CUNA Comment Letter

Docket No. R-1090, Proposed Revisions to Regulation Z (Home Ownership and Equity Protection Act)

March 9, 2001

Ms. Jennifer J. Johnson
Board of Governors of the
Federal Reserve System
20th Street and Constitution Avenue, NW
Washington, DC 20551

Re: Docket No. R-1090, Proposed Revisions to Regulation Z (Home Ownership and Equity Protection Act)

Dear Ms. Johnson:

The Credit Union National Association (CUNA) appreciates the opportunity to comment on the proposed revisions to Regulation Z, which implements the Home Ownership and Equity Protection Act (HOEPA). The proposed revisions, which appeared in the Federal Register on December 26, 2000, will broaden the scope of mortgage loans subject to HOEPA by adjusting the thresholds used to determine which loans are covered under HOEPA. The proposal will also prohibit certain additional acts and practices in connection with mortgage loans, strengthen current prohibitions, and enhance the disclosures that borrowers receive prior to the closing of loans covered under HOEPA.

CUNA represents more than 90 percent of our nation’s 10,700 state and federal credit unions. This letter reflects the views of our member credit unions and of CUNA's Consumer Protection Subcommittee, chaired by Kris Mecham, CEO of Deseret First Credit Union, Salt Lake City, Utah.

Summary of CUNA’s Position

General Comments

The proposed revisions to Regulation Z will lower the APR thresholds used to determine which loans are covered under HOEPA from ten to eight percentage points above comparable United States Treasury securities. The fee-based thresholds will also be modified to include optional insurance premiums and similar credit protections that are paid for at closing. Certain acts will also be prohibited, such as “due-on-demand-- clauses and the refinancing of certain loans when such refinancing is not in the borrowers’ best interest. The proposed revisions will also strengthen the current prohibitions against making loans without considering the ability to repay and will enhance the disclosures that borrowers receive regarding the financing of additional products or services.

CUNA generally supports the proposed changes to the HOEPA provisions of Regulation Z, which are intended to combat abusive predatory lending practices and are directed primarily at high-priced mortgage loans. The advantage to addressing predatory lending issues through HOEPA is that this is a targeted approach. This contrasts with the proposed changes to Regulation C, the Home Mortgage Disclosure Act (HMDA), that are also intended to address predatory lending practices but apply to all lenders, including credit unions, which have not been involved in these abusive practices. CUNA’s concerns with regard to the HMDA revisions are addressed in a separate comment letter.

CUNA condemns predatory lending practices and has issued ethical standards that are contained in the CUNA Member Credit Union Mortgage Lending Standards and Ethical Guidelines. In this document, CUNA’s Board of Directors calls on every CUNA member credit union to adopt a series of home lending standards and ethical guidelines that will help emphasize credit unions’ concern for consumers and further distinguish credit unions as institutions that care more about people than money.

CUNA also supports additional changes to the HOEPA provisions of Regulation Z that may help advance the goal of eradicating abusive predatory lending practices. These changes address the issue of single premium credit life insurance and prepayment penalties. The change regarding single premium credit life insurance is intended to be acceptable to both mainstream financial institutions and those that would advocate a complete ban on the practice of providing such insurance. CUNA’s position on these issues is discussed below, followed by comments regarding the changes contained in the current proposal.

Single-Premium Credit Life Insurance Financed Over a Long Time Period Should be Prohibited

After reviewing the proposed rule and the issue of single-premium credit life insurance in general, CUNA believes that single-premium insurance that is financed over a much longer period of time than the term of the insurance should be prohibited. Such a practice is one of the most abusive predatory lending practices with little benefit for borrowers.

Credit life insurance is a loan product generally paid for by the borrower that repays the lender should the borrower die. Single premium credit insurance is not inherently predatory. It has been successfully written for many years by many reputable financial institutions with few problems. Unfortunately, by severing the connection between the term of the loan and the coverage period of the insurance, predatory lenders have seriously diminished the value of the product.

Credit insurance premiums that are financed into the loan up-front in a lump sum and amortized over a long period of time, such as thirty years, do little more than strip equity from homeowners. Although benefits will be paid if the borrower dies or is injured, it just does not make sense to finance this insurance over such a long period of time.

By way of illustration, if $10,000 of insurance premiums is financed over a thirty-year period using a 16% interest rate, only $104 of the premium amount will be repaid during the first five years. The borrower will still owe $9,896, or about 99% of the original credit insurance premium, yet the insurance has expired. If the borrower then refinances the subprime loan with the same or another lender, almost the entire amount of the financed premium is stripped directly out of the borrower’s equity. Borrowers will not realize the impact on their equity until it is too late.

This method of stripping equity has been widely criticized. Fannie Mae, Freddie Mac, the United States Department of Treasury (Treasury), the Department of Housing and Urban Development (HUD), Congressional Democrats (by way of bills introduced last year by Paul Sarbanes (D-MD) and John LaFalce (D-NY)), the Federal Home Loan Bank of Atlanta, and the North Carolina Generally Assembly, among others, have all condemned this practice.

