Federal Register: December 20, 2001 (Volume 66, Number 245)

DOCID: FR Doc 01-31264

Federal Reserve System

CFR Citation: 12 CFR Part 226

DOCUMENT ID: [Regulation Z; Docket No. R-1090]

NOTICE: RULES

ACTION: Truth in lending (Regulation Z):

DOCUMENT ACTION: Final rule.

SUBJECT CATEGORY:

Truth in Lending

DATES: The rule is effective December 20, 2001; compliance is mandatory as of October 1, 2002.

DOCUMENT SUMMARY:

The Board is adopting amendments to the provisions of Regulation Z (Truth in Lending) that implement the Home Ownership and Equity Protection Act (HOEPA). HOEPA was enacted in 1994, in response to evidence of abusive lending practices in the homeequity lending market. HOEPA imposes additional disclosure requirements and substantive limitations (for example, restricting shortterm balloon notes) on homeequity loans bearing rates or fees above a certain percentage or amount. The Board's amendments to Regulation Z broaden the scope of mortgage loans subject to HOEPA by adjusting the price triggers used to determine coverage under the act. The ratebased trigger is lowered by two percentage points for firstlien mortgage loans, with no change for subordinatelien loans. The feebased trigger is revised to include the cost of optional credit insurance and similar debt protection products paid at closing. The amendments restrict certain acts and practices in connection with homesecured loans. For example, creditors may not engage in repeated refinancings of their HOEPA loans over a short time period when the transactions are not in the borrower's interest. The amendments also strengthen HOEPA's prohibition against extending credit without regard to consumers' repayment ability, and enhance disclosures received by consumers before closing for HOEPAcovered loans.

SUMMARY:

Home-equity lending market—; Abusive lending practices; additional disclosure requirements and substantive limitations for certain loans; implementation; and predatory lending practices,

SUPPLEMENTAL INFORMATION

I. Background

Since the mid1990s, the subprime mortgage market has grown substantially, providing access to credit to borrowers with lessthan perfect credit histories and to other borrowers who are not served by prime lenders. With this increase in subprime lending there has also been an increase in reports of ``predatory lending.'' The term ``predatory lending'' encompasses a variety of practices. In general, the term is used to refer to abusive lending practices involving fraud, deception, or unfairness. Some abusive practices are clearly unlawful, but others involve loan terms that are legitimate in many instances and abusive in others, and thus are difficult to regulate. Loan terms that may benefit some borrowers, such as balloon payments, may harm other borrowers, particularly if they are not fully aware of the consequences. The reports of predatory lending have generally included one or more of the following: (1) Making unaffordable loans based on the borrower's home equity without regard to the borrower's ability to repay the obligation; (2) inducing a borrower to refinance a loan repeatedly, even though the refinancing may not be in the borrower's interest, and charging high points and fees each time the loan is refinanced, which decreases the consumer's equity in the home; and (3) engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrowerfor example, ``packing'' loans with credit insurance without a consumer's consent.

A. The Home Ownership and Equity Protection Act

In response to anecdotal evidence about abusive practices involving homesecured loans with high rates or high fees, in 1994 the Congress enacted the Home Ownership and Equity Protection Act (HOEPA), Pub. L. 103325, 108 Stat. 2160, as an amendment to the Truth in Lending Act (TILA), 15 U.S.C. 1601 et seq. TILA is intended to promote the informed use of consumer credit by requiring disclosures about its terms and cost. TILA requires creditors to disclose the cost of credit as a dollar amount (the ``finance charge'') and as an annual percentage rate (the ``APR''). Uniformity in creditors' disclosures is intended to assist consumers in comparison shopping. TILA requires additional disclosures for loans secured by a consumer's home and permits [[Page 65605]]
consumers to rescind certain transactions that involve their principal dwelling. TILA is implemented by the Board's Regulation Z, 12 CFR part 226.

HOEPA identifies a class of highcost mortgage loans through rate and fee triggers, and it provides consumers entering into these transactions with special protections. HOEPA applies to closedend homeequity loans (excluding homepurchase loans) bearing rates or fees above a specified percentage or amount. A loan is covered by HOEPA if (1) the APR exceeds the rate for Treasury securities with a comparable maturity by more than 10 percentage points, or (2) the points and fees paid by the consumer exceed the greater of 8 percent of the loan amount or $400. The $400 figure set in 1994 is adjusted annually based on the Consumer Price Index. The dollar figure for 2001 is $465 and for 2002 is $480. 66 FR 57849, November 19, 2001.

HOEPA is implemented in Sec. 226.32 of the Board's Regulation Z. HOEPA also amended TILA to require additional disclosures for reverse mortgages that are contained in Sec. 226.33 of Regulation Z. For purposes of this notice of rulemaking, however, the term ``HOEPA covered loan'' or ``HOEPA loan'' refers only to mortgages covered by Sec. 226.32 that meet HOEPA's rate or feebased triggers.

Creditors offering HOEPAcovered loans must give consumers an abbreviated disclosure statement at least three business days before the loan is closed, in addition to the disclosures generally required by TILA before or at closing. The HOEPA disclosure informs consumers that they are not obligated to complete the transaction and could lose their home if they take the loan and fail to make payments. It includes a few key items of cost information, including the APR. In loans where consumers have three business days after closing to rescind the loan, the HOEPA disclosure thus affords consumers a minimum of six business days to consider accepting key loan terms before receiving the loan proceeds.

HOEPA restricts certain loan terms for highcost loans because they are associated with abusive lending practices. These terms include shortterm balloon notes, prepayment penalties, nonamortizing payment schedules, and higher interest rates upon default. Creditors are prohibited from engaging in a pattern or practice of making HOEPA loans based on the homeowner's equity without regard to the borrower's ability to repay the loan. Under HOEPA, assignees are generally subject to all claims and defenses with respect to a HOEPA loan that a consumer could assert against the creditor. HOEPA also authorizes the Board to prohibit acts or practices in connection with mortgage lending under defined criteria.

B. Continued Concerns About Predatory Lending Practices

Since the enactment of HOEPA in 1994, the volume of homeequity lending has increased significantly in the subprime mortgage market. Based on data reported under the Home Mortgage Disclosure Act (HMDA), 12 U.S.C. 2801 et seq., the number of nonpurchasemoney loans made by lenders that are identified as engaging in subprime lending increased about fivefoldfrom 138,000 in 1994 to roughly 658,000 in 2000. While such lending benefits consumers by making credit available, it also raises concerns that the increase in the number of subprime loans brings a corresponding increase in the number of predatory loans.

