Consumer Compliance Outlook: First Quarter 2015

The Expanded Scope of High-Cost Mortgages Under the Dodd-Frank Wall Street Reform and Consumer Protection Act

By Rachel Leary, Examiner, Federal Reserve Bank of Kansas City

The Home Ownership and Equity Protection Act (HOEPA)1 was enacted in 1994 as an amendment to the Truth in Lending Act (TILA) to address abusive lending practices for mortgages with high annual percentage rates (APRs) and/or high points and fees (known as high-cost mortgages) by restricting loan terms and features. The law also provides enhanced remedies for violations in a private civil action.2

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) amended the HOEPA to enhance its protections. The amendments:

In January 2013, the Consumer Financial Protection Bureau (CFPB) issued implementing regulations for the HOEPA amendments, which became effective on January 10, 2014.3

The purpose of this article is to remind bankers that more residential loans may qualify as high-cost mortgages subject to the HOEPA’s enhanced protections and remedies as a result of the Dodd-Frank Act amendments. This article also discusses the history of HOEPA, its expanded coverage under the amendments, the remedies available to borrowers for violations, the new substantive restrictions for high-cost mortgages, and suggestions for compliance programs.

HOEPA History

Congress enacted the HOEPA in 1994 to respond to abusive mortgage lending practices in the subprime mortgage market, particularly the issue of equity stripping loans (loans that erode a borrower’s equity in his or her home through high interest rates and/or high points and fees). The HOEPA addressed this problem by creating a regulatory category for residential loans known as high-cost mortgages based on the loan’s APR and/or its points and fees. The HOEPA restricted loan features on these mortgages, required disclosures to the applicant, and provided enhanced remedies to borrowers for violations in a civil action.4

The HOEPA excluded residential mortgage transactions (defined as a mortgage to finance the acquisition or construction of a principal dwelling, commonly known as a purchase-money mortgage);5 reverse mortgages; and open-end, home-secured credit transactions (e.g., HELOCs) from its coverage. Thus, as originally enacted, the HOEPA focused on closed-end refinance, home-equity, and home-improvement loans with high APRs and/or high points and fees.

Dodd-Frank Act HOEPA Changes

Expanded Product Coverage

The amended HOEPA now applies to purchase-money mortgages and open-end, dwelling-secured credit transactions such as HELOCs. Reverse mortgages and construction loans remain exempt. The CFPB also added a new exemption for loans originated and financed by housing finance agencies, and loans originated through the U.S. Department of Agriculture’s Rural Housing Service Section 502 Direct Loan Program.6

Threshold Changes

APR Threshold Test

The prior APR test was based on a margin added to the rate for a Treasury security of comparable duration. The revised test is based on a lower margin added to the average prime offer rate (APOR)7 for a comparable transaction.

Previous HOEPA APR Test
Revised HOEPA APR Test8
Treasury rate + 8.5 percentage points for first-lien loan APOR + 6.5 percentage points for first-lien loan (except as described below)
Treasury rate + 10 percentage points for subordinate-lien loan APOR + 8.5 percentage points for subordinate-lien loan
APOR + 8.5 percentage points for a first-lien loan if the dwelling is personal property and the loan amount is less than $50,000

As a result of the changes to this test, the APR threshold for a high-cost mortgage has been lowered so more loans will qualify.

Points and Fees Threshold Test

The previous and revised points and fees test are listed below.

Previous Points and Fees Test
Revised Points and Fees Test
Equals or exceeds 8 percent of the total loan amount9 Equals or exceeds 5 percent of the total loan amount for loans either equal to or greater than $20,000 (adjusted for inflation annually)
Exceeds the lesser of either 8 percent of the total loan amount or $1,00010 (adjusted for inflation annually) for total loan amounts less than $20,000

The major change here is that the points and fees threshold was lowered from 8 percent to 5 percent of the total loan amount, except for loans of less than $20,000, for which points and fees cannot exceed $1,000 or 8 percent of the total loan amount, whichever is lower.

