New York Statute: Bad to the Bone

The following article is reprinted from Basis Points® , Vol. 1, Issue 11, Copyright © 2002, with the permission of CounselorLibrary.com, LLC. All Rights Reserved. Further reproduction is prohibited without permission.

News of the New York high cost loan statute reaches us from Grace Sterrett in Hudson Cook's Albany, NY office. The statute contains much tougher standards than exist under Part 41 of the Banking Department's existing rules. The new law becomes effective 180 days after enactment, or approximately April 1, 2003. Governor Pataki signed the measure into law on October 3, 2002 - the same day it was sent to him by the legislature.

Possible Changes. Many lenders and investors hope the legislature will consider amending the onerous penalty provisions and/or issue clarifying amendments before the effective date, but the prospects for either are generally rated as ranging from unlikely to slim.

Will the Regulators Pitch In? Among other issues, the statute provides that "the superintendent of banks is authorized to promulgate any and all rules and regulations and take any measures to implement this act on its effective date on or before such date." However, in New York legislative parlance, an "authorization" is not the same as a "directive." As a consequence, the Banking Department is not required to implement regulations. Absent such a requirement, the Department may elect to sit this one out and refrain from issuing any regulations. If this happens, the industry will be at a great disadvantage. Without a regulator who can provide implementing rules and guidelines, matters of interpretation will be settled through enforcement actions brought by the attorney general, the superintendent, or a private party. Finally, the new law does not contain a preemption clause, so that other municipalities are free to adopt their own version of an anti-predatory lending law or ordinance.

Recent Changes to Part 41. While the legislative process for enacting this new law was at a stand-still, the Banking Board proceeded to amend its High Cost Mortgage Regulation, known as "Part 41" to:

• Prohibit any lender or affiliate from financing single premium credit insurance offered in connection with a high cost loan subject to Part 41;
• Provide two alternative sources for lenders to determine the applicable yield on US Treasury securities (vital for calculating the APR "triggers"), and
• Enact several other clarifying amendments making the regulation comport with many of the unofficial interpretations provided by the Banking Department since October 1, 2000, the date the regulation initially became effective.

These amendments were published in the New York State Register on October 2, 2002 and are expected to become effective in early November. To find out more information on Part 41, click on the Banking Department's website at www.banking.state.ny.us and look for references to "High Cost Loans." Unless the Banking Department takes some action, Part 41 will be obsolete and replaced by the new statute on its effective date.

Is This New Law Much Different (Worse) Than Part 41?

Penalties - Much Worse. With respect to the penalty and related enforcement provisions, the new act is much tougher than Part 41. The current banking regulations impose requirements on brokers and lenders soliciting and originating Part 41 loans. Those who violate Part 41 are subject to administrative penalties. The Banking Department is authorized to impose administrative sanctions on lenders and brokers. Those penalties could be as severe as canceling a mortgage broker's registration or a mortgage banker's license to do business in New York. However, Part 41 does not create a private cause of action for consumers or affect the rights of assignees in the loan.

The new law provides for actual damages, statutory damage - including forfeiture of all interest on the loan (earned and unearned), fees and closing costs. A court may rescind any loan that violates the new law. The penalty for intentional violations is even more draconian - the court may declare the entire transaction void and mandate a complete refund of all principal and interest to the borrower.

Assignees who seek to foreclose a high-cost home loan, or to take some enforcement action after the loan has been in default for 60 or more days, may be subject to claims under the act in recoupment or defense to payment that the borrower could have asserted against the original lender.

Foreclosure Uncertain. A companion act provides borrowers with a defense to a foreclosure proceeding if anyone violates the act. Lenders will be required to affirm that they have complied with all requirements under Banking Law §595-a (which addresses various compliance procedures ranging from advertising to the making, closing, and funding of mortgage loans with various disclosure and substantive obligations) and the new law, Banking Law §6-1. This may be difficult for any lender to do. It will be virtually impossible for an assignee to do when that assignee has no real factual knowledge of everything that was given (or not given) to the borrower in the course of the solicitation, application and closing process. Due diligence regarding the purchase of loan portfolios does not typically include a total review of each loan transaction for technical and substantive compliance with every New York requirement.

Threshold Triggers. The new law applies to all loans/lines of $300,000 or less (higher limits may apply for 2-4 family dwellings per Fannie Mae thresholds) made for consumer purposes secured by an owner-occupied principal residence. The loan could be purchase money or non-purchase money. The loan could be open or closed-end. Reverse mortgages are not included.

