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   ARTICLE   |   From Scotsman Guide Residential Edition   |   December 2009

Pending Changes Require Attention

Changes to APR and yield-spread-premium calculation highlight Reg Z plan

The mortgage world could change dramatically in about a year as a result of a recent Federal Reserve Board proposal to make major alterations to the Truth in Lending Act (TILA). Those changes would alter the way annual percentage rate (APR) is calculated, create new disclosures for prospective borrowers and spell the end of yield-spread premiums (YSPs).

The Fed announced and published its proposal this past summer. The comment period ended Dec. 24. For brokers, it's wise not only to educate yourself about the changes but also to take advantage of comment periods.

About the changes

The Fed's proposed amendments to TILA apply to closed-end mortgage loans and home-equity lines of credit. They include new single-page disclosures, including one called "Key Questions to Ask About Your Mortgage" and another called "Fixed vs. Adjustable Rate Mortgages." The ARM document is designed to replace the "Consumer Handbook on Adjustable-Rate Mortgages" booklet.

Among other things, the Fed is proposing to include more loan closing costs in the calculation of APR. Mortgage brokers and compliance staffs have been vexed for years about which fees are considered prepaid finance charges -- and hence, included in the APR calculation -- and which are not. In about a year, if the proposal is finalized, APR will more accurately represent the costs of a loan.

The Fed also wants lenders to provide prospective borrowers with a chart showing how their proposed APR compares with the APRs offered to borrowers with excellent credit.

The issue garnering the most attention from mortgage brokers, however, is the Fed's proposal to "prohibit certain payments … based on the loan's terms or conditions." This would make it difficult, if not impossible, to be paid a YSP.

This form of indirect compensation that lenders pay to brokers is controversial because it can provide an incentive for brokers to charge borrowers higher rates. Some opponents of YSP consider it a kickback, and they have worked hard to eliminate the payment.

The Fed's proposal also wants to prohibit mortgage brokers from steering consumers to transactions not in their best interests.

Inside YSP thinking

The proposal's comments on YSP are uniformly negative. The Fed believes YSPs "can create financial incentives to steer consumers to riskier loans for which loan originators will receive greater compensation" and "present a significant risk of economic injury to consumers." Further, the Fed believes "consumers generally are not aware of loan originators' conflict of interest and cannot reasonably protect themselves against it."

The proposal does acknowledge that YSPs may provide some benefit to consumers. According to the Fed, this occurs when "consumers do not have to pay loan originators' compensation in cash or through financing."

The Fed, however, also notes that such a benefit may be outweighed when borrowers pay a higher interest rate or agree to a prepayment penalty or adjustable rate they otherwise may not have selected. The Fed goes as far as to say that payment of YSP may lead to deceptive lending practices.

This prohibition wouldn't apply to payments consumers make to brokers directly, though in those cases, brokers couldn't receive compensation from another party.

It seems clear the Fed has lost confidence in the power of disclosures, claiming even a disclosure that reveals or explains YSP "would be insufficient for most consumers to avoid the harm" caused by YSPs. Coincidentally, the new good-faith estimate the U.S. Department of Housing and Urban Development will require as of Jan. 1 forces brokers not only to disclose YSP but also to credit it to borrowers. Despite the contention by mortgage brokers that YSP can help borrowers pay closing costs and lead to more closed loans, this form of payment seems likely to disappear. 

(Editor's note: This past October, U.S. Rep. Gary Miller [R-Calif.] indicated Congress would address the YSP issue by merging House Resolution No. 1728, which passed the House, and House Resolution No. 3126, which passed the House Financial Services Committee. At press time, the Senate had yet to consider the bills.)


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