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Federal Reserve Bank OF DALLAS W IL L IA M H. W ALLACE F IR S T V IC E p r e s i d e n t NOVeillbGr 16 A N D C H IE F O P E R A T IN G O F F IC E R 1989 DALLAS, T E X A S 75222 5 Circular 89-71 TO: The Chief Executive Officer of all member banks, bank holding companies and others concerned in the Eleventh Federal Reserve District SUBJECT Slip sheets with amendments to the Official Staff Commentary on Regulation Z — Truth in Lending DETAILS The Board of Governors of the Federal Reserve System has published amendments in slip-sheet form to Regulation Z, effective September 1989. Also, enclosed is an amended slipsheet to Sections 226.5 and 226.9. The new slip sheets should be inserted in Volume 2 of your Regulations Binders. ATTACHMENTS The slip sheets are enclosed. MORE INFORMATION For more information, please contact Dean A. Pankonien at (214) 651-6228. Sincerely yours, For additional copies of any circular please conta c t the Public Affairs D ep artm en t at (214) 6 51 -6 2 8 9 . Banks and others are encouraged to use the follow ing incoming W A TS numbers in c ontacting this Bank (800) 4 4 2 -7 1 4 0 (intrastate) and (800) 5 2 7 -9 2 0 0 (interstate). This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) Board of Governors of the Federal Reserve System Corrections to Regulation Z Truth in Lending* • ___________________________ 1. Section 226.5a (a) (3) is corrected by adding the words "of the type" before the words "subject to the requirements of section 226.5b". 2. Section226.5a (g) (2) is corrected by deleting "and is figured in the same way as the first balance" from the last sentences of subpara graphs (i) and (ii). 3. Section 226.9 (e) (1) and (f) (1) are corrected by adding the words "of the type" before the words "subject to section 226.5a”. * A complete Regulation Z, as amended and corrected effective June 7,1989 consists of — • the pamphlet dated July 1989 (see inside cover) and • this slip sheet Board of Governors of the Federal Reserve System Amendments to the Official Staff Commentary on Regulation Z Truth in Lending September 1989* The following amendments are effective Feb ruary 28, 1989, or, at the creditor’s option, October 1, 1989. 4 (b ) Examples o f Finance Charges * * * * * Paragraphs 4(b)(7) and (8) S E C T IO N 226.2— D efinitions an d R ules o f C o n stru c tio n 2 ( a ) D efinitions * * * * * 2(a) (25) ‘‘S ecurity Interest’’ * * * * * 6. Specificity o f disclosure. A creditor need not separately disclose multiple security inter ests that it may hold in the same collateral. The creditor need only disclose that the trans action is secured by the collateral, even when security interests from prior transactions re main of record and a new security interest is taken in connection with the transaction. * * * * * * * * * 2. Insurance written in connection with a transaction. Insurance sold after consumma tion in closed-end credit transactions or after the opening of a plan in open-end credit trans actions is not “written in connection with” the credit transaction if the insurance is writ ten because of the consumer’s default (for ex ample, by failing to obtain or maintain re quired property insurance) or because the consumer requests insurance after consumma tion or the opening of a plan (although credit sale disclosures may be required for the insur ance sold after consummation if it is financed). • * * * * * S E C T IO N 226.4— F in an c e C h a rg e SUBPART C— CLOSED-END CREDIT 4 ( a ) D efinition * * * * * 3. Charges by third parties. * * * in con trast, charges imposed on the consumer by someone other than the creditor are finance charges (unless otherwise excluded) if the creditor requires the services of the third par ty. For example: • A fee charged by a loan broker if the con sumer cannot obtain the same credit terms from the creditor without using a broker. * * * * * * The complete Regulation Z commentary, as amended effective February 28, 1989, consists of— • the commentary pamphlet dated June 1988 and • this slip sheet. SECTION 226.17— General Disclosure Requirements 17(a) Form of Disclosures Paragraph 17(a)(1) * * * * * 5. Directly related. * * * The disclosures set forth under section 2 2 6 .18(0(1) for variable-rate transactions subject to section 2 26 .18 (0(2 ). • * * * * 17(c) Basis of Disclosures and Use of Estimates l Regulation Z § 226.17 Paragraph 17(c)(1) * • * * * 8. Basis o f disclosures in variable-rate transac tions. The disclosures for a variable-rate transaction must be given for the full term of the transaction and must be based on the terms in effect at the time of consummation. Creditors should base the disclosures only on the initial rate and should not assume that this rate will increase. For example, in a loan with an initial rate of 10 percent and a 5 percentage points rate cap, creditors should base the dis closures on the initial rate and should