic payments are required, including the maximum possible interest rate and payment. If payments are scheduled to increase independent of an interest-rate adjustment, the increased payment must be disclosed. Payments for amortizing loans must separately itemize an estimate of the amount for taxes and insurance if the creditor will establish an escrow account. If a borrower may make one or more payments of interest only, all payment amounts disclosed must be itemized to show the amount that will be applied to interest and the amount that will be applied to principal. Special rate and payment disclosures are required for loans with negative amortization. Creditors must provide the information about interest rates and payments in the form of a table, and creditors are not permitted to include other, unrelated information in the table. The table must be in a minimum 10-point font to ensure that it is clear and conspicuous.
The interim rule prescribes the number of interest rates and payments that may be shown in the table. The number of columns and rows for the table required will vary depending on whether the loan is an amortizing loan and whether it has an adjustable rate. In all cases, the tables must have no more than five columns across, to avoid information overload for consumers. Creditors may not include information in the table that is not required. Model clauses are provided in Appendix H.
III. INTEREST RATES
A. Amortizing Loans
The interim final rule requires disclosure of interest rates for amortizing loans. For a fixed-rate mortgage with no scheduled payment increases or balloon payments, the creditor discloses only one interest rate. Fixed-rate loans with payment increases require the creditor to disclose the interest rate along with each payment increase, even if the interest rate does not change.
B. Fixed Rate Mortgages
For fixed-rate mortgages, creditors must disclose the interest rate applicable at consummation. If the transaction does not provide for any payment increases, only one interest rate is disclosed. Some fixed rate mortgages, however, have scheduled payment increases. In those cases the creditor must show the interest rate associated with such payments, even though the rate has not changed.
C. Adjustable-Rate Mortgages and Step-Rate Mortgages
The interim final rule requires creditors to disclose examples of payment increases, including the maximum possible payment, for adjustable-rate mortgages and other mortgages where payments may vary. Creditors must disclose more than one interest rate for adjustable-rate mortgages and step-rate mortgages because the payments can vary.
Creditors must base their disclosures on the first five years after the first regular periodic payment due date, rather than the first five years after consummation. This provision is intended to ensure the disclosures are consistent with the manner in which payments are typically structured for adjustable-rate transactions that are “five/one ARM” loans.
D. Interest Rates at Consummation
The creditor must provide the interest rate at consummation and the period of time until the first adjustment, labeled as “introductory rate and monthly payment.”
E. Maximum Rate During First Five Years
The creditor must disclose the maximum possible rate at any time during the first five years after consummation, even if that is not the first adjustment, and the earliest date that rate may apply. If the interest rate may reach the maximum possible during the loan’s term within the first five years, the creditor should disclose the rate as the maximum possible interest rate, discussed below.
F. Maximum Possible Interest Rate
Creditors must disclose the maximum interest rate that could apply at any time, and the earliest date on which that rate could apply. The Board is requiring this disclosure for step-rate mortgages as well, because the rate and payment may increase in such loans.
If an amortizing adjustable-rate mortgage has intermediate limitations on interest rate increases, then the table required will have at least three columns; if the transaction has no intermediate limitations on interest rates, then the table will have two columns, one showing the rate at consummation and the other showing the maximum possible under the loan’s terms.
G. Interest Rate Applicable at Scheduled Payment Increase
Some mortgages provide for a payment increase that is not attributable to an interest rate adjustment or increase. For example, a loan may permit the borrower to make payments that cover only accrued interest for some specified period, such as the first five years following consummation; at the end of the interest-only period, the borrower must begin making larger payments to cover both interest accrued and principal. Where such a payment increase will not coincide with an interest rate adjustment, the creditor must include a column that discloses the interest rate that would apply at the time the adjustment is scheduled to occur, and the date on which the increase would occur. Thus, for a fixed-rate mortgage, the creditor shows the same interest rate twice.
The same is true for adjustable-rate mortgages and step-rate mortgages. For example, some adjustable-rate mortgages permit the borrower to make interest-only payments for a specified period, such as the first five years following consummation. A scheduled payment increase may or may not coincide with a scheduled interest rate adjustment. If a scheduled payment increase does not coincide with an interest rate adjustment (or rate increase for a step-rate mortgage), creditors must include a column that discloses the interest rate that will apply at the time of the increase, the date the increase is scheduled to occur, and an appropriate description such as “first increase” or “first adjustment,” as appropriate.
H. Negative Amortization Loans
For negative amortization loans, for which any scheduled payment may cause the principal balance to increase, disclosure of the interest rate applicable at consummation is required. Some ARM loans do not provide any limitations on interest rate increases (“interest rate caps”); the only cap is the maximum possible interest rate required. For these payment option loans, the creditor must disclose the interest rate in effect at consummation and assume that the interest rate reaches the maximum at the next adjustment - often the second month after consummation. The creditor must disclose that rate for the first and second scheduled payment increases. And the creditor must disclose that rate a third time, in the last column, when the loan has recast, i.e., converted to fully amortizing payments over the remainder of the loan’s term.