In the past two years, various initiatives to address predatory lending have been undertaken. The Senate Banking Committee held hearings in July 2001 at which consumers and representatives of industry and consumer groups testified; the House Banking Committee held hearings in May 2000 at which the banking regulators and others testified; and bills have been introduced to address predatory lending. Several states and municipalities have enacted or are considering legislation or regulations. The Department of Housing and Urban Development and the Department of Treasury held a number of public forums on predatory lending and issued a report in June 2000. The report makes recommendations to the Congress regarding legislative action and to the Board urging the use of its regulatory authority to address predatory lending practices. Fannie Mae and Freddie Mac published guidelines last year to avoid purchasing loans that are potentially predatory; they are also making efforts to develop consumers' awareness of their credit options.

The Board has conferred with its Consumer Advisory Council and Board staff have met with other industry representatives and consumer advocates on the issue of predatory lending. In 2000, the Board held hearings in Charlotte, Boston, Chicago, and San Francisco, to consider approaches the Board might take in exercising its regulatory authority under HOEPA. The Board's hearings focused on expanding the scope of mortgage loans covered by HOEPA, prohibiting specific acts or practices, improving consumer disclosures, and educating consumers. Transcripts of the hearings can be accessed on the Board's Internet web site at http://www.federalreserve.gov/community.htm. In the notices announcing the hearings, the Board also solicited written comment on possible revisions to Regulation Z's HOEPA rules. 65 FR 45547, July 24, 2000. The Board received approximately 450 comment letters in response to the notices, twothirds of which were from consumers generally encouraging Board action to curb predatory lending.

C. The Board's Proposed Rule to Amend Regulation Z

The Board published a proposed rule to amend Regulation Z in December 2000. 65 FR 81438, December 26, 2000. The Board proposed to broaden the scope of mortgage loans subject to HOEPA by adjusting the price triggers used to determine coverage under the act; to prohibit certain acts and practices in connection with homesecured loans covered by HOEPA; to require increased scrutiny on creditors' practices to document and verify income; and to enhance disclosures received by consumers before closing for HOEPAcovered loans.

The Board received approximately 200 letters that specifically addressed the proposed revisions and represented the views of the mortgage lending industry, credit insurance industry, consumer and community development groups, and government agencies. In addition, the Board received approximately 1,100 identical email comment letters from consumers generally encouraging the Board to curb predatory lending.

Most of the creditors and other commenters involved in mortgage lending opposed making more loans subject to HOEPA. They believe that the coverage of more loans would reduce competition and the availability of credit in the range of rates affected because some lenders, as a matter of policy, will not make HOEPA loans. With regard to the new rules that would apply to HOEPA loans, creditors wanted more flexibility and compliance guidance. Consumer representatives and community development organizations generally supported the proposal as a step forward in addressing the problem of predatory lending but believed additional steps are needed to ensure consumers are protected. II. Summary of Final Rule

With some exceptions, the Board is adopting the revisions substantially as proposed to address predatory lending and unfair practices in the homeequity market. The revisions are adopted [[Page 65606]]
pursuant to the Board's authority to adjust the APR trigger and add additional charges to the points and fees trigger. See 15 U.S.C. 1602(aa). Revisions are also issued pursuant to the Board's authority under HOEPA to prohibit certain acts or practices (1) affecting mortgage loans if the Board finds the act or practice to be unfair, deceptive, or designed to evade HOEPA, or (2) affecting refinancings if the Board finds the act or practice to be associated with abusive lending or otherwise not in the interest of the borrower. 15 U.S.C. 1639(l)(2). Revisions are also adopted pursuant to section 105(a) of TILA to effectuate the purposes of TILA, to prevent circumvention or evasion, or to facilitate compliance. 15 U.S.C. 1604(a).

The amendments (1) extend the scope of mortgage loans subject to HOEPA's protections, (2) restrict certain acts or practices, (3) strengthen HOEPA's prohibition on loans based on homeowners' equity without regard to repayment ability, and (4) enhance HOEPA disclosures received by consumers before closing, as follows.

The final rule adjusts the APR trigger for firstlien mortgage loans, from 10 percentage points to 8 percentage points above the rate for Treasury securities having a comparable maturity, the maximum amount that the Board may lower the trigger. The APR trigger for subordinatelien loans remains at 10 percentage points. The feebased trigger is adjusted to include amounts paid at closing for optional credit life, accident, health, or lossofincome insurance, and other debtprotection products written in connection with the credit transaction.

The final rule also addresses some ``loan flipping'' within the first year of a HOEPA loan. Except in limited circumstances, a creditor that has made a HOEPA loan to a borrower is generally prohibited for twelve months from refinancing any HOEPA loan made to that borrower into another HOEPA loan. Assignees holding or servicing a HOEPA loan are subject to similar restrictions.

To prevent the evasion of HOEPA, which only covers closedend loans, the final rule prohibits a creditor from wrongfully documenting such loans as openend credit. For example, a highcost mortgage may not be structured as a homesecured line of credit if there is no reasonable expectation that repeat transactions will occur under a reusable line of credit. To ensure that lenders do not accelerate the payment of HOEPA loans without cause, the final rule prohibits a creditor from exercising ``dueondemand'' or call provisions in a HOEPA loan, unless the clause is exercised in connection with a consumer's default. A similar rule applies to homesecured lines of credit under Regulation Z.

The final rule seeks to strengthen HOEPA's prohibition on making loans based on homeowners' equity without regard to repayment ability. It creates a presumption that a creditor has violated the statutory prohibition on engaging in a pattern or practice of making HOEPA loans without regard to repayment ability if the creditor generally does not verify and document consumers' repayment ability.

The final rule revises the HOEPA disclosures (given three days before loan closing) for refinancings, to alert consumers to the total amount borrowed, which may be substantially higher than the loan amount requested due to the financing of credit insurance, points, and fees. To enhance consumer awareness, and deter insurance packing, the HOEPA disclosure must specify whether the total amount borrowed includes the cost of optional insurance.

The staff commentary to Regulation Z has also been revised to provide guidance on the new rules and to clarify existing requirements. Revisions to the regulation and the staff commentary are discussed in detail below in the sectionbysection analysis.
III. SectionbySection Analysis of Final Rule
Subpart AGeneral
Section 226.1Authority, Purpose, Coverage, Organization, Enforcement and Liability

Section 226.1(b) on the purpose of the regulation is revised as proposed to reflect the addition of prohibited acts and practices in connection with credit secured by a consumer's dwelling. Section 226.1(d) on the organization of the regulation is revised to reflect the restructuring of Subpart E (rules for certain home mortgage transactions).
Subpart CClosedend Credit
Section 226.23Right of Rescission

23(a) Consumer's Right to Rescind

The proposed amendment to footnote 48 to Sec. 226.23(a)(3) is unnecessary given the organization of the final rule, and thus has not been adopted.
Subpart ESpecial Rules for Certain Home Mortgage Transactions Section 226.31General Rules
31(c) Timing of Disclosure

31(c)(1)(i) Change in Terms

Section 226.31(c)(1) requires a threeday waiting period between the time the consumer is furnished with disclosures required under Sec. 226.32 and the time the consumer becomes obligated under the loan. If the creditor changes any terms that make the disclosures inaccurate, new disclosures must be given and another threeday waiting period is triggered.

