Federal Reserve Board Issues Proposed Rule Under Regulation Z Concerning A Consumer’s Ability To Pay and Minimum Mortgage Underwriting Standards

On Tuesday, April 19, 2011 the Federal Reserve Board officially requested public comment on a proposed rule under Regulation Z (12 CFR 226), which implements the Truth in Lending Act (TILA). The proposed rule requires a creditor to determine whether a consumer has the ability to repay a mortgage prior to making the loan as well as establishing certain minimum mortgage underwriting standards. The rule also adds certain limitations on prepayment penalties.

These changes are being made pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act.

As summarized by the Federal Reserve Board,

"the proposal... provide[s] four options for complying with the ability-to-repay requirement.

• First, a creditor can meet the general ability-to-repay standard by considering and verifying specified underwriting factors, such as the consumer’s income or assets.


• Second, a creditor can make a "qualified mortgage" which provides the creditor with special protection from liability provided the loan does not have certain features, such as negative amortization; the fees are within specified limits; and the creditor underwrites the mortgage payment using the maximum interest rate in the first five years. The Board is soliciting comment on two alternative approaches for defining a "qualified mortgage."


• Third, a creditor operating predominantly in rural or underserved areas can make a balloon-payment qualified mortgage. This option is meant to preserve access to credit for consumers located in rural or underserved areas where banks originate balloon loans to hedge against interest rate risk for loans held in portfolio.


• Finally, a creditor can refinance a "non-standard mortgage" with risky features into a more stable "standard mortgage" with a lower monthly payment. This option is meant to preserve access to streamlined refinancings."

The comment period is open until July 22, 2011. As the Consumer Financial Protection Bureau (CFPB) is set to obtain rulemaking authority over the TILA on July 21, the CFPB will be disseminating the finalized rule.

The largest thing of note, are the two alternative approaches for defining a "qualified mortgage." As set forth by the rule, it is a loan that provides special protections from liability and it shields creditors from a need to retain 5% of the risk on all loans sent to the secondary market. This element is the most influential portion of the rule, and the one likely to cause the most contention.

See the original release from the Federal Reserve Board to learn more.