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Home Ownership and Equity Protection Act (HOEPA) Explanation
In September 1994 President Clinton signed into law the Home Ownership and Equity Protection Act (HOEPA) of 1994, written by US Rep. Joseph P. Kennedy (D-Mass).1
The law addresses certain deceptive and unfair practices in home equity lending. It amends the Truth in Lending Act (TILA) and establishes requirements for certain loans with high rates and/or high fees. The rules for these loans are contained in Section 32 of Regulation Z, which implements the TILA, so the loans also are called “Section 32 Mortgages.” Here’s what loans are covered, the law’s disclosure requirements, prohibited features, and actions you can take against a lender who is violating the law.2
What Loans Are Covered?
A loan is covered by the law if it meets the following tests:
- For a first-lien loan, that is, the original mortgage on the property, the annual percentage rate (APR) exceeds by more than eight percentage points the rates on Treasury securities of comparable maturity;
- For a second-lien loan, that is, a second mortgage, the APR exceeds by more than 10 percentage points the rates in Treasury securities of comparable maturity; or
- The total fees and points payable by the consumer at or before closing exceed the larger of $592 or eight percent of the total loan amount. (The $592 figure is for 2011. This amount is adjusted annually by the Federal Reserve Board, based on changes in the Consumer Price Index.) Credit insurance premiums for insurance written in connection with the credit transaction are counted as fees.
The rules primarily affect refinancing and home equity installment loans that also meet the definition of a high-rate or high-fee loan. The rules do not cover loans to buy or build your home, reverse mortgages or home equity lines of credit (similar to revolving credit accounts).
What Disclosures Are Required?
If your loan meets the above tests, you must receive several disclosures at least three business days before the loan is finalized:
- The lender must give you a written notice stating that the loan need not be completed, even though you’ve signed the loan application and received the required disclosures. You have three business days to decide whether to sign the loan agreement after you receive the special Section 32 disclosures.
- The notice must warn you that, because the lender will have a mortgage on your home, you could lose the residence and any money put into it, if you fail to make payments.
- The lender must disclose the APR, the regular payment amount (including any balloon payment where the law permits balloon payments, discussed below), and the loan amount (plus where the amount borrowed includes credit insurance premiums, that fact must be stated). For variable rate loans, the lender must disclose that the rate and monthly payment may increase and state the amount of the maximum monthly payment.
These disclosures are in addition to the other TILA disclosures that you must receive no later than the closing of the loan.
What Practices Are Prohibited?
The following features are banned from high-rate, high-fee loans:
- All balloon payments — where the regular payments do not fully pay off the principal balance and a lump sum payment of more than twice the amount of the regular payments is required — for loans with less than five-year terms. There is an exception for bridge loans of less than one year used by consumers to buy or build a home: In that situation, balloon payments are not prohibited.
- Negative amortization, which involves smaller monthly payments that do not fully pay off the loan and that cause an increase in your total principal debt.
- Default interest rates higher than pre-default rates.
- Rebates of interest upon default calculated by any method less favorable than the actuarial method.
- A repayment schedule that consolidates more than two periodic payments that are to be paid in advance from the proceeds of the loan.
- Most prepayment penalties, including refunds of unearned interest calculated by any method less favorable than the actuarial method. The exception is if:
- the lender verifies that your total monthly debt (including the mortgage) is 50 percent or less of your monthly gross income;
- you get the money to prepay the loan from a source other than the lender or an affiliate lender; and
- the lender exercises the penalty clause during the first five years following execution of the mortgage.
- A due-on-demand clause. The exceptions are if:
- there is fraud or material misrepresentation by the consumer in connection with the loan;
- the consumer fails to meet the repayment terms of the agreement; or
- there is any action by the consumer that adversely affects the creditor’s security.
Creditors also may not:
- Make loans based on the collateral value of your property without regard to your ability to repay the loan. In addition, proceeds for home improvement loans must be disbursed either directly to you, jointly to you and the home improvement contractor or, in some instances, to the escrow agent.
- Refinance a HOEPA loan into another HOEPA loan within the first 12 months of origination, unless the new loan is in the borrower’s best interest. The prohibition also applies to assignees holding or servicing the loan.
- Wrongfully document a closed-end, high-cost loan as an open-end loan. For example, a high-cost mortgage may not be structured as a home equity line of credit if there is no reasonable expectation that repeat transactions will occur.
Limiting or Prohibiting Practices that are Unfair, Deceptive, or Abusive3
Loan Flipping - The Board proposes a variety of measures designed to limit the ability of a lender to refinance repeatedly its HOEPA loans. This practice, commonly referred to as loan “flipping,” can be harmful to borrowers because typically each time a loan is refinanced, or flipped, new points and/or fees are charged, often without regard to the borrower’s ability to repay the additional amount. As the Board notes, victims of flipping are typically borrowers who already are having difficulty repaying their original loan. Although these refinancings often result in little, if any, additional cash to the borrower or other significant benefits, points and fees are often imposed on the entire amount of the new loan, not just on the incremental amount added to the loan principal through each successive refinancing.
