What is the Deal with These High-Cost Loans?

Questions roll in weekly now by those engaged in owner-finance lending as to, “what are the interest rate limits this week?”  The question demonstrates a level of understanding that an owner-financier doesn’t want to make a “predatory” loan, and they know that a determinative factor to avoid making such a loan is the amount of interest charged.

However, a bit more education is needed in order to fully answer the following questions: What is a high-cost loan?  What generally happens if a person makes a high-cost loan?  Does the floor open up and swallow them?  Are they permanently exiled to the island of Saint Helena?  No.  But should they exercise caution and act from a highly educated perspective?  Yes.

Generally, when a person originates a high-cost mortgage, they must give additional disclosures (including a disclosure on the face of the loan documents to apprise potential purchasers of the loan that it is a high-cost loan), avoid certain loan terms, and ensure the consumer receives additional protections, including homeownership counseling.

High-cost loans apply to credit transactions securing a consumer’s principal dwelling, including personal property manufactured home loans.  Therefore, non-principal dwelling loans for loans securing vacation or second homes are not covered under this rule.  I mention this due to the prevalence in the state of Texas for retirees who choose to have secondary homes and live the life of “winter Texans” half of the year.  As well as for the ranch and hunting lease related purchases many make in the state for homes that will not be their primary residence.

Assuming a loan is for a consumer’s principal dwelling, there are three triggering characteristics that will make a loan a high-cost loan:

  1. The APR on the loan exceeds the threshold of 6.5% above APOR (8.5% if the loan is for BOTH personal property AND less than $50,000).
    a. Note: the 6.5% threshold applies to a personal property loan for more than $50,000;
    b. The APOR is published weekly at http://www.ffiec.gov/ratespread/YieldTableFixed.CSV 
    c. The average APOR for year-to-date 2014 is approximately 4.4% for a 12-year term fixed rate loan. This would put the range of high-cost loans near 10.9%APR (or 12.9%APR for a personal property of less than $50,000)
  2. The points and fees exceed 5 percent of the total loan amount for a loan amount greater than or equal to $20,000; and exceed 8 percent of the total loan amount or $1,000 (whichever is less) for a loan amount less than $20,000; or
  3. The charge of a prepayment penalty is more than 36 months after consummation or account opening, or in an amount more than 2 percent of the amount prepaid.

Let’s say you exceed one of the thresholds and make a high-cost loan; what must you do?  There are specific disclosure requirements, restrictions on terms, restrictions on fees, ability to repay requirements and a pre-loan credit counseling requirement.

Disclosure Requirements

At least three days before a consumer enters into a loan the high-cost loan lender must Inform the consumer that the loan will not be effective until consummation, explain the consequences of default, disclose loan terms such as APR, amount borrowed, and monthly payment, and in the case of variable-rate loans, explain the maximum monthly payment that may be required under the terms of the loan or credit plan. 

The notice must say exactly the following: “You are not required to complete this agreement merely because you have received these disclosures or have signed a loan application. If you obtain this loan, the lender will have a mortgage on your home. You could lose your home, and any money you have put into it, if you do not meet your obligations under the loan.”

The rule provides a model disclosure form in Appendix H-16. To view the model disclosure click here: http://www.ecfr.gov/graphics/pdfs/er22de11.049.pdf 

Terms and Fees Restrictions

High-cost loan lenders are prohibited from the following:

  1. Having balloon payments (with four allowable exceptions),
  2. Prepayment penalties,
  3. Due-on-demand features (with three allowable exceptions),
  4. Recommending default on an existing loan to be refinanced by a high-cost mortgage,
  5. Charge a fee to modify, defer, renew, extend, or amend a high-cost mortgage,
  6. Late fees are restricted to 4 percent of the past due payment, and pyramiding of late fees is prohibited.
    a. There are rules for imposing late fees when a consumer resumes making payments after missing one or more payments.
  7. Charging fees for generation of payoff statements (with limited exceptions),
  8. Financing points and fees (i.e. rolled into the loan amount),
    a. However, you can finance closing charges excluded from the definition of points and fees, such as bona fide third-party charges including non-affiliated credit counseling fees.
  9. Structure a transaction to evade HOEPA coverage (for example, splitting a loan into two loans to divide the loan fees to avoid the points-and-fees threshold),
  10. Making a loan that has negative amortization,
  11. Making a loan that has a payment schedule that consolidates more than two periodic payments and pays them in advance from loan proceeds,
  12. Making a loan where the interest rate increases after default,
  13. In the case of acceleration as a result of default in payment, a refund of interest calculated in a manner less favorable to the consumer than the actuarial method,
  14. Paying a contractor under a home-improvement contract from the proceeds of a high-cost mortgage,
  15. Selling a high-cost mortgage in the secondary market without providing a high-cost mortgage notice to the assignee,
    a. Notice must read as follows: “Notice: This is a mortgage subject to special rules under the Federal Truth in Lending Act. Purchasers or assignees of this mortgage could be liable for all claims and defenses with respect to the mortgage that the consumer could assert against the creditor.”
  16. Refinancing any high-cost mortgage into another high-cost mortgage within one year after having extended credit, unless the refinancing is in the consumer’s interest.

Importantly, the disclosure to potential secondary market purchasers of loans that the mortgage is a high cost loan may affect the marketability of the loan.  The purchaser of such a loan is subject to all claims and defenses that the borrower may have against the original lender.  Recall also that if you wish to finance your lending operations by pledging loans to your local bank, your local bank will see that legend and pause before it lends against such collateral.  In short, if you make high-cost loans, plan to hold them in portfolio for the life of the loan, as you probably will not be able to sell or pledge such loans. 

Ability to Repay

The same general requirement that applies to all home loans also applies to high-cost loans.  The lender must make, “a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms.”  To satisfy the ability to repay requirement a lender must account for the eight provisions that provide the basis to determine if a consumer has a reasonable ability to repay.

Pre-loan Credit Counseling

After a consumer is given all of the high-cost disclosures previously mention and before making a high-cost mortgage, a lender must receive written certification that the consumer has received homeownership counseling on the advisability of the mortgage from a HUD-approved counselor or a state housing finance authority, if permitted by HUD.  The counselor must verify that the consumer received all of the high-cost disclosures. 

The counseling does not have to be an in-person meeting.  So long as the counselor is approved and independent from the lender the counseling can occur over the phone.  A lender can also receive the counselor certification via mail or email.

In order to pay for the counseling service there are three options – lender pays, consumer pays, or roll the fee into the mortgage loan.
To locate housing counselors go to this link: http://www.consumerfinance.gov/find-a-housing-counselor/


Now you understand the basics of what a high-cost loan is and what must happen in order for a lender to enter into a high-cost loan with a borrower.  All lenders differ on the loan products they are willing to offer, and some view high-cost loans as a lending space in which they do not want to participate.  However, others look at the additional restrictions, disclosures and provisions and do not view these conditions as so prohibitive as to preclude their offering high-cost loans to consumers.  The determination to make or not to make high-cost loans is up to each lender to decide for themselves.

As noted above, however, and important consideration a lender should think about is if the lender plans to sell, assign or borrow against a high-cost loan or a portfolio of loans containing high-cost loans.  If a lender needs to sell or leverage against their book of high-cost loans, then they should speak with their loan buyers or its commercial lenders to verify they will lend based on a portfolio of high-cost loans.