Comment Sec. 226.31(c)(1)(i)2 is added, as proposed, to clarify redisclosure requirements when, after a consumer receives a HOEPA disclosure and before consummation, loan terms change that make the disclosure inaccurate. The Board's 2000 hearings revealed that some creditors offer credit insurance and other optional products at loan closing. If the consumer finances the purchase of such products and as a result the monthly payment differs from what was previously disclosed under Sec. 226.32, the terms of the extension of credit have changed; redisclosure is required and a new threeday waiting period applies. See discussion below concerning Sec. 226.32(c)(3) on when optional items may be included in the regular payment disclosure.
Section 226.32Requirements for Certain Closedend Home Mortgages 32(a) Coverage

HOEPA disclosures and restrictions cover homeequity loans that meet one of the act s two highcost triggers a rate trigger and a points and fees trigger. Under the final rule, both triggers are revised to cover more loans.

APR triggerCurrently, a loan is covered by HOEPA if the APR exceeds by more than 10 percentage points the rate for Treasury securities with a comparable maturity. Section 103(aa) of TILA authorizes the Board to adjust the APR trigger by 2 percentage points from the current standard of 10 percentage points upon a determination that the increase or decrease is consistent with the consumer protections against abusive lending contained in HOEPA and is warranted by the need for credit.

The Board had proposed to reduce the rate trigger from 10 to 8 percentage points above the rate for Treasury securities with a comparable term for all loans, the maximum adjustment that the Board can make. With this change, based on recent rates for Treasury securities, homeequity loans with a term of 10 years would be subject to HOEPA if they have an APR of approximately 13 percent or higher.

The Board solicited comment on an alternative approach that would differentiate between first and subordinatelien loans in the application of the APR trigger. Under the twotiered alternative, the APR trigger for firstlien mortgages would be
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reduced to 8 percentage points; the APR trigger for subordinatelien loans would remain at 10 percentage points. The final rule adopts the twotiered alternative approach.

HOEPA provides that the Board may adjust the APR trigger after consulting with representatives of consumers and lenders and determining that the increase or decrease is consistent with the purpose of consumer protection in HOEPA and is warranted by the need for credit. (The Board may not adjust the trigger more frequently than once every two years.) Consistent with this mandate, the Board has held public hearings, considered the testimony at other hearings held by government agencies and the Congress, analyzed comment letters, held discussions with community groups and lenders, consulted its Consumer Advisory Council, and reviewed data from various studies and reports on the homeequity lending market.

Most of the information the Board received about predatory lending is anecdotal, as it was when Congress passed HOEPA in 1994. The reports of actual cases (including additional Congressional testimony by consumers) are, however, widespread enough to indicate that the problem warrants addressing. Homeowners in certain communitiesfrequently the elderly, minorities, and womencontinue to be targeted with offers of highcost, homesecured credit with onerous loan terms. The loans, which are typically offered by nondepository institutions, carry high upfront fees and may be based solely on the equity in the consumers' homes without regard to their ability to make the scheduled payments. When homeowners have trouble repaying the debt, they are often pressured into refinancing their loans into new unaffordable, highfee loans that rarely provide economic benefit to the consumers. These refinancings may occur frequently. The loan balances increase primarily due to fees that are financed resulting in reductions in the consumers' equity in their homes and, in some cases, foreclosure may occur. The loan transactions also may involve fraud and other deceptive practices.

Creditors have expressed concern that lowering the HOEPA rate trigger would adversely affect credit availability for loans in the range of rates that would be covered by the lowered trigger. Many creditors, ranging from community banks to national lenders, have stated that they do not offer HOEPA loans due to their concerns about compliance burdens, potential liability, reputational risk, and difficulty in selling these loans to the secondary market. Some creditors believe there are insufficient data about the incidence of predatory lending occurring in loans immediately below the existing HOEPA triggers to support lowering the trigger.

Anecdotal evidence suggests that subprime borrowers with rates below the current HOEPA triggers also have been subject to abusive lending practices. There are no precise data, however, on the number of subprime loans in the market as a whole that would be affected by lowering the HOEPA rate trigger. The precise effect that lowering the APR trigger will have on creditors' business strategies is difficult to predict. It seems likely that lenders that already make HOEPA loans and have compliance systems in place would continue making them under a revised APR trigger. Some creditors that choose not to make HOEPA loans may refrain from making loans in the range of rates that would be covered by the lowered threshold. But other creditors may fill any void left by creditors that do not make HOEPA loans, either because they already make HOEPA loans or because they are willing to do so in the future. And others may have the flexibility to avoid HOEPA's coverage by lowering rates or fees for some loans at the margins, consistent with the risk involved. Data submitted by a trade association representing nondepository institution lenders suggest that there is an active market for HOEPA loans under the current APR trigger. There is no evidence that the impact on credit availability will be significant if the trigger is lowered. Accordingly, the Board believes that lowering the APR trigger to expand HOEPA's protections to more loans is consistent with consumers' need for credit, and therefore, warranted.

Moreover, lowering the rate trigger seeks to ensure that the need for credit by subprime borrowers will be fulfilled more often by loans that are subject to HOEPA's protections. Borrowers who have lessthan perfect credit histories and those who might not be served by prime lenders have benefited from the substantial growth in the subprime market. But a borrower does not benefit from expanded access to credit if the credit is offered on unfair terms, the repayment costs are unaffordable, or the loan involves predatory practices. Because consumers who obtain subprime mortgage loans have, or perceive they have, fewer options than other borrowers, they may be more vulnerable to unscrupulous lenders or brokers.

The Board has also determined that lowering the rate trigger is consistent with the consumer protections against abusive lending provided by HOEPA. The Act's purpose is to protect the most vulnerable consumers, based on the cost of the loans, from abusive lending practices. As noted above, anecdotal evidence suggests that subprime borrowers with loans priced below HOEPA's current APR trigger have been subject to predatory practices, such as unaffordable lending, loan flipping and insurance packing. These are the very types of abuses that HOEPA was intended to prevent. With a lowered trigger, more consumers with highcost loans will receive cost disclosures three days before closing (instead of at closing) and will be protected by HOEPA's prohibitions against onerous loan terms, such as nonamortizing payment schedules, balloon payments on shortterm loans, or interest rates that increase upon default. A wider range of highcost loans will also be subject to HOEPA's rule against unaffordable lending, and to HOEPA's restrictions on prepayment penalties. The rules being adopted by the Board to address loan flipping will also apply to more loans. Lastly, more highcost loans will be subject to the HOEPA rule that holds loan purchasers and other assignees liable for any violation of law by the original creditor with respect to the mortgage.