The definition of “negative amortization loan” excludes loan products that do not have a minimum required payment that results in negative amortization. For example, some loans that are designed for borrowers with seasonal employment require level, amortizing payments, but do not require payments in certain months; during months when no payment is made the accrued interest increases the loan balance. Special disclosure requirements for negative amortization loans do not apply to the excluded loans, even though some negative amortization can occur because of the capitalization of accrued interest from time to time. Such loans will be disclosed under the rules for amortizing loans.
I. Introductory Rate Disclosure for Amortizing Adjustable-Rate Mortgages
Many adjustable-rate mortgages have an introductory or “teaser” rate, set below the sum of the index and margin used for later adjustments. A special disclosure of any introductory rate is required. In consumer testing conducted for the Board, many participants did not understand the ramifications of an introductory interest rate. Participants understood that if market interest rates increased, the interest rate and payment on their loan would increase. In contrast, participants did not understand that, if they had an introductory rate, their interest rate and payment would increase when the introductory rate expired, even if market interest rates did not increase.
The Board is requiring an explanation of the introductory rate below the table itself. Disclosure of the introductory rate, how long it will last, and that the interest rate will increase at the first scheduled adjustment even if market rates do not increase is required. Creditors also must disclose the fully indexed rate that otherwise would apply at consummation. This disclosure must be placed in a box beneath the table, in a format substantially similar to Model Clause H-4(I).
J. Payments for Amortizing Loans
1. Principal and Interest Payments
The interim final rule requires disclosure of the principal and interest payment that corresponds to each interest rate disclosed. If all regular periodic payments include principal and interest, each disclosed payment amount must be listed in a single row in the table with a description such as “principal and interest.” Separate rules apply to amortizing loans with interest-only payments.
a) Regular Periodic Payments. For transactions where the regular periodic payment fully amortizes the loan, the payment amount including both principal and interest must be disclosed. Disclosure of the payment amount at any scheduled payment increase that does not coincide with an interest rate adjustment, and the date on which the increase is scheduled to occur is required. For example, a fixed-rate loan might have terms under which part of the scheduled payment is applied to principal for an initial period, thus it is not an interest-only loan. The amount of principal covered by such payments, however, may be insufficient to amortize the loan fully over its life. In such cases, a scheduled increase in the payment amount from such a partially amortizing payment to a fully amortizing payment would be required to be disclosed.
b) Escrows: Mortgage Insurance Premiums. If an escrow account will be established, the creditor must disclose the estimated payment amount for taxes and insurance, including any mortgage insurance. Consumer testing conducted for the Board shows that many consumers compare loans based on the monthly payment amount. The Board believes that, for consumers to understand the monthly amount they actually will be required to pay for a particular loan, information about payments for taxes and insurance is necessary.
Escrow information is included in the table to make it easier for consumers to identify whether there is an escrow account and how much of their payment applies to the escrow. Comments to the interim final rule provide guidance on how to determine the length of time for which mortgage insurance payments must be included in the estimate. The payment amount should reflect the consumer’s mortgage insurance payments until the date on which the creditor must automatically terminate coverage under applicable law, even though the consumer may have a right to request that the insurance be canceled earlier.
c) Credit Insurance. Premiums or payments for credit protection products (debt suspension contracts, debt cancellation agreements and other similar products) should not be included in the disclosed escrow amounts.
d) Total Periodic Payments. The total estimated monthly payment must be disclosed. The total estimated monthly payment is the sum of the principal and interest payments required and the estimated taxes and insurance payments required to be disclosed.
2. Interest-Only Payments
Disclosure of regular periodic payments corresponding to the amortizing loan interest rates disclosure is required. In addition, special itemization of the payment is required if the loan permits the consumer to make any interest-only payments. For each interest rate disclosed, the creditor must disclose the earliest date that rate may apply and the corresponding periodic payment. For an interest-only loan, if the corresponding payment will be applied to both accrued interest and principal, the creditor must disclose the earliest date that such payments will be required. Creditors should disclose the earliest date that the interest rate becomes effective rather than the date that the first payment is due under the new rate. These rules apply only if the loan is not also a negative amortization loan.
a) Principal and Interest Payment Itemization. If any regular periodic payment amounts will include interest but not principal, all payments for the loan must be itemized into principal and interest. For a payment that includes no principal, the creditor is required to indicate that none of the payment amount will be applied to principal. The creditor must label the dollar amount to be applied to interest “interest payment.”
b) Escrows and Total Periodic Payments. Disclosure of an estimate of the amount of taxes and insurance, including mortgage insurance, is also required as the interim final rule requires disclosure of the estimated total payment including principal, interest, taxes and insurance.