not as sume that this rate will increase 5 percentage points. However, in a variable-rate transaction with a seller buydown that is reflected in the credit contract, a consumer buydown, or a discounted or premium rate, disclosures should not be based solely on the initial terms. In those transactions, the disclosed annual percentage rate should be a composite rate based on the rate in effect during the initial period and the rate that is the basis of the variable-rate feature for the remainder of the term. (See the commentary to section 226.17(c) for a discussion of buydown, dis counted, and premium transactions and the commentary to section 226.19(a)(2) for a discussion of the redisclosure in certain resi dential mortgage transactions with a variablerate feature). * * * * * [Comments 14 and 15 are redesignated 15 and 16.) 14. Reverse mortgages. Reverse mortgages, also known as reverse annuity or home equity conversion mortgages, typically involve the disbursement of monthly advances to the con sumer for a fixed period or until the occur rence of an event such as the consumer’s death. Repayment of the loan (generally a single payment of principal and accrued inter est) may be required to be made at the end of the disbursements or, for example, upon the death of the consumer. In disclosing these transactions, creditors must apply the follow ing rules, as applicable: • If the reverse mortgage has a specified peri2 od for disbursements but repayment is due only upon the occurrence of a future event such as the death of the consumer, the cred itor must assume that disbursements will be made until they are scheduled to end. The creditor must assume repayment will occur when disbursements end (or within a peri od following the final disbursement which is not longer than the regular interval between disbursements). This assumption should be used even though repayment may occur be fore or after the disbursements are sched uled to end. In such cases, the creditor may include a statement such as “The disclo sures assume that you will repay the loan at the time our payments to you end. As pro vided in your agreement, your repayment may be required at a different time.” • If the reverse mortgage has neither a speci fied period for disbursements nor a specified repayment date and these terms will be de termined solely by reference to future events including the consumer’s death, the creditor may assume that the disbursements will end upon the consumer’s death (esti mated by using actuarial tables, for exam ple) and that repayment will be required at the same time (or within a period following the date of the final disbursement which is not longer than the regular interval for dis bursements). Alternatively, the creditor may base the disclosures upon another fu ture event it estimates will be most likely to occur first. (If terms will be determined by reference to future events which do not in clude the consumer’s death, the creditor must base the disclosures upon the occur rence of the event estimated to be most like ly to occur first.) • In making the disclosures, the creditor must assume that all disbursements and accrued interest will be paid by the consumer. For example, if the note has a nonrecourse pro vision providing that the consumer is not obligated for an amount greater than the value of the house, the creditor must none theless assume that the full amount to be disbursed will be repaid. In this case, how ever, the creditor may include a statement such as “The disclosures assume full repay ment of the amount advanced plus accrued § 226.19 Regulation Z interest, although the amount you may be required to pay is limited by your agreement.” • Some reverse mortgages provide that some or all of the appreciation in the value of the property will be shared between the con sumer and the creditor. Such loans are con sidered variable-rate mortgages, as de scribed in comment 1 7 ( c ) ( l ) - ll, and the appreciation feature must be disclosed in accordance with section 226.18(0(1)- If the reverse mortgage has a variable interest rate, is written for a term greater than one year, and is secured by the consumer’s prin cipal dwelling, the shared-appreciation fea ture must be described under section 226.19(b)(2) (vii). » * • * * SECTION 226.18— Content of Disclosures * * * * • 18(f) Variable Rate * * * * * Paragraph 18(f)(2) 1. Disclosure required. * * * (See the com mentary to section 226.17(a)(1) regarding the disclosure of certain directly related infor mation in addition to the variable-rate disclo sures required under section 2 2 6 .1 8 (0 (2 ).) * * * * * SECTION 226.19— Certain Residential Mortgage Transactions * * * * * 19(b) Certain Variable-Rate Transactions 1. Coverage. * * * In determining whether a construction loan that may be permanently financed by the same creditor is covered under this section, the creditor may treat the con struction and the permanent phases