Twotiered approachOf the 200 commenters on the proposal, about 40 discussed the twotiered trigger approach and were about evenly divided. Creditors and some consumer groups favored the twotiered trigger approach. Those opposed included community groups, some creditors, and others that generally believe that there should be no distinction drawn between firstlien and subordinatelien loans. Community groups believe that the maximum number of subprime mortgage loans should be subject to HOEPA's protections. Many suggested that the twotiered approach could be helpful if both triggers were
substantially lower than what the Board is authorized to adopt. Some creditors that opposed the tieredapproach believe that the Board should not issue a rule that might encourage the making of loans that would place creditors in a subordinate lien position. One institution noted that a subordinatelien loan may not be more favorable to a consumer if it results in a combined monthly payment on the first and second mortgages that is higher than the monthly payment on a consolidated firstlien mortgage loan. Some commenters believe that borrowers with subordinatelien loans face similar risks of abusive practices as with firstlien
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loans. A few stated that the tiered approach would add unnecessary complexity to both compliance and enforcement efforts.

Data are not available on the number of homeequity loans currently subject to HOEPA, or the number of loans that would be covered if the APR trigger were lowered. At the time of the proposal, data from the Mortgage Information Corporation (MIC) compiled by the Office of Thrift Supervision suggested that lowering the APR trigger by 2 percentage points could expand HOEPA's coverage from approximately 1 percent to 5 percent of subprime mortgage loans. Further analysis of additional MIC data suggests that these percentages of coverage may be typical of longerterm, firstlien mortgages, and that the coverage percentages are higher for shorterterm and subordinatelien loans.

In response to the Board's request in the proposal, a few commenters provided data on the number of loans they offered in recent years that would have been affected by a rate trigger of 8 percentage points above a comparable Treasury security. The most extensive data were submitted by a trade association representing nondepository institution lenders. The association collected data from the subprime lending divisions of nine member institutions. The number of loans surveyed is about 36 percent of the number of loans of subprime lenders recorded under HMDA during the survey period (midyear 1995 through midyear 2000). The dollar volume for the loans surveyed is about 20 percent of the dollar volume of loans reported by subprime lenders under HMDA. Overall, the trade association data show that for these loans, HOEPA's existing APR trigger would have covered about 9 percent of the firstlien loans, and that lowering the APR trigger by 2 percentage points would have resulted in coverage of nearly 26 percent of the firstlien loans surveyed. For subordinatelien loans, about 47 percent of the surveyed loans would have been covered by HOEPA's APR trigger, and the data suggest that lowering the APR trigger by 2 percentage points would have resulted in coverage of about 75 percent of the subordinatelien loans.

Most of the evidence of predatory lending brought to the Board's attention to date has involved abuses in connection with firstlien mortgage loans. When a consumer seeks a loan to consolidate debts or finance home repairs, some creditors require consumers to borrow additional funds to pay off the existing first mortgage as a condition of providing the loan, even though the existing first mortgage may have been at a lower rate. This ensures that the creditor will be the senior lienholder, but it also results in an increase, perhaps significant, in the points and fees paid for the new loan (since the latter are calculated on a much larger loan amount).

The Board's final rule lowers the APR trigger for first lien mortgages only. Subordinatelien loans are already covered more frequently by HOEPA because the rates on these loans are higher than firstlien loans. The data suggests that coverage under the current triggers could be significant for subordinatelien loans. Moreover, the evidence of abusive practices has pertained primarily to first lien mortgages. Based on these factors, the Board is adjusting the APR trigger only for firstlien loans, but retains the ability to lower the trigger for subordinatelien loans at a future date.

32(b) Definition

Points and fees triggerCurrently, homeequity loans are subject to HOEPA if the points and fees payable by the consumer at or before loan closing exceed the greater of 8 percent of the total loan amount or $465. (The dollar trigger is $480 for 2002; 66 FR 57849, November 19, 2001.) ``Points and fees'' include all finance charges except for interest. The trigger also includes some fees that are not finance charges, such as closing costs paid to the lender or an affiliated third party. HOEPA authorizes the Board to add ``such other charges'' to the points and fees trigger as the Board deems appropriate.

The comment letters and testimony at the hearings raised a number of concerns about singlepremium credit insurance, such as excessive costs, highpressure sales tactics, consumers' confusion as to the voluntariness of the product, and ``insurance packing.'' The term ``packing'' in this case refers to the practice of automatically including optional insurance in the loan amount without the consumer's request; as a result, some consumers may perceive that the insurance is a required part of the loan, and others may not be aware that insurance has been included.

In response to the reported abuses, the Board proposed to include in the fee trigger premiums paid at closing for optional credit life, accident, health, or lossofincome insurance and other debtprotection products; such premiums are typically financed. Premiums paid for required credit insurance policies are considered finance charges and are already included in the points and fees trigger.

Many commenters expressed views on this issue. The views were sharply divided. In general, consumer representatives, some federal agencies, state law enforcement officials, and some others supported the inclusion of optional credit insurance premiums in HOEPA's points and fees trigger, although they would have preferred an outright ban on the purchase or financing of singlepremium products. Consumer representatives were generally concerned about the cost of the insurance, its voluntariness, and its contribution to equity stripping. They believe that borrowers are often unaware that insurance has been included in their loan balance or that borrowers perceive that the insurance is required. They also note that these problems exist notwithstanding the fact that TILA currently requires creditors to disclose before consummation that the insurance is optional in order to exclude it from the HOEPA fee trigger. (If creditors fail to disclose that the insurance is optional, TILA requires that the cost be treated as a finance charge, and all finance charges other than interest are in the current HOEPA fee trigger.) They state that excessively high premiums contribute to the problem of equity stripping. They also note that consumers pay interest on the financed premium for the entire loan term even though insurance coverage typically expires much earlier.

Most creditors and commenters representing the credit insurance industry strongly opposed the inclusion of optional insurance premiums paid at closing in the points and fees trigger. Some creditors questioned the Board's use of its authority under HOEPA to mandate inclusion; they pointed to legislative history that discusses the potential inclusion of credit insurance premiums if there is evidence that credit insurance premiums are being used to evade HOEPA. These commenters believe that a finding of evasion is a prerequisite to inclusion; they do not believe the standard has been met because the proposal merely noted that the change might prevent such evasions in the future. They also cited an exchange in the Congressional Record between two Senators, when the Congress was considering HOEPA legislation, about credit insurance being treated consistently with other provisions of TILA. Because premiums for optional credit insurance are not automatically included in the calculation of TILA's finance charge and APR, these commenters believe such premiums should not be included in HOEPA's points and fees calculation.