3. Payments for Negative Amortization Loans
For each interest rate disclosed for a loan with negative amortization, the creditor must disclose payments in two separate rows. One row of the table shows the fully amortizing payment for each interest rate; for purposes of calculating these payments the creditor would assume the interest rate reaches the maximum at the earliest possible date and that the consumer makes only fully amortizing payments. The other row of the table shows the minimum required payment for each rate, until the recast point. At the recast point, the minimum payment row shows the fully amortizing payment.
For purposes of the minimum payment row, creditors must assume the interest rate reaches the maximum at the earliest possible date and that the consumer makes only the minimum required payment for as long as permitted under the terms of the legal obligation. The interest rate and payment summary would display only two payment options, even if the terms of the legal obligation provide for others, such as an option to make interest-only payments. The table would show only the option to make minimum payments that would result in negative amortization, and the option to make fully amortizing payments.
a) Minimum Payment Amounts. The rule requires a disclosure of the amount of the minimum required payment applicable for each interest rate required to be disclosed and the date on which that payment becomes applicable.
b) Payment Increases. Some payment option loans do not have interest rate adjustment caps, and thus the interest rate may reach its maximum at the first interest rate adjustment. Such loans may have limits, however, on the amount that the minimum payment may increase following an interest rate adjustment. For example, a minimum payment increase may be limited by a certain percentage, such as 7.5% greater than the previous minimum payment. (Such limits are generally subject to conditions and will apply only until a specific time, such as at the fifth year of the loan, or until the loan balance reaches a certain maximum.) If adjustments in the minimum payment amount are limited such that the payment will not fully amortize the loan even after the interest rate has reached the maximum, a disclosure of the minimum payment amount at the first and second payment adjustments is required. That is, in cases where the first interest rate adjustment will be the only interest rate adjustment, but payment adjustments will continue to occur before the minimum payment recasts to a fully amortizing payment, a disclosure of up to two additional minimum payment adjustments is required.
c) Explanation of Negative Amortization. The creditor must provide a statement that the minimum payment will cover only some of the accrued interest and none of the principal and will cause the principal balance to increase.
d) Payment after Recast. The interim final rule requires disclosure of the fully amortizing payment that will be required when the loan recasts, i.e., when minimum payments no longer are permitted and fully amortizing payments are required under the terms of the legal obligation. This payment amount must reflect the maximum possible interest rate that will be applicable at that time, based on the terms of the legal obligation.
e) Fully Amortizing Payments. The fully amortizing payment, assuming that the consumer makes only fully amortizing payments beginning at consummation, must be disclosed in a separate row of the table. The fully amortizing payment row must be completed for each interest rate required to be disclosed.
4. Balloon Payments
If a loan’s terms provide for a balloon payment, the payment must be disclosed in the last row of the table rather than in a column, unless it coincides with an interest rate adjustment or other payment increase such as the expiration of an interest-only option. Payment is a balloon payment if it is more than twice the amount of other payments. If a balloon coincides with an interest rate adjustment or other payment increase, the balloon payment is disclosed in the table as that payment increase.
5. Special Disclosures for Loans with Negative Amortization
a) Statement of Balance Increase and Other Information. A statement of the amount of the increase in the loan’s principal balance if the consumer makes only minimum payments and the earliest month and year in which the minimum payment will recast to a fully amortizing payment under the terms of the legal obligation, assuming that the interest rate reaches its maximum at the earliest possible time, is required.
In addition, to help consumers navigate the information in the table, a statement must appear directly above the interest rate and payment summary table explaining that the loan offers payment options. The explanation preceding the table also must state the maximum possible interest rate and the smallest number of months or years in which the interest rate could reach its maximum.
The creditor also must disclose whether an escrow account will be established and, if so, an estimate of the amount for taxes and insurance included in each periodic payment. Comments note that mortgage insurance payments decline over a loan’s term, and the payment amounts shown in the table should reflect the mortgage insurance payment that will be applicable at the time each disclosed periodic payment will be in effect.
Accordingly, the disclosed mortgage insurance payment will be zero if it corresponds to a periodic payment that will occur after the creditor will be legally required to terminate mortgage insurance. On the other hand, because only one escrow amount is disclosed for negative amortization loans and escrows are not itemized in the payment amounts, the single escrow amount disclosed should reflect the mortgage insurance amount that will be collected as of the outset of the loan’s term.
IV. “NO-GUARANTEE-TO-REFINANCE" STATEMENT
The interim final rule requires creditors to disclose a statement that there is no guarantee that the consumer will be able to refinance the loan to obtain a lower interest rate and payment. This disclosure applies to both variable rate transactions and fixed-rate transactions secured by a dwelling, as well as transactions secured by real property without a dwelling, but does not apply to transactions secured by time share plans.