Variable rate mortgage loan

Fed eases variable-rate mortgage disclosures

The Federal Reserve Board's revisions to Regulation Z last November will enable credit unions to more easily comply with disclosure rules for closed-end, adjustable-rate mortgages.

The revisions affect the disclosure of a 15-year historical example of rates and payments. For variable-rate loans with terms exceeding one year and secured by a member's principal dwelling, the credit union can provide a statement that the periodic statement may substantially increase or decrease, together with a "worst-case" example of the maximum interest rate and payment based on a $10,000 loan, in lieu of having to provide a 15-year historical example of index values.

The revision still permits both disclosures. Under the prior law, however, it was mandatory to disclose both the 15-year historical example and the worst-case example. The previously required 15-year historical example of index values has been difficult to calculate and cumbersome to disclose. As such, most credit unions will probably opt to eliminate it from their programs and disclose only the worstcase example. Exercising this option will substantially reduce your regulatory burden of closed-end, adjustable-rate mortgage disclosures.

Reg Z covers two categories of credit transactions-open- and closed-end credit. Open-end credit is defined as a plan under which the creditor reasonably contemplates repeated transactions, and which provides for a finance charge that may be computed from time to time on the outstanding unpaid balance. A credit card is an example of open-end credit. Closed-end credit is defined as any credit arrangement that doesn't fall within the definition of open end.

In the amendments, which were passed as part of the Economic Growth and Regulatory Reduction Act of 1996, Congress amended only the closed-end requirements for adjustable-rate loans. Therefore, the revisions apply only to closedend, adjustable-rate mortgage disclosures.

There's a bill pending to eliminate the 15-year historical example from the early disclosures required for open-end home equity loans, but a hearing isn't scheduled until later this year.

Closed-end, variable-rate mortgages also must have a term of more than one year and be secured by the member's principal dwelling. These were the loans that required disclosure of the 15-year historical example before the revisions.

The closed-end rule, which is in 226.19(b) of Reg Z, applies to any closed-end loan (purchase money or not) secured by a consumer's home with a term longer than one year if the interest rate can increase after consummation of the loan. At the time an application form is provided to a member or before the member pays a nonrefundable fee, whichever is earlier, the credit union must give the member the following two items:

1. The board-prescribed Consumer Handbook on Adjustable Rate Mortgages (or a comparable substitute), and

2. A loan program disclosure for each variable-rate program in which the member expresses an interest.

Both the Consumer Handbook on Adjustable Rate Mortgages and the loan program disclosure are intended to provide the member with detailed information about variable-rate mortgage programs. In the loan program disclosure, the credit union was required to provide both a 15-year historical example as well as a worst-case example. The amendments now give credit unions the option of giving a statement that the periodic payments may increase or decrease substantially, along with a worst-case example based on a $10,000 loan, in lieu of the IS-year historical example.

Many creditors have wrestled with the complexity of disclosing the 15-year historical example. This option to eliminate the 15-year historical example in making closedend, adjustable-rate mortgages should reduce your regulatory burden. By taking advantage of the new amendments, you can disclose the worst-case example and opt to eliminate the historical example from your program disclosures.

The worst-case example must show the maximum interest rate and payment for a $10,000 loan originated at the initial interest rate. The final rule defines the initial interest rate-which will be used for the maximum rate and payment disclosure-as one in effect as of an identified month and year for the particular program. This eliminates any requirement for creditors to update the maximum rate and payment disclosure more frequently than the loan program disclosure.

Also, to clarify that the initial and maximum interest rates and payments should reflect any offered discount or premium, a definition of the initial interest rate is provided. This definition states that the initial interest rate is based on the index plus margin and adjusted by the amount of any discount or premium.

To conform with the Reg Z amendments, the Federal Reserve Board revised appropriate sections of Part 226, the Official Staff Commentary, and the sample clause and model forms of appendix H-4 and H-14. Appendix H-14 provides a model for the worstcase example. It states in part that "on a $10,000, 30-year loan with an initial interest rate of 12.41% in effect in July 1996, the maximum amount that the interest rate can rise under this program is five percentage points-to 17.41%. The monthly payment can rise from a firstyear payment of $106.03 to a maximum of $145.34 in the fourth year. To see what your payment is, divide your mortgage amount by $10,000; then multiply the monthly payment by that amount. (For example, the monthly payment for a mortgage amount of $60,000 would be: $60,000 divided by $10,000 = 6; 6 x 106.03 = $636.18 per month.)"

In calculating the worst-case example, the credit union must assume that the interest rate increases as rapidly as possible under the loan program, and the maximum payment disclosed should reflect the loan's amortization during this period. For example, in a loan that has an annual interest-rate cap of two percentage points and an overall cap of five percentage points, the maximum interest rate would be five percentage points higher than the initial interest rate disclosed. The loan, therefore, wouldn't reach the maximum interest rate until the fourth year because of the two-percentage-point annual rate limitations. The maximum payment disclosed would reflect the loan's amortization during this period.

Reg Z requires you to update the loan program disclosures once a year, after the new index values become available. You can choose to adopt the changes the next time you update your loan program disclosures.

Compliance is optional until Oct. 1, 1998.

-Reported by Eun Kim, compliance staff attorney, regulatory affairs department of CUNA's legal division