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The commenters' suggestion that credit insurance premiums can only be included in the HOEPA trigger if the Board finds that creditors are using the premiums to evade HOEPA is directly contradicted by the express language of the statute, which states that the Board need only make a finding that this action is ``appropriate.'' In construing a statute, the plain meaning of the statutory text generally governs. When the plain meaning of the statutory language is clear, there is no reason to resort to legislative history. In this case, if the Congress had intended to make ``evasions'' the sole standard of
``appropriateness'' for including additional charges in the fee trigger, it would have done so expressly. For example, such language was used in section 129(l)(2)(A), which authorizes the Board to prohibit acts and practices that the Board finds to be ``unfair, deceptive, or designed to evade'' the provisions of HOEPA.

In light of the unambiguous statutory text, the Board believes that the legislative history cited by the commenters is not dispositive, and that evasion is merely one example of when the Board might find that inclusion of additional charges is ``appropriate.'' The Senate floor colloquy, which refers to HOEPA as being consistent with TILA's treatment of insurance premiums, should not be construed as guidance on how the Board might, in the future, adjust HOEPA's points and fees trigger. It merely clarified that optional credit insurance premiums were not automatically included in the statutory points and fees trigger, as would have been the case under an earlier version of the legislation.

Industry commenters opposed including optional credit insurance premiums in HOEPA's points and fees trigger when, for purposes of TILA disclosures generally, the premiums are not included in the cost of the credit. The Board believes that HOEPA's points and fees trigger is not intended to be the equivalent of the ``cost of credit,'' as measured by TILA's finance charge and APR. Indeed, HOEPA expressly includes certain charges in the points and fees trigger that are not included in the finance charge, and authorizes the Board to include others. The HOEPA points and fees trigger is intended to be used to identify transactions with high costs where consumers may be vulnerable and thus need the benefit of HOEPA's special protections.

Creditors also asserted that, based on typical premium rates, most mortgage loans that include singlepremium credit insurance would be considered highcost and thus would be covered under HOEPA's feebased trigger. As a result, they caution that lenders choosing not to make HOEPA loans would be foreclosed from offering singlepremium credit insurance products to their loan customers. They asserted that the financing of singlepremium insurance provides protection to cashpoor consumers who are underinsured, and in some cases offers less costly coverage compared with other forms of insurance. In short, these commenters generally support the current rule that does not include insurance premiums for optional credit insurance in the points and fees trigger. Alternatively, they recommend a rule that allows the insurance premiums to be excluded based on the consumers' ability to cancel the coverage and obtain a full refund, where consumers are also provided with adequate information about their rights to do so after the loan closing.

The Board believes that it is appropriate and consistent with the purposes of HOEPA to include premiums paid by consumers at or before closing for credit insurance (and other debtprotection products) in HOEPA's points and fees trigger. The coverage is purchased by the consumer in connection with the mortgage transaction, and the creditor or the credit account is the beneficiary. In addition, creditors receive commissions which may be significant for selling credit insurance (and retain the fee assessed for debtcancellation coverage). This oftentimes represents a significant addition to the cost of the transaction to the borrower and an increase in benefit to the creditor. Moreover, when financed in connection with a subprime mortgage loan, as is typically the case, these charges can represent a significant addition to the loan balance, and thus, to the cost of the transaction and the size of the lien on the borrower's home. For example, according to insurance industry commenters, the typical cost of singlepremium credit life insurance for an individual borrower could amount to the equivalent of several points. The total cost of credit insurance in a particular mortgage transaction, however, also depends on the number of borrowers covered, and the types of coverage purchased. HOEPA is specifically designed to help borrowers in highcost mortgage transactions to understand the costs of the transaction and the risk that they may lose their homes if they do not meet the full amount of their obligation under the loan.

Importantly, anecdotal evidence has revealed that there are sometimes abuses associated with the sale and financing of single premium credit insurance, which typically occurs in subprime loans. Some consumers are not aware that they are purchasing the insurance, some may believe the insurance is required, and some may not understand that the term of insurance coverage may be shorter than the term of the loan. These abuses and misunderstandings can be addressed somewhat by applying HOEPA's protections and remedies, to the extent that including insurance in the points and fees test brings these loans under HOEPA. Moreover, including credit insurance premiums in HOEPA's feebased trigger prevents unscrupulous creditors from evading HOEPA by packing a loan with such products in lieu of charging other fees that already are included under the current HOEPA trigger.

One likely effect of this adjustment to the trigger is that significantly more of the loans that include singlepremium insurance will be covered by HOEPA's protections. Data from a trade association of nondepository lenders indicate that lowering the APR trigger for firstlien loans by 2 percentage points and including optional credit insurance premiums in the points and fees tests would increase the percentage of firstlien mortgage loans covered by HOEPA, from 26 to 38 percent, for the firms surveyed. With a lowered APR trigger, coverage of subordinatelien mortgage loans would increase from 47 to 61 percent for the firms surveyed.

When there are abuses such as coercive or deceptive sales practices, borrowers will benefit from HOEPA's rule requiring disclosures three days before closing. With the enhanced HOEPA disclosure of the amount borrowed, these consumers will receive advance notice about the additional amount they must borrow beyond their original loan request if they purchase the insurance. As part of that new disclosure, under the final rule, creditors must specify whether the amount borrowed includes the cost of optional insurance. Moreover, creditors and assignees will be subject to HOEPA's strict liability and remedies when there are violations of law concerning the mortgage. See Sec. 226.32(c)(5).

As commenters noted, some creditors choose not to make loans covered by HOEPA, and if these creditors have been offering single premium insurance, they may decide to cease doing so in order to remain outside of HOEPA's coverage. To the extent that some creditors choose not to offer singlepremium policies, they can make credit insurance available through other vehicles such as
[[Page 65610]]
policies that assess and bill monthly premiums on the outstanding loan balance.

Industry commenters assert that singlepremium policies are less costly than monthly premium insurance and provide greater continuity of coverage because a borrower's missed payments on the monthlypay product might result in cancellation of insurance. Singlepremium and monthlypremium policies have relative advantages and disadvantages. For example, a fiveyear policy with a financed singlepremium may result in smaller monthly payments because the cost is spread over the full loan term, which may be ten or twenty years. But the consumer will also pay ``points'' (and interest over the life of the loan) on the additional amount financed for the coverage. Premiums assessed monthly, based on the outstanding loan balance, may result in a higher monthly expense, but they are not financed and would only be payable during the five years that coverage was in force, so the overall cost to the consumer could be lower. Regardless of the relative merits, under the final rule creditors will continue to have the ability to decide what types of insurance products they will make available to borrowers.