as sepa rate transactions with distinct terms to matu rity or as a single combined transaction. For purposes of the disclosures required under section 226.18, the creditor may nevertheless treat the two phases either as separate trans actions or as a single combined transaction in accordance with section 226.17(c)(6). Final ly, in any assumption of a variable-rate trans action secured by the consumer’s principal dwelling with a term greater than one year, disclosures need not be provided under sec tions 226.1 8 (0 (2 )(ii) or 226.19(b). * * * * * Paragraph 19(b)(2) 1. Disclosure fo r each variable-rate pro gram. A creditor must provide disclosures to the consumer that fully describe each of the creditor’s variable-rate loan programs in which the consumer expresses an interest. If a program is made available only to certain cus tomers of an institution, a creditor need not provide disclosures for that program to other consumers who express a general interest in a creditor’s ARM programs. Disclosures must be given at the time an application form is provided or before the consumer pays a nonrefundable fee, whichever is earlier. If pro gram disclosures cannot be provided because a consumer expresses an interest in individual ly negotiating loan terms that are not general ly offered, disclosures reflecting those terms may be provided as soon as reasonably possi ble after the terms have been decided upon, but not later than the time a nonrefundable fee is paid. If a consumer who has received program disclosures subsequently expresses an interest in other available variable-rate pro grams subject to section 226.19(b)(2), or the creditor and consumer decide on a program for which the consumer has not received dis closures, the creditor must provide appropri ate disclosures as soon as reasonably possible. The creditor, of course, is permitted to give the consumer information about additional programs subject to section 226.19(b) initially. 2. Variable-rate loan program defined. If the identification, the presence or absence, or the exact value of a loan feature must be disclosed under this section, variable-rate loans that dif fer as to such features constitute separate loan programs. For example, separate loan pro grams would exist based on differences in any of the following loan features: * * * 3 Regulation Z § 226.19 In addition, if a loan feature must be taken into account in preparing the disclosures re quired by section 226.19(b)(2)(viii) and (x), variable-rate loans that differ as to that feature constitute separate programs under section 226.19(b)(2). If, however, a representative value may be given for a loan feature or the feature need not be disclosed under section 226.19(b)(2), variable-rate loans that differ as to such features do not constitute separate loan programs. For example, separate loan programs would not exist based on differences in the following loan features: * * * [Comments 3 and 4 are redesignated 4 and 5. ] 3. Form o f program disclosures. A creditor may provide separate program disclosure forms for each ARM program it offers or a single disclosure form that describes multiple programs. A disclosure form may consist of more than one page. For example, a creditor may attach a separate page containing the his torical payment example for a particular pro gram. A disclosure form describing more than one program need not repeat information ap plicable to each program that is described. For example, a form describing multiple pro grams may disclose the information applicable to all of the programs in one place with the various program features (such as options permitting conversion to a fixed rate) dis closed separately. The form, however, must state if any program feature that is described is available only in conjunction with certain other program features. Both the separate and multiple program disclosures may illustrate more than one loan maturity or payment am ortization—for example, by including multiple-payment and loan-balance columns in the historical payment example. Disclosures may be inserted or printed in the Consumer H and book (or a suitable substitute) as long as they are identified as the creditor’s loan-program disclosures. * • * * * Paragraph 19(b)(2)(iii) 1. Determination o f interest rate and pay ment. This provision requires an explana tion of how the creditor will determine the 4 consumer’s interest rate and payment. In cas es where a creditor bases its interest rate on a specific index and adjusts the index through the addition of a margin, for example, the dis closure might read, “Your interest rate is based on the index plus a margin, and your payment will be based on the interest rate, loan balance, and remaining loan term.” In transactions where paying the periodic pay ments will not fully amortize the outstanding balance at the end of the loan term and where the final payment will equal the periodic pay ment plus