Prepayment Penalties Threshold Test

Under the new prepayment penalty threshold, a consumer credit transaction secured by the consumer’s principal dwelling is a high-cost mortgage if:

One complexity of this provision is that Regulation Z also prohibits prepayment penalties for high-cost mortgages.12 Thus, the new threshold creates an anomaly: If a loan has a prepayment penalty that crosses the threshold, it is a high-cost mortgage under §1026.32(a)(1)(iii) External Link, yet a high-cost mortgage cannot have a prepayment penalty under §1026.32(d)(6) External Link.

The CFPB discussed this issue in the preamble to the January 2013 final rule, explaining that the new prepayment penalty test “effectively establish[es] a maximum period during which a prepayment penalty may be imposed, and a maximum prepayment penalty amount that may be imposed, on a transaction secured by a consumer’s principal dwelling, other than a mortgage that is exempt from high-cost mortgage coverage under §1026.32(a)(2).”13 In other words, creditors offering loans secured by a consumer’s principal dwelling (except construction loans, reverse mortgages, and certain government guaranteed loans14) cannot impose prepayment penalties that cross the thresholds discussed previously.

Creditors should also recognize that another section of the regulation restricts prepayment penalties for certain dwelling-secured credit transactions. In particular, 12 C.F.R. §1026.43(g) External Link limits prepayment penalties on a “covered transaction,” which is defined as a consumer credit transaction secured by a dwelling, with certain exclusions (including HELOCs).15 For a covered transaction, a prepayment penalty is only allowed if the transaction is a qualified mortgage and if the penalty is otherwise permitted by law.16 Even then, additional restrictions apply: The APR cannot change after consummation; a penalty can only be imposed during the first 36 months after consummation; the penalty cannot exceed 2 percent if incurred during the first two years following consummation and cannot exceed 1 percent if incurred during the third year following consummation; and the loan cannot be a higher-priced mortgage loan.17

Thus, creditors considering prepayment penalties for dwelling-secured consumer credit transactions should consider these limitations during the product development stage for new loan products and should review their existing products for compliance with these changes.

New Restrictions on High-Cost Mortgages

Determining if a loan is subject to the HOEPA is only the first step in originating a high-cost mortgage loan. If the HOEPA applies, creditors must ensure they are complying with the HOEPA’s disclosure requirements and substantive restrictions. The Dodd-Frank Act added the following new substantive restrictions on HOEPA loans, as implemented in Regulation Z:

To facilitate compliance with these requirements, the CFPB offers several resources on its website, including an updated small entity compliance guide25 and a web page focused solely on the HOEPA rule.26

Effect of HOEPA Restrictions and Remedies on HOEPA Originations

According to recent mortgage lending data, most lenders do not extend HOEPA loans. For example, the 2013 HMDA data indicate that 428 lenders (out of a total of 7,190 HMDA reporters) extended 1,873 HOEPA loans, which accounts for less than 2 percent of all refinance and home-improvement loans. The data also indicate that only 203 of these loans were sold to secondary market participants.27

Lenders’ reluctance to originate HOEPA loans since the statute’s enactment likely reflects several concerns: HOEPA’s significant restrictions on loan terms,28 enhanced damages for violations in a civil action, assignee liability, and an extended statute of limitations. For example, the TILA’s remedies in a civil action for a HOEPA violation include refund of the sum of all finance charges and fees paid, statutory damages, court costs, and attorney’s fees.29 In addition, the statute of limitations for a HOEPA violation is three years, compared with one year for most other violations of the TILA.30 Finally, the TILA generally limits the liability of loan assignees to violations that are clear on the face of the disclosure statement;31 however, for HOEPA loans, the assignee is subject to all claims and defense of the original creditor — unless the assignee can demonstrate that it was not apparent the mortgage purchased was subject to the HOEPA.32 The creditor must also provide a notice to the assignee regarding the assignee’s potential liability for violations.

Compliance Management Considerations

The HOEPA amendments expand the scope of loans qualifying as high-cost mortgages and impose new substantive restrictions. Lenders must ensure that their systems, policies, procedures, training, and controls have been updated to account for the new rules and expanded scope. Lenders should also ensure that they have systems in place to determine whether their existing loan products are high-cost mortgages under the amendments. If so, they need to ensure that those loans comply with HOEPA’s restrictions, disclosures, and counseling requirements.

Specific issues and questions should be raised with your primary regulator.