Definition of "High Cost" Mortgage: the legislation tightens the definition of a "high cost mortgage" for which certain consumer protections are triggered. The new definition, which amends the "Home Ownership Equity Protection Act," (HOEPA) is as follows:

• first mortgages with APRs that exceed Treasury securities by six (6) percentage points;
• second mortgages with APRs that exceed Treasury securities by eight (8) percentage points; or
• mortgages where total points and fees payable by the borrower exceed the greater of five percent (5%) of the total loan amount, or $1,000. The bill revises the definition of points and fees to be more inclusive. It allows for two bona fide discount points outside of the 5% trigger.

Current law defines a "high cost mortgage" as loans with APRs that exceed Treasury securities by 8% (reduced from 10% this year by the Fed). The Fed, through regulation, has also created a trigger for second mortgages at 10% above Treasuries.

Current law: Protections are triggered when points and fees equal 8%, not including "reasonable fees" to unaffiliated 3^rd parties, yield spread premiums, credit insurance, unlimited discount points, and other fees.

NOTE: The bill allows for 2 bona fide discount points, outside the 5% trigger, if those discount points are knowingly paid by the borrower and used to buy down the interest rate. In order to prevent this from being abused, the discount points must buy the rate down from a "benchmark rate" set in the proposed statute. The benchmark rate is defined at the yield on a 5-year Treasury security, plus 5%. Today, this would be about 10%, just slightly higher than the best rates offered by some large subprime lenders.

The following key protections are triggered for high cost mortgages only:

• Restrictions on financing of points and fees. The bill restricts a creditor from directly or indirectly financing any portion of the points, fees or other charges greater than 3% of the total sum of the loan, or $600. The lender cannot finance prepayment penalties or points paid by the consumer if the originator of the loan is refinancing the loan. Moreover, the lender or any affiliated creditor cannot finance points and fees for the refinancing of a loan they originated within the prior 36 months. These limitations and prohibitions are designed to discourage lenders from"flipping" the mortgage in order to extract additional excessive fees.

• Limitation on the payment of prepayment penalties. The bill prohibits the lender from imposing prepayment penalties after the initial 24 month period of the loan. During the first 24 months of a loan, prepayment penalties are limited to the difference in the amount of closing costs and fees financed and 3% of the total loan amount. This approach is designed to ensure that the lender is compensated for the costs of originating the loan without being able to strip equity.

Current law: Allows unlimited prepayment penalties within the first 5 years of the loan so long as the lender independently verifies the borrower’s income. If the debt-to-income ratio of the borrower is greater than 50%, there can be no prepayment penalty. In practice, this latter limitation never seems to come into play.

• Prohibition on balloon payments. The bill prohibits the use of balloon payments. In the case of loans with high interest rates, balloon payments are unnecessary. Lenders typically offer balloon payments in exchange for keeping the interest rate lower or keeping monthly payments affordable for a borrower. In predatory lending, balloon payments are used as a tool to mask the total cost of a high cost loan, and to force the borrower to refinance the loan.

Current law: Allows for balloon payments that are at least 5 years.

• Limitation on single premium credit insurance. The bill would prohibit the upfront payment or financing of credit life, credit disability or credit unemployment insurance on a single premium basis. However, borrowers are free to purchase such insurance with the regular mortgage payment on a periodic basis, provided that it is a separate transaction that can be canceled at any time.

Current Law: No equivalent provision. The Federal Reserve did recently change its regulations to require the cost of single premium credit insurance being financed into the mortgage to be included in the calculation of points and fees in determining whether a loan in covered by HOEPA. It is expected that this will make it more difficult to "pack" in such products. However, current law does not prohibit the sale or financing of these products on HOEPA loans.

• Extension of liability for home improvement contract loans. The bill would make lenders, or subsequent holders of loans arranged by a contractor liable for HOEPA violations if the contractor goes out of business to avoid liability. This will help ensure that lenders work only with bona fide contractors.

Current law: Requires that both the borrower and the contractor endorse the check. HOEPA provides no other protections if the loan was not made by the contractor, even if the contractor fails to perform.

• Limitation on mandatory arbitration clauses. The bill prohibits mortgages from including terms which require arbitration or other non-judicial settlement as the sole method of settling claims or disputes arising under the loan agreement. The bill is not intended to limit the ability of a borrower and lender to enter into any form of binding or non-binding arbitration or other non-judicial settlement of a claim or dispute at any time after a dispute arises. However, an agreement by the borrower to settle a claim does not waive any protection or right conferred by the bill. NOTE: The FTC recommended in 2000, by a unanimous vote, that mandatory arbitration clauses on high cost mortgages be prohibited.

Current Law: No equivalent provision.

Other provisions in the bill:

• Increase statutory damages in individual civil actions and class actions. The maximum amount that can be awarded in individual actions is increased to $10,000. The maximum amount that can be awarded in a class action is the greater of: (i) the maximum amount of the liability available for an individual action multiplied by the number of members or (ii) 2 percent of the net worth of the creditor.

Current law: Individual damages up to $2000 in individual cases. The lesser of 1% of the firm’s net worth or $500,000.

• Require that as a condition for making a high cost loan, a creditor make a determination at the time the loan is consummated, that the borrower will be able to make the scheduled payments to repay the loan obligation. NOTE: This provision also follows a unanimous FTC recommendation.

Current law: same requirement, but violations can be punished only if a consumer can show a pattern or practice of failing to meet this requirement. In practice, it has been virtually impossible to meet the pattern and practice test, thereby making it impossible to enforce this provision.

• Prohibit a lender from making a high cost loan unless it certifies that it has provided the borrower with certain information regarding the risks associated with high cost loans and the availability of home ownership counseling.

Current Law: No equivalent provision.

• Require additional disclosures related to the risks associated with high cost mortgages.

Current Law: Some disclosures are required.

• Prohibit a creditor/lender from: (i) recommending or encouraging default on an existing loan or other debt prior to, or in connection with, a closing on a high cost loan, (ii) including any provision which permits the creditor, in its sole discretion, to accelerate the indebtedness under the loan, or (iii) charging a borrower any fee to modify a high-cost loan or defer payment due under such high cost loan unless it provides a material benefit to the borrower.

Current Law: No equivalent provision.

• Require that a creditor annually report both favorable and unfavorable payment history of borrowers to credit bureaus.

Current Law: No equivalent provision.