the remaining unpaid balance, the creditor must disclose this fact. For example, the disclosure might read, “Your periodic payments will not fully amortize your loan and you will be required to make a single pay ment of the periodic payment plus the remain ing unpaid balance at the end of the loan term.” The creditor, however, need not reflect any irregular final payment in the historical example or in the disclosure of the initial and maximum rates and payments. If applicable, the creditor should also disclose that the rate and payment will be rounded. * * * * * Paragraph 19(b)(2)(v) 1. Discounted and prem ium interest rate. * * * In a transaction with a consumer buy down or with a third-party buydown that will be incorporated in the legal obligation, the creditor should disclose the program as a dis counted variable-rate transaction, but need not disclose additional information regarding the buydown in its program disclosures. • * * Paragraph 19(b)(2)(vi) 1. Frequency. * * * In certain ARM trans actions, the interval between loan closing and the initial adjustment is not known and may be different from the regular interval for ad justments. In such cases, the creditor may dis close the initial adjustment period as a range of the minimum and maximum amount of time from consummation or closing. For ex ample, the creditor might state: “The first ad justment to your interest rate and payment will occur no sooner than 6 months and no later than 18 months after closing. Subsequent Regulation Z § 226.19 adjustments may occur once each year after the first adjustment." (See comments 19(b) (2) (viii)-7 and 19(b) (2) (x)-4 for guidance on other disclosures when this alter native disclosure rule is used.) Paragraph I9(b)(2)(vii) 1. Rate and paym ent caps. * * * The credi tor need not disclose each periodic or overall rate limitation that is currently available. As an alternative, the creditor may disclose the range of the lowest and highest periodic and overall rate limitations that may be applicable to the creditor’s ARM transactions. For ex ample, the creditor might state: “The limita tion on increases to your interest rate at each adjustment will be set at an amount in the following range: between 1 and 2 percentage points at each adjustment. The limitation on increases to your interest rate over the term of the loan will be set at an amount in the follow ing range: between 4 and 7 percentage points above the initial interest rate.” A creditor us ing this alternative rule must include a state ment in its program disclosures suggesting that the consumer ask about the overall rate limitations currently offered for the creditor’s ARM programs. (See comments 19(b)(2) (viii)-6 and 19(b) (2) (x)-3 for an explana tion of the additional requirements for a credi tor using this alternative rule for disclosure of periodic and overall rate limitations. * * • • • Paragraph 19(b)(2)(viii) 1. Index movement. * • * For the remain ing ten years, 1982-1991, the creditor need only show the remaining index values, margin and interest rate and must continue to reflect all significant loan program terms such as rate limitations affecting them. * * * * • * • • 5. Term o f the loan. In calculating the pay ments and loan balances in the historical ex ample, a creditor need not base the disclosures on each term to maturity or payment amorti zation that it offers. Instead, disclosures for ARM s may be based upon terms to maturity or payment amortizations of 5, 15 and 30 years, as follows: ARM s with terms or am or tizations from over 1 year to 10 years may be based on a 5-year term or amortization; ARMs with terms or amortizations from over 10 years to 20 years may be based on a 15year term or amortization; and ARM s with terms or amortizations over 20 years may be based on a 30-year term or amortization. Thus, disclosures for ARMs offered with any term from over 1 year to 40 years may be based solely on terms of 5, 15 and 30 years. Of course, a creditor may always base the disclo sures on the actual terms or amortizations of fered. If the creditor bases the disclosures on 5-, 15- or 30-year terms or payment amortiza tions as provided above, the term or payment amortization used in making the disclosure must be stated. 6. Rate caps. A creditor using the alterna tive rule described in comment 19(b)(2) (vii)-l for disclosure of rate limitations must base the historical example upon the highest periodic and overall rate limitations disclosed under section 226.19(b) ( 2 ) (vii). In addition, the creditor must state the limitations used in the historical example. (See comment 19(b) (2) (x)-3 for an explanation of the use of the highest rate limitation in other disclosures.) 