The final rule also provides guidance in calculating the HOEPA fees trigger. A mortgage loan is covered by HOEPA if the ``points and fees'' exceed 8 percent of the ``total loan amount.'' The total loan amount is based on the ``amount financed'' as provided in Sec. 226.18(b). Comment 32(a)(1)(ii)1 of the staff commentary to Regulation Z discusses the calculation of the total loan amount. The comment is revised, as proposed, to illustrate that premiums or other charges for credit life, accident, health, lossofincome, or debtcancellation coverage that are financed by the creditor must be deducted from the amount financed in calculating the total loan amount.

Disclosure alternativesThe Board solicited comment on whether optional credit insurance premiums should be excluded from the trigger when consumers have a right to cancel the policy and when disclosures about that right are provided after closing. Consumer representatives were opposed to the approach, expressing doubt that disclosures would be effective. Industry commenters supported the exclusion as a reasonable approach to address concerns about insurance packing. Upon further analysis, the Board believes that postclosing disclosures would be less effective than the HOEPA disclosures and remedies in deterring abusive sales practices in connection with insurance. Moreover, reliance on the consumer's exercise of their right to cancel the insurance would not prevent abuses but would unfairly require borrowers to take the initiative in remedying them.

32(c) Disclosures

Section 129(a) of TILA requires creditors offering HOEPA loans to provide abbreviated disclosures to consumers at least three days before the loan is closed, in addition to the disclosures generally required by TILA at or before closing. The HOEPA disclosures inform consumers that they are not obligated to complete the transaction and could lose their home if they take the loan and fail to make payments. The HOEPA disclosures also include a few key cost disclosures, such as the APR and the monthly payment (including the maximum payment for variable rate loans and any balloon payment). Under the final rule these disclosures have been enhanced somewhat to further benefit borrowers. Section 226.32(c) is revised to provide, in accordance with TILA section 129(a), that the disclosures must be in a conspicuous type size.

32(c)(3) Regular Payment; Balloon Payment

Section 226.32(c)(3) requires creditors to disclose to consumers the amount of the regular monthly (or other periodic) payment, including any balloon payment. The regulation is revised to move the disclosure requirement for the amount of the balloon payment from the commentary to the regulation, to aid in compliance. Model Sample H16, which illustrates the disclosures required under Sec. 226.32(c), is revised to include a model clause on balloon payments.

Under comment 32(c)(3)1 of the staff commentary, creditors are allowed to include voluntary items in the regular payment disclosed under Sec. 226.32 only if the consumer has previously agreed to such items. The comment is revised for clarity as proposed.

Testimony at the Board's 2000 public hearings and other comments received suggest that some HOEPA disclosures provided in advance of closing include insurance premiums in the monthly payment, even though consumers may not agree to purchase optional insurance until closing. Consequently, the Board solicited comment on whether consumers should be required to request or affirmatively agree to purchase optional items in writing, to aid in enforcing the rule.

Some commenters supported having a rule where consumers would separately agree to purchase optional products. These commenters thought the rule would be useful in preventing ``packing.'' Other commenters, representing both consumer and industry interests, opposed such an approach. The consumer representatives preferred creditors to have the duty to ensure ``voluntariness.'' Industry representatives expressed a variety of concerns. Some believed that such a rule would be burdensome to creditors and borrowers alike, necessitating additional visits to sign the document at least three days before closing. They believed a separate affirmation to be duplicative and unnecessary. Others believed the rule would have the unintended effect of making consumers feel obligated, and ultimately less likely to reverse an earlier decision prior to or at closing.

Having carefully considered commenters' concerns regarding burden, and the effectiveness of a separate written agreement to purchase optional products to reduce ``packing,'' the Board is not taking further action to require a separate written agreement at this time. To address insurance ``packing,'' pursuant to its authority under section 129(l)(2)(B) of TILA, the Board has instead enhanced the final rule to require that the disclosure of the amount borrowed in mortgage refinancings expressly state whether optional credit insurance or debt cancellation coverage is included in the amount financed, as discussed below.

The final rule for disclosing the ``amount borrowed'' includes a $100 tolerance for minor errors. As discussed below, if the amount borrowed is inaccurate by any amount, the regular payment disclosure will be inaccurate also. To be meaningful to creditors, any tolerance for the amount borrowed must ``pass through'' to the regular payment. Such an approach is consistent with TILA's rule in closedend transactions secured by real property or a dwelling, where the finance charge as well as other disclosures affected by the finance charge are considered accurate within prescribed limits. Pursuant to its authority under section 129(l)(2)(B) of TILA, the Board is providing a tolerance to the regular payment disclosure required under Sec. 226.32(c)(3), if the payment disclosed is based on an amount borrowed that is deemed accurate and disclosed under Sec. 226.32(c)(5).

32(c)(5) Amount Borrowed

Section 226.32(c)(5) is added to require disclosure of the total amount the consumer will borrow, as reflected by the face amount of the note, pursuant
[[Page 65611]]
to the Board's authority under Section 129(l)(2)(B) of TILA. This disclosure responds to concerns by consumers and consumer
representatives that consumers sometimes seek a modest loan amount such as for medical or home improvement costs, only to discover at closing (or after) that the note amount is substantially higher due to fees and insurance premiums that are financed along with the requested loan amount. The amount borrowed disclosure is enhanced in the final rule; when the loan amount includes premiums or other charges for optional credit insurance or debtcancellation coverage, the disclosure must so specify, to address insurance ``packing'' where consumers may not be aware that insurance coverage has been added to the loan balance. Comment 32(c)(5)1 to the staff commentary provides guidance regarding terminology for debtcancellation coverage.

Consumer representatives and some industry representatives supported the proposal as aiding consumers' understanding that additional fees might be financed. Other industry representatives opposed the proposal. Some of these commenters believed consumers would be confused by an ``amount borrowed'' in addition to TILA's ``amount financed,'' which does not include amounts borrowed to cover loan fees.

Creditors must provide updated HOEPA disclosures if, after giving the disclosures required by Sec. 226.32(c) to the consumer and before consummation, the creditor changes any terms that make the disclosure inaccurate. Sec. 226.31(c)(1). The Board requested comment on whether it would be appropriate to provide for a tolerance for insignificant changes to the amount borrowed, and if so, what would be a suitable margin.

