High-Rate, High-Fee Loans
Section 32 Mortgages
If you’re refinancing your mortgage or
applying for a home equity installment loan, you should know about the "Home
Ownership and Equity Protection Act of 1994." The law addresses certain deceptive and
unfair practices in home equity lending. It amends the Truth in Lending Act (TILA) and
establishes requirements for certain loans with high-rates and/or high-fees. The rules for
these loans are contained in Section 32 of Regulation Z, which implements the TILA, so the
loans also are called "Section 32 Mortgages." Here's what loans are covered, the
law’s disclosure requirements, prohibited features, and actions you can take against
a lender who is violating the law.
What Loans Are Covered?
A loan is covered by the law if it meets the following tests:
- the annual percentage rate (APR) exceeds by more than 10 percentage points the rates on
Treasury securities of comparable maturity; or
- the total fees and points exceed the larger of $435 or 8 percent of the total loan amount. (The $435
figure is for 1998. This amount is adjusted annually by the Federal Reserve Board, based
on changes in the Consumer Price Index.)
The rules primarily affect refinancing and home equity installment
loans that also meet the definition of a high-rate or high-fee loan. The rules do not cover loans to purchase or initially construct your home, reverse mortgages, or home
equity lines of credit (similar to revolving credit accounts).
What Disclosures Are Required?
If your loan meets the above tests, you must receive several
disclosures at least three business days before the loan is finalized:
- The lender must give you a
written notice stating that the loan need not be completed, even though you’ve signed
the loan application and received the required disclosures. You have three business days
to decide whether to sign the loan agreement after you receive the special Section 32
disclosures.
- The notice must warn you that
because the lender will have a mortgage on your home, you could lose the residence and any
money put into it, if you fail to make payments.
- The lender must disclose the
APR and the regular payment amount (including any balloon payment where the law permits
balloon payments, discussed below) for high-rate, high-fee loans. For variable rate loans,
the lender must disclose that the rate and monthly payment may increase and state the
amount of the maximum monthly payment.
These disclosures are in addition to the other TILA disclosures that you must receive
no later than closing of the loan.
What Practices Are Prohibited?
The following features are banned from high-rate, high-fee loans:
- All balloon-payments —
where the regular payments do not fully pay off the principal balance and a lump sum
payment of more than twice the amount of the regular payments is required — for loans
with less than five-year terms. There is an exception for bridge loans of less than one
year used by consumers to buy or build a home: in that situation, balloon payments are not prohibited.
- Negative amortization, which
involves smaller monthly payments that do not fully pay off the loan and that cause an
increase in your total principal debt.
- Default interest rates higher than pre-default rates.
- Rebates of interest upon
default calculated by any method less favorable than the actuarial method.
- A repayment schedule that
consolidates more than two periodic payments that are to be paid in advance from the
proceeds of the loan.
- Most prepayment penalties,
including refunds of unearned interest calculated by any method less favorable than the
actuarial method. The exception is if:
- the lender verifies that your total monthly debt
(including the mortgage) is 50% or less of your monthly income.
- you get the money to prepay the loan from a source
other than the lender or an affiliate lender; and
- the lender exercises the penalty clause during the
Creditors also are prohibited from engaging in a pattern or practice of lending based
on the collateral value of your property without regard to your ability to repay the loan.
In addition, proceeds for home improvement loans must be disbursed either directly to you,
jointly to you and the home improvement contractor, or, in some instances, to the escrow
agent.
How Are Compliance Violations
Handled?
You may have the right to sue a lender for violations of these
new requirements. In a successful suit, you may be able to recover statutory and actual
damages, court costs, and attorney’s fees. In addition, a violation of the new
high-rate, high-fee requirements of the TILA may enable you to rescind (or cancel) the
loan for up to three years.
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