7. Frequency o f adjustments. In certain transactions, creditors may use the alternative rule described in comment 19(b) (2 )(v i)-l for disclosure of the frequency of rate and payment adjustments. In such cases, the cred itor may assume for purposes of the historical example that the first adjustment occurred at the end of the first full year in which the ad justment could occur. For example, in an A RM in which the first adjustment may occur between 6 and 18 months after closing and annually thereafter, the creditor may assume that the first adjustment occurred at the end of the first year in the historical example. (See comment 19(b) (2) (x)-4 for an explanation of how to compute the maximum interest rate and payment when the initial adjustment peri od is not known.) Paragraph I9(b)(2)(ix) 1. Calculation o f payments. A creditor is re quired to include a statement on the disclo5 Regulation Z § 226.19 sure form that explains how a consumer may calculate his or her actual monthly payments for a loan amount other than $10,000. The example should be based upon the most recent payment shown in the historical example. However, in transactions in which the latest payment is shown in the historical example is not for the latest year of index values shown (such as in a five-year loan), a creditor may provide additional examples based on the ini tial and maximum payments disclosed under section 226.1 9 (b )(2 )(x ). The creditor, how ever, is not required to calculate the consum er’s payments. (See the model clauses in ap pendix H -4(C ).) and maximum rates and payments upon the earliest possible first adjustment disclosed un der section 226.1 9(b )( 2 ) (vi). (See comment 19 (b)(2)(viii)-7 for an explanation of how to disclose the historical example when the ini tial adjustment period is not known.) Paragraph 19(b)(2)(x) Paragraph 20(c)(4) * * * * * 2. Term o f the loan. In calculating the ini tial and maximum payments, the creditor need not base the disclosures on each term to maturity or payment amortization offered un der the program. Instead, the creditor may follow the rules set out in comment 19(b)(2)(viii)-5. In calculating the initial and maximum payment, the terms to maturity or payment amortizations selected for the purpose of making disclosures under section 226.19(b)(2) (viii) must be used. In addition, creditors must state the term or payment am ortization used in making the disclosures un der this section. 3. Rate caps. A creditor using the alterna tive rule for disclosure of interest rate limita tions described in comment 1 9 (b )(2 )(v ii)-l must calculate the maximum interest rate and payment based upon the highest periodic and overall rate limitations disclosed under section 226.19(b)(2)(vii). In addition, the creditor must state the rate limitations used in calcu lating the maximum interest rate and pay ment. (See comment 19(b)(2) (viii)-6 for an explanation of the use of the highest rate limi tation in other disclosures.) 4. Frequency o f adjustments. In certain transactions, a creditor may use the alterna tive rule for disclosure of the frequency of rate and payment adjustments described in com ment 1 9 (b )(2 )(v i)-l. In such cases, the cred itor must base the calculations of the initial 6 * * * * * S E C T IO N 226.20— Subsequent D isclosure R eq u irem en ts * * * * * 2 0 (c )V a ria b le -R a te A d ju stm en ts * * * * * 1. Contractual effects o f the adjustment. The contractual effects of an interest rate adjust ment must be disclosed including the payment due after the adjustment is made whether or not the payment has been adjusted. In trans actions where paying the periodic payments will not fully amortize the outstanding bal ance at the end of the loan term and where the final payment will equal the periodic payment plus the remaining unpaid balance, the amount of the adjusted payment must be dis closed if such payment has changed as a result of the rate adjustment. A contractual effect of a rate adjustment would include, for example, • * * Paragraph 20(c)(5) 1. Fully amortizing payment. This para graph requires a disclosure only when nega tive amortization occurs as a result of the ad justment. A disclosure is not required simply because a loan calls for non-amortizing or partially amortizing payments. For example, in a transaction with a five-year term and pay ments based on a longer amortization sched ule, and where the final payment will equal the periodic payment plus the remaining un paid balance, the creditor would not have to disclose the payment necessary to fully amor tize the loan in the remainder of the five-year term. A disclosure is required, however, if the payment disclosed under section 226.20(c) (4) is not sufficient to prevent negative amor tization in the loan. The adjustment notice Regulation Z • § 226.20 must state the payment required to prevent negative amortization. (This paragraph does not apply if the payment disclosed in section 226.20(c)(4) is sufficient to prevent negative amortization in the loan but the final payment will be a different amount due to rounding.) * * * • • 7
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