Commenters had mixed views on the desirability for a tolerance. Consumer groups supported either no tolerance or a very small tolerance such as $100, consistent with the existing tolerance for understated finance charges in closedend transactions secured by real property or a dwelling. Sec. 226.18(d)(1). Industry commenters wanted a much larger tolerance such as 1 percent of the loan amount or 10 percent of the regular payment.

Pursuant to its authority under section 129(l)(2)(B) of TILA, the Board is providing a tolerance for the disclosure of the amount borrowed. Under the final rule, the amount borrowed is accurate if it is not more than $100 above or below the amount required to be disclosed.

Counseling

The Board requested comment on whether a generic disclosure advising consumers to seek independent advice might encourage borrowers to seek credit counseling. Consistent with views expressed in connection with the Board's 2000 hearings, both consumer and creditor commenters acknowledged the benefits of preloan counseling as a means to counteract predatory lending. There was uniform concern, however, about requiring a referral to counseling for HOEPA loans because the actual availability of local counselors may be uncertain. Based on the comments received and further analysis, the Board is not adopting a generic counseling disclosure at this time.
32(d) Limitations

32(d)(8) Dueondemand Clause

As proposed, Sec. 226.32(d)(8) is added to restrict the use of ``dueondemand'' clauses or ``call'' provisions for HOEPA loans, unless the clause is exercised in connection with a consumer's default. The limitation on the use of these provisions in HOEPA loans is added pursuant to the Board's authority under section 129(l)(2)(A) to prohibit acts that are unfair or are designed to evade HOEPA. The staff commentary to Sec. 226.32(d)(8) provides guidance concerning the exercise of ``dueondemand'' clauses when a consumer fails to meet repayment terms or impairs the creditor's security for the loan.

Commenters generally supported the proposal. A few commenters suggested that the rule was not needed because they believe that due ondemand clauses were generally not being used by mortgage lenders. Some industry commenters asked the Board to limit the rule's applicability to the first five years of a HOEPA loan, to coincide with HOEPA's ban on balloon payments. One commenter sought clarification that the rule limiting ``dueon demand'' clauses would not affect ``dueonsale'' clauses.

The final rule is adopted as proposed. To prevent creditors from forcing consumers to pay additional points and fees to refinance their loans or face possible foreclosure, section 129(e) of TILA prohibits the use of balloon payments for HOEPA loans with terms of less than five years. Although ``dueondemand'' and ``call'' provisions currently do not appear to be widely used in HOEPA loans, a creditor could potentially force the consumer to refinance by exercising the right to call the loan and demanding payment of the entire outstanding balance. Restricting call provisions in HOEPA loans is intended to ensure that lenders do not accelerate the payment of these loans, without cause, at any time during the loan term, in order to force consumers to refinance. When a creditor can unilaterally terminate the loan without cause, the consumer may be subject to unnecessary refinancings, excessive loan fees, higher interest rates, or possible foreclosure. Consequently, this rule prevents creditors from using call provisions in a manner that would cause substantial harm to HOEPA borrowers.

Loans covered by HOEPA are more likely to involve borrowers who have lessthanperfect credit histories, or who might not be served by prime lenders. As noted earlier, because these consumers either have or perceive they have fewer options than other borrowers, they may be more vulnerable to unscrupulous lenders or brokers. Accordingly, HOEPA includes limitations on certain loan provisions to protect these borrowers from onerous loan terms. The Board finds that it is also appropriate to protect HOEPA borrowers from the potentially harsh effects of allowing a creditor to exercise a ``dueondemand'' clause at any time, unless there is legitimate cause.

The hearing testimony and comments received by the Board failed to identify any benefits to using ``dueondemand'' clauses in HOEPA loans, other than in the legitimate cases that are permitted under the Board's rule. The rule allows creditors to exercise such clauses when the creditor is faced with borrower misrepresentations or fraud, the borrower fails to meet repayment terms, or a borrower's action (or failure to act) affects the creditor's security for the loan. The rule does not affect creditors' use of ``dueonsale'' clauses.

The limitations on ``dueondemand'' clauses adopted by the Board for HOEPA loans are similar to TILA's existing limits on the use of such clauses for homeequity lines of credit (HELOCs). See TILA, Section 127A; 12 CFR Sec. 226.5b(f)(2). The rule for HELOCs is contained in the Home Equity Loan Consumer Protection Act of 1988 (Pub. Law No. 100709, 102 Stat. 4725). The 1988 act recognized that allowing creditors to unilaterally terminate a homeequity line (or
significantly change loan terms) is fundamentally unfair when the consumer's home is at stake. Allowing creditors' unlimited discretion to call the loan and require immediate repayment is similarly unfair with HOEPA loans.
[[Page 65612]]
Section 226.34Prohibited Acts or Practices in Connection with Credit Secured by a Consumer's Dwelling

Section 129(l) of TILA authorizes the Board to prohibit acts or practices to curb abusive lending practices. The act provides that the Board shall prohibit practices: (1) In connection with all mortgage loans if the Board finds the practice to be unfair, deceptive, or designed to evade HOEPA; and (2) in connection with refinancings of mortgage loans if the Board finds that the practice is associated with abusive lending practices or otherwise not in the interest of the borrower. The Board is exercising this authority to prohibit certain acts or practices, as discussed below. The final rule is intended to curb unfair or abusive lending practices without unduly interfering with the flow of credit, creating unnecessary creditor burden, or narrowing consumers' options in legitimate transactions. The rule prohibiting ``loan flipping'' has been modified to expand its scope. The rule protecting lowrate loans has not been adopted due to concerns about the compliance burden on the homeequity lending market generally. Other provisions have been adopted as proposed.

The final rule creates a new Sec. 226.34, which contains prohibitions against certain acts or practices in connection with credit secured by a consumer's dwelling. This section includes the rules currently contained in Sec. 226.32(e).
34(a) Prohibited Acts or Practices for Loans Subject to Sec. 226.32 34(a)(1) Home Improvement Contracts

Section 226.32(e)(2) regarding homeimprovement contracts is renumbered as Sec. 226.34(a)(1) without substantive change. Comment 32(e)(2)(i)1 of the staff commentary is now comment 34(a)(1)(i)1. 34(a)(2) Notice to Assignee

Section 226.32 (e)(3) regarding assignee liability for claims and defenses that consumers may have in connection with HOEPA loans is renumbered as Sec. 226.34(a)(2) without substantive change. Comments 32(e)(3)1 and 2 are now comments 34(a)(2)1 and 2 respectively.