CUNA is concerned that the current proposal of including these costs in the definition of “points and fees-- may not adequately address the problems posed by the long-term amortization of financed credit insurance premiums. In these situations, unscrupulous lenders are currently trying to hide the fact that the borrower is obtaining credit insurance or will lead the borrower to believe that credit insurance is required or strongly recommended by the lender. Regardless of any disclosure requirements, there will certainly be an incentive to continue this practice to the extent possible. As noted in the Joint HUD/Treasury Report on Recommendations to Curb Predatory Home Mortgage Lending that was issued on June 20, 2000, lenders receive, on average, a 30% up-front commission.

Homeowners will benefit enormously from the additional equity they will retain as a result of the prohibition of long-term amortization of financed credit insurance. Again, we are not advocating the prohibition of credit insurance, but rather the prohibition of the use of mortgage proceeds to purchase a single-premium policy that is amortized over a much longer term than the term of the insurance. Interested homeowners will still be able to purchase this product at a reasonable cost, either on a monthly, nonfinanced basis or financed over a relatively short period of time.

Prepayment Penalties for HOEPA Loans Should be Prohibited or Included in the Definition of “Points and Fees--

The legitimate subprime sector serves an important function for borrowers who encounter temporary credit problems that keep them from receiving low-rate conventional loans. This sector should provide borrowers a bridge to conventional financing as soon as the borrower qualifies to make the transition.

However, subprime loans become abusive when they prevent borrowers from making this transition when their credit improves. This is exactly what results from prepayment penalties because these penalties either trap borrowers into paying high interest rates when they may no longer have to or the amount of the penalty is stripped out of the equity as punishment for obtaining a better loan. Such borrowers should not be penalized for trying to improve their financial situation. One way to remedy this situation is to prohibit prepayment penalties for HOEPA loans.

Subprime borrowers are generally not aware of these penalties. According to Duff and Phelps, 80% of subprime loans have prepayment penalties, while only 2% of the conventional loans have such penalties. Rational subprime borrowers would simply not prefer such fees at a rate significantly higher than the rate for conventional borrowers. In fact, rational subprime borrowers should prefer such penalties at a lower rate than conventional borrowers because subprime borrowers would want to refinance into a conventional loan as soon as possible. This information indicates that borrowers are either unaware of these penalties or do not understand the situations that will require them to pay such penalties.

In these situations, prepayment penalties are merely hidden, deferred fees that strip significant equity from the subprime borrowers who refinance or move, often as a result of the financial hardship created by these loans. Prepayment penalties of six months of interest for paying off a loan within the first five years are common, which is usually equivalent to several thousands of dollars that are stripped directly from the borrower’s equity. These penalties are paid by more than one-half of all subprime borrowers. Extrapolating these figures nationwide leads us to conclude that up to 350,000 homeowners per year may lose well over $2 billion dollars of home equity as a result of these hidden prepayment penalties.

An alternative to banning prepayment penalties could be to include such penalties in the HOEPA definition of “points and fees.-- At the very least, one-half of the penalties could be included in this definition, to reflect that about half of all borrowers of HOEPA loans will eventually have to pay these penalties.

The Proposal Restricting the Refinancing of Certain Low-rate Loans Would be Burdensome for all Lenders and the Benefits Would not Outweigh these Burdens

The proposed rule will prohibit lenders in the first five years of a “low-cost-- loan from replacing that loan with a higher rate loan, unless the refinancing is in the borrower’s interest. Unlike the other provisions of the proposed rule, this proposal will affect all lenders, regardless of whether the lender is making HOEPA loans. As noted in our comment letter to the Board in response to the proposed changes to the regulations that implement HMDA, we do not support regulatory changes addressing predatory lending practices that apply to all lenders, including credit unions, which have not been involved in these abusive practices.

Under this proposal, all lenders, not just those that make HOEPA loans, will be required to obtain details about the borrower’s existing loan in order to determine if it meets the definition of “low-cost.-- This includes information about the APR and the commencement date. Since the definition of “low-cost-- is based on comparable Treasury securities, lenders will also be required to maintain current information about the yields on these Treasury securities and their maturities and to compare those yields with the loan APR. Lenders will also have to evaluate and document the benefits to borrowers that want to refinance these “low-cost-- loans.

Gathering, evaluating, and maintaining this additional information will result in significant costs for all lenders, including those that do not engage in high-cost lending. We do not believe the benefits of this proposal will outweigh such costs.