- Limitations on the Refinancing of HOEPA Loans - The Commission supports the Board’s proposal to restrict the refinancing of HOEPA loans within the first twelve months. The Board would permit such refinancing if it would provide a “tangible benefit” to borrowers. The Commission suggests that the Board provide in the Final Rule, for both compliance and enforcement purposes, additional guidance concerning the “tangible benefit” standard.
- Limitations on the Refinancing of Certain Low-Rate Loans - The Commission also supports the Board’s proposal to prohibit for five years the refinancing of certain low-rate loans with higher-costs loans unless the refinancing is in the interest of the borrower. The prohibition would apply to such loans, regardless of whether they are covered by HOEPA. As the Board observes, abuses have been documented with respect to the refinancing of loans issued through mortgage-assistance programs serving low- or moderate-income borrowers. This is of particular concern because those programs, typically sponsored by government or not-for-profit entities, often offer these borrowers their first opportunity for homeownership. As a result of refinancing, these borrowers may be required to pay higher, unaffordable rates and/or fees that can result in foreclosure and the loss of the borrower’s first home. The Board would permit refinancing determined to be the “in the interest of the borrower.” The Commission suggests that the Board provide in the Final Rule, for both compliance and enforcement purposes, additional guidance concerning the “in the interest of the borrower” standard.
Call Provisions - The Board proposes to prohibit “payable on demand” or “call” provisions in HOEPA loans that allow the creditor to demand repayment of the loan principal at any time unless invoked in connection with a borrower’s default. The Commission supports this common-sense proposal. Like the current limitations on balloon notes, which HOEPA already prohibits if the loan term is less than five years, this proscription helps avoid forced refinancing in short-term loans in order to satisfy the demand clauses. As the Board observes, these provisions raise similar concerns as balloon notes, which require lump-sum repayment of the principal at the end of the loan term, and thus warrant comparable protections. This amendment would also be consistent with the TILA’s treatment of home-equity lines of credit, and for that reason as well should be implemented.
Asset-Based Lending - The Board’s proposal would require that creditors generally document and verify consumers’ current or expected income, existing obligations, and employment, to the extent applicable. Further, it would amend the commentary to establish a rebuttable presumption of a violation of that rule if the creditor engaged in a pattern or practice of extending loans without complying with the documentation and verification requirements. It would also amend the commentary to refer to external legal standards to help determine whether a pattern or practice of lending without regard to creditworthiness exists. Asset-based lending is among the most harmful of predatory lending practices. A loan based on the borrower’s equity in the home and not the borrower’s ability to repay the loan is more likely to result in foreclosure, which injures not only the homeowner but also the surrounding community. Statistical evidence noted by the Commission in its prior testimony to the Board demonstrates the link between subprime lending and foreclosure rates, the latter of which have increased more than the market share of subprime loans. For example, in Chicago between 1991 and 1997, the subprime share of the mortgage origination market increased from 3 percent to 24 percent, but between 1993 and 1998, the percentage of foreclosures attributable to subprime loans rose from 1.3 percent to 35.7 percent. The Commission has specifically addressed the practice of asset-based lending as part of its HOEPA enforcement agenda. In its investigations of predatory lending practices, the Commission has frequently encountered either missing or extremely poor documentation by lenders regarding what factors were considered in determining ability to pay; in some cases, lenders have failed to verify income. While Regulation B, which implements the Equal Credit Opportunity Act, requires a creditor to retain “written or recorded information used in evaluating the application,” it does not generally require that such information be created in the first instance.
Notice to Assignees - The Board proposes a new comment that would “clarify” that assignees of HOEPA loans are subject to all claims and defenses, including but not limited to violations of TILA and HOEPA, that the borrower could bring against the originating creditor. However, because the Commission believes that the existing law clearly establishes this principle, it is an unnecessary addition to the HOEPA commentary. The statutory language is unambiguous — an assignee is subject to “all claims and defenses.” Moreover, the legislative history of HOEPA makes clear that this provision was intended to have an effect similar to that of the FTC’s Trade Regulation Rule on Preservation of Consumers’ Claims and Defenses, also known as the “Holder in Due Course” Rule. As stated in the House Conference Report,
[This provision] eliminates holder-in-due-course protections for purchasers and assignees of [HOEPA] mortgages. Consumers maintain all claims and defenses in connection with such mortgages against assignees that can be asserted against creditors. With this provision, the conferees intend to insure that the market polices itself in order to eliminate abuses. Similar liability has been previously extended by the FTC to consumer installment paper, including automobile loans, without a significant impact on credit availability.
Moreover, the proposed “clarification” could potentially complicate the Commission’s efforts to enforce HOEPA against secondary market purchasers. Assignees might argue that the Board’s action suggests that, prior to the “clarification,” the law was unclear on this issue and, thus, assignees who previously purchased HOEPA loans should not be held liable.
How Are Compliance Violations Handled?
You may have the right to sue a lender for violations of these requirements. In a successful suit, you may be able to recover statutory and actual damages, court costs and attorney’s fees. In addition, a violation of the high-rate, high-fee requirements of the TILA may enable you to rescind (or cancel) the loan for up to three years.