Comment 34(a)(2)3 is added to clarify the statutory provision on the liability of purchasers or other assignees of HOEPA loans, as proposed. Section 131 of TILA provides that, with limited exceptions, purchasers or other assignees of HOEPA loans are subject to all claims and defenses with respect to a mortgage that the consumer could assert against the creditor. The comment clarifies that the phrase ``all claims and defenses'' is not limited to violations of TILA as amended by HOEPA. This interpretation is based on the statutory text and is supported by the legislative history. See Conference Report, Joint Statement of Conference Committee, H. Rep. No. 103652, at 22 (Aug. 2, 1994).
34(a)(3) Refinancings Within Oneyear Period
``Loan flipping'' generally refers to the practice by brokers and creditors of frequently refinancing homesecured loans to generate additional fee income even though the refinancing is not in the borrower's interest. Loan flipping is among the more flagrant of lending abuses. Victims tend to be borrowers who are having difficulty repaying a highcost loan; they are targeted with promises to refinance the loan on more affordable terms. The refinancing typically provides little benefit to the borrower, as the loan amount increases mostly to cover fees. Often, there is minimal or no reduction in the interest rate. The monthly payment may increase, making the loan even more unaffordable. Sometimes the loan is amortized so that the monthly payment is reduced, but the loan may still be unaffordable. As long as there is sufficient equity to support the financing of additional fees, the consumer may be targeted repeatedly, resulting in equity stripping.

The proposed rule prohibited an originating creditor (or assignee) holding a HOEPA loan from refinancing that loan into another HOEPA loan within the first twelve months following origination, unless the new loan was ``in the borrower's interest.'' Pursuant to its authority under Section 129(l)(2)(A) of TILA, the Board is adopting a final rule to address ``loan flipping,'' as discussed below.

Consumer representatives generally supported the proposal, but they believed the rule was too narrow and that all creditors and brokers should be covered. Federal agencies, community groups, and consumers and their representatives believe that the prohibition should be lengthened; suggestions ranged from 18 months to as long as four years.

Creditors' comments mainly focused on the ``interest of the borrower'' test. oth creditors and consumer representatives sought additional guidance in this area. Consumer representatives viewed the standard as too lenient, while creditors believed that the standard's lack of certainty would subject them to litigation risk. Creditors also expressed concerns about the proposal's coverage of affiliates and sought clarification about whether an assignee merely servicing HOEPA loans is covered by the rule.

The Board is adopting a final rule that broadens the proposal's coverage somewhat. Under the final rule, within the first twelve months of originating a HOEPA loan to a borrower, the creditor is prohibited from refinancing that loan (whether or not the creditor still holds the loan) or another HOEPA loan held by that borrower.

The proposal was narrowly tailored to curb the more egregious cases of loan flipping: repeated refinancing by creditors that hold HOEPA loans in portfolio. Once a creditor assigned the loan, the assignee would have been covered, but the originating creditor could then have refinanced the HOEPA loan. Thus, the proposed rule did not cover loan originators that close loans in their own name and immediately assign them to a funding party or sell them in the secondary market. The hearing testimony and comments suggest that some of these originators are the source of unaffordable loans because they do not have a vested interest in the borrower's ability to repay the loan. Once they are no longer holding a loan, they can target the same borrower with an offer to refinance the loan. The final rule has been expanded to cover creditors (including brokers) that originate HOEPA loans, whether or not they continue to hold the loan. The loan flipping rule may deter some unaffordable lending if the parties making, holding, or servicing the loan are not permitted to refinance the loan within the first year.

Assignees are covered by the rule because in some instances they are the ``true creditor'' funding the loan. Even when they are not acting as the true creditors, assignees of HOEPA loans are subject to the refinancing restrictions to ensure that loans are not transferred for the purpose of evading the prohibition and that borrowers are not pressured into frequent refinancings by the party holding or servicing their loans. Thus, the rule has been revised to clarify that it applies to assignees that are servicing a HOEPA loan, whether or not they own the obligation. Assignees will be under the same restrictions as the original creditor while holding or servicing the loan. Comment 34(a)(3)2 of the staff commentary is added to provide examples of how the rule is applied in specific cases.

Under the proposal, the regulatory prohibition applicable to creditors would have applied to their affiliates in all cases. Industry commenters were concerned about the compliance burdenparticularly for creditors with
[[Page 65613]]
broad geographic and corporate structures. The final rule has been narrowed and would not apply in routine cases where consumers seek a refinancing from an affiliate. Under the final rule, loans made by an affiliate are prohibited only if the creditor engages in a pattern or practice of arranging loans with an affiliate to evade the flipping prohibition, or engages in other acts or practices designed to evade the rule. The final rule also prohibits creditors from arranging refinancings of their own loans with unaffiliated creditors to evade the flipping prohibition.

As noted above, some commenters believe that the prohibition should be lengthened. Although a longer period might further limit the opportunity for loan flipping, one year provides an appropriate balance between the need to address the clearest cases of abusive refinancings and the need not to restrict the free flow of credit in legitimate transactions. Thus, the final rule retains the oneyear limitation, as proposed.

Borrower's interestUnder the proposal, creditors are permitted to refinance a HOEPA loan within the oneyear period when ``in the borrower's interest.'' The determination of whether or not a benefit exists would be based on the totality of the circumstances. Consumer representatives viewed the standard as too lenient. They asserted that the lack of specificity or examples under the proposal would lead creditors to liberally construe the ``borrower's interest'' standard to permit any borrower predicament or any arguable ``improvement'' in term, payment, or rate, as sufficient justification for refinancing within the first year. Creditors, conversely, believed that the standard's lack of certainty would lead to litigation, inconsistent application, and borrower and judicial secondguessing of creditors. This, creditors argued, could ultimately result in a hesitancy by creditors to extend refinance credit at all in the first year of origination of a HOEPA loan.

Commenters offered many suggestions for more specific guidance, asking the Board to provide that lowering the interest rate or the monthly payment, or eliminating a balloon payment or variable rate feature, was per se, ``in the borrower's interest.'' Although a list of acceptable loan purposes would provide more certainty, it is difficult to identify circumstances that would be unequivocally in the borrower's interest in all or even most cases. A good reason in one context may be abusive in other circumstances. For example, a homeowner's equity could still be stripped through repeated refinancings that carry high up front fees even if they result in incrementally lower APRs.

The Board believes that precisely defining circumstances that are ``in the borrower's interest'' is not necessary, given the nature of the loan flipping prohibition. The prohibition applies for a relatively short period, and is intended as a strong deterrent for the more egregious cases. T

FOR FURTHER INFORMATION CONTACT

Minh-Duc T. Le, Attorney, Daniel G. Lonergan, Counsel, or Jane E. Ahrens, Senior Counsel, Division of Consumer and Community Affairs, at (202) 4523667 or 4522412; for users of Telecommunications Device for the Deaf (``TDD'') only, contact (202) 2634869.

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