The Board Should Clarify the Terms “Borrowers’ Best Interest-- and “Totality of the Circumstances--

Under the proposed rule, a lender holding a HOEPA loan will be prohibited from refinancing that loan within the first twelve months, unless the refinancing is in the “borrower’s best interest.-- The proposed rule will also prohibit lenders in the first five years of a zero interest rate or other low-cost loan from replacing that loan with a higher-rate loan, unless the refinancing is in the “borrower’s best interest.--

The term “borrowers’ best interest-- needs to be clarified further, and we urge the Board to include specific criteria in the final rule. Otherwise, this determination of “best interest-- can be very subjective and there can reasonable disagreement as to its meaning. For example, some may believe that refinancing at a higher rate is always against the borrowers’ best interest, and this may generally be the case. However, this may not always be true, such as when a borrower may need to refinance to borrow additional funds. It may still be in the “borrower’s best interest-- to accept such a loan even if the borrower may no longer qualify for the same interest rate as before due to recent instances that resulted in a deteriorating credit report.

The same need for clarification also applies to the term “totality of the circumstances,-- which is analyzed in determining if the refinancing of a HOEPA loan within the first twelve months is in the borrower’s best interest.

A review of the “totality of the circumstances-- is also referenced when determining whether the lender has engaged in a “pattern or practice-- of making HOEPA loans without considering the borrowers ability to repay the loan, which is currently prohibited under HOEPA.

There Should be an Exception to the Requirement to Provide Revised Disclosures When Changes are "Insignificant--

The proposed rule will clarify that lenders must provide revised disclosures if the terms to a loan agreement have been changed after the original disclosures were provided to the borrower. The Board has requested comment on whether it would it be appropriate to provide an exception if the changes to the amount borrowed are “insignificant-- and a threshold for defining “insignificant.--

CUNA would support such an exception, provided that the standard is objective and reasonable. For example, we believe that a change could be considered insignificant if the resulting monthly payment reflects an APR no greater than one-eighth of a percentage point above the originally quoted APR. This is similar to the one-eighth of a percentage point threshold under Regulation Z, the Truth in Lending Act, which permits the APR itself to vary by this amount.

Credit Counseling Should be Strongly Encouraged

The Board has requested comment on whether lenders of HOEPA loans should be required to provide a disclosure advising borrowers to seek credit counseling regarding the merits of the loan.

CUNA believes such counseling should be strongly encouraged and included in the written disclosures. Financial education is a hallmark of the credit union movement, and credit unions provide such counseling as an integral part of their daily operations. This is crucial to providing the highest quality of service for credit union members and all lenders should follow this example.

We also believe that such disclosures should include a toll-free telephone number of an objective, independent counseling service. This will prevent lenders from steering borrowers to an affiliate of the lender.

The Agreement to Purchase Additional Products and Services Should be in Writing

The Board has requested comment on whether consumers who agree to purchase additional products and services in connection with the loan be required to provide this agreement in writing. CUNA would support such a requirement in an effort to further educate borrowers about the loan and to minimize misunderstandings.

With Evidence, it Could be Assumed that HOEPA has been Violated when the Borrower Receives an Open-end Credit Line that Exceeds the HOEPA Thresholds

The Board has also requested comment on whether it should be assumed that a lender violated HOEPA if a borrower applies for a closed-end mortgage loan, but then receives an open-end line of credit that is priced above the HOEPA triggers for APR, points, and fees. We believe this approach may be necessary to prevent lenders from evading the HOEPA requirements by trying to document a loan as open-end credit when the features do not meet the open-end credit requirements. However, this assumption should only be made if there is some evidence that the lender is trying to evade the HOEPA requirements, such as when a lender issues open-end lines of credit without a reasonable expectation for repeat transactions.

Maintaining the Ten Percent Threshold for Subordinate-lien Mortgages

For certain loans, lenders may require that consumers borrow additional amounts in order to pay off the existing first mortgage. Although this ensures that the lender is the senior lien-holder, the borrower may pay higher fees and points and may be replacing a first mortgage that has a low rate. To encourage lenders to offer subordinate-lien mortgages, rather than to refinance existing first-lien mortgages, the Board has requested comment on whether the APR trigger for subordinate-lien mortgages should remain at ten percent above comparable United States Treasury securities, even though the threshold for first-lien mortgages would be lowered to eight percentage points above comparable Treasury securities.

CUNA does not believe the Board should encourage lenders to favor one product over another. The Board should only encourage lenders to develop a variety of products that are in the best interests of consumers and require lenders to provide the necessary disclosures.

We also do not believe that this change would be effective in accomplishing the Board’s goals. When applying for loans, borrowers focus primarily on the monthly payment and will likely not focus on the APR that applies to either the first or subordinate lien mortgage. It is the total monthly payment that will be the determinative factor for the borrower, not whether it is structured as one or two loans. We also believe that two different APRs for first and subordinate liens will only create confusion for borrowers.

Thank you for the opportunity to comment on the proposed revisions to Regulation Z. If you or other Board staff have questions about our comments, please give Associate General Counsel Mary Dunn or me a call at (202) 682-4200.


Jeffrey Bloch
Assistant General Counsel