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Lenders Are Required to Disclose Terms For Bad Credit Loans

The Homeownership and Equity Protection Act of 1994 was enacted to offer consumers protection regarding certain home-equity loans that may charge high interest rates and high fees. This act does not limit the finance charges or rates that may be imposed on such loans, but it requires lenders to offer several disclosures to potential borrowers making them fully aware of the the applicable loan terms.

It amends the Truth in Lending Act (TILA) to define a class of non-purchase or non-construction loans with high interest rates or up-front fees. To ensure that consumers understand the terms of such loans and are protected from high pressure sales tactics, the legislation requires creditors making such loans to provide a special, streamlined disclosure three days before consummation of the transaction, in addition to the other disclosures required by the TILA. The bill also restricts the use of certain loan terms such as negative amortization and balloon payments that have proven particularly problematic. Finally, the bill provides increased civil liability for failure to comply with the requirements for such loans and enables a borrower to assert all claims and defenses against an assignee of the mortgage that could be asserted against the originator.

'The Homeownership and Equity Protection Act of 1994' defines certain loans as (103(aa) loans)

. This category is made up of closed-end loans secured by a consumer's principal dwelling, but not obtained for purchase or construction of the dwelling, in which:

1. the annual percentage rate is more than 10 percentage points greater than the yield on a Treasury security of comparable maturity; or
2. points and fees exceed the greater of 8% of the loan amount or $400. This amount includes compensation paid to brokers.

The definition specifically excludes open end credit transactions and reverse mortgage transactions.

The above points and fees include certain fees listed in Section 106(e) of the TILA such as fees paid to a third party for title examination, document preparation, credit reports, notary services, and appraisal, unless the charges meet three criteria.

1. The charge must be reasonable.
   'Reasonableness' will be interpreted consistently with interpretations of the existing reasonableness standard necessary to exclude such charges from the finance charge under Regulation Z (226.4(c)(7)).
   
   
2. The creditor must not receive direct or indirect compensation for such charges.
3. The fee must be paid to a third party unaffiliated with the creditor.

As such information is readily available to the creditor, it is the creditor's burden to establish that any such charge meets these three criteria for exclusion.

The Federal Reserve Board has authority to include additional charges in calculating the triggers, such as credit insurance premiums, if evidence establishes that such charges are being used to circumvent or evade the provisions of this legislation. The Federal Reserve Board is also provided authority to adjust the 10% trigger between 8% and 12% to reflect changes in the credit markets.

The act defines the specific disclosures required for 103(aa) loans as `material disclosures', thereby providing the consumer with a right of rescission (as with other TILA disclosures) for up to three years in the event that the required disclosures are not provided.

LENDERS MUST PROVIDE THE FOLLOWING DISCLOSURES TO BORROWERS of 103(aa) loans:

• Prior to originating such a mortgage, a creditor must conspicuously disclose that the consumer could lose his/her home for failure to meet the loan obligations and is not obligated to complete the agreement.
• The creditor must disclose the annual percentage rate and the regular monthly payment or, for a variable rate loan, the annual percentage rate, monthly payment, and a statement that the interest rate and monthly payment can increase. Variable rate transactions must also indicate the maximum possible monthly payment possible under the loan. The Competitive Equality Banking Act of 1987 requires all variable rate transactions to include interest rate caps.
• The creditor must provide the required disclosures in writing at least three days before consummation of the transaction. Lenders are also prohibited from making subsequent changes in the loan terms that affect the APR or monthly payment unless revised disclosures are provided in writing three days prior to consummation. The Federal Reserve Board may modify or waive the disclosures for bona fide emergencies.
• The legislation provides that revised disclosures may be provided by telephone if the changes in loan terms are initiated by the consumer and the parties certify in writing at consummation that the telephone disclosures were provided three days prior to closing.

PROHIBITED TERMS ON SECTION 103(aa) loans:

• Default interest rates higher than the rate prior to default
• Balloon payments if the loan term is shorter than 5 years
• Negative amortization
• Prepaid payments of more than 2 periodic payments consolidated and paid in advance from the loan proceeds
• Payment to a home improvement contractor other than in a form payable to the consumer or jointly to the consumer and contractor, or, at the election of the consumer, to an escrow agent.
• prepayment penalties
  The term 'prepayment penalty' includes any refund of unearned scheduled interest that is computed by a method that is less favorable than the actuarial method, as defined in section 933(d) of the Housing and Community Development Act of 1992. (Some states impose their own guidelines for lenders regarding this issue) This reference is not intended to be limiting, however, and common forms of prepayment penalties such as percentages of outstanding balance or number of months of interest are also prohibited under the legislation.
• This act also prohibits creditors from engaging in a pattern or practice of extending mortgage credit to consumers through Sec. 103(aa) loans unless they have given consideration to a consumer's current or expected income, current obligations, repayment capacity, or employment. These underwriting factors are intended to be illustrative, and not prescriptive or restrictive. Assessing the expected income of an employed borrower, for example, would not be necessary. Such an assessment, however, would be necessary for an unemployed borrower.