APR Test. A first lien loan is subject to the act if the APR at consummation exceeds the yield on US Treasury Securities with a comparable term to maturity plus eight percentage points. For junior lien loans, the margin is nine percentage points. In either case, you use the Treasury yield in effect on the 15th day of the month preceding the month in which the application is taken. If the initial rate is discounted, then you use the fully indexed rate for this test.

Points and Fees Test. A first lien loan is subject to the act if the points and fees exceed five percent of the total loan amount (six percent if the loan is a purchase money FHA/VA loan).

Special rules apply if the total loan amount is less than $50,000. In this case, the loan is subject to the act if the points and fees exceed the greater of $1,500 or six percent of the total loan amount. However, you are also allowed to charge and exclude from the points and fees test up to two "bona fide loan discount points" if either of the following is true:

• The interest rate that would have applied without the discount points is no more than one percentage point over the Treasury yield used for the APR Test, described above, or
• The discount points are funded, directly or indirectly, through a grant from a federal, state or local government agency, or a charitable organization registered under Section 501(c)(3) of the Internal Revenue Code.

Definitions. While the New York act steals phrases like "points and fees" and "total loan amount" from the HOEPA rules, the definitions of those terms differ from the definitions under HOEPA. Here are some key definitions under the New York law.

Points and Fees. "Points and fees" are calculated the same as under the HOEPA rules, with one major exception. In New York, the "points and fees" include:

• All prepaid finance charges,
• All fees excluded from the finance charge under Section 226.4(c)(7) if the fee is paid to the lender or its affiliate,
• All credit insurance premiums, paid at closing or financed, that have somehow escaped the definition of prepaid finance charge (i.e., the creditor has complied with the rules under Section 226.4(d)(1) to exclude the premiums from the finance charge), plus
• All compensation paid directly or indirectly to a mortgage broker, including a broker who originates loans in its own name through table funded transactions.

The HOEPA rules do not include the last category, fees paid to a mortgage broker that are not finance charges, in the calculation. As a result, you must include things like yield spread premium payments in the New York calculation of points and fees even though those same sums are excluded from the HOEPA calculation.

Total Loan Amount. The "total loan amount" is also dramatically different under New York law. Under New York law, the "total loan amount" equals:

• The principal amount minus
• Any portion of NY points and fees that are financed.

Under the HOEPA definition, the "total loan amount" is the principal minus all prepaid finance charges (whether financed or not), minus the sum of the following items, provided they are financed (added to the principal):

• All fees excluded from the finance charge under Section 226.4(c)(7) if the fee is paid to the lender or its affiliate, plus
• All credit insurance premiums, paid at closing or financed, that have somehow escaped the definition of prepaid finance charge (i.e., the creditor has complied with the rules under Section 226.4(d)(1) to exclude the premiums from the finance charge).

So, if you have prepaid finance charges or voluntary credit insurance premiums that are paid out of pocket by the borrower, the NY total loan amount will be less than the HOEPA total loan amount.

Bona Fide Loan Discount Points. Bona fide loan discount points include loan discount points that:

• Are knowingly paid by the borrower or funded through any source
• For the purpose of reducing the interest rate
• And actually reduce the interest rate
• By an amount reasonably consistent with established industry norms and practices for secondary market transactions.

The act presumes a point is a bona fide loan discount point if it reduces the interest rate by a minimum of 25 basis points, assuming all other loan terms remain constant. Notwithstanding this presumption, you may want to use a disclosure or agreement where the consumer acknowledges each of the four criteria set forth in the definition.

Limitations and Prohibited Practices. A high-cost home loan is subject to the following limitations:

• No Call Provisions. You may not have the right, in it your sole discretion, to accelerate the indebtedness. This does not prohibit you from accelerating the loan in good faith due to borrower's failure to abide by material terms of the loan.
• No Balloon Payments. No scheduled payment may be more than twice as large as the average of earlier scheduled payments, unless the balloon payment is due 15 years or more after origination. Exception: This prohibition does not apply to loans where the payment schedule is adjusted to the seasonal or irregular income of the borrower.
• No Negative Amortization. The payment schedule may not provide for regular periodic payments that cause the principal balance to increase.
• No Increased Interest Rate After Default. (This does not prohibit interest rate changes under a variable rate formula, provided the increase is not triggered by an event of default.)
• Limitation On Advance Payments. You may not consolidate and pay in advance from the loan proceeds more than two periodic payments required under the loan terms.
• No Modification Or Deferral Fees. You may not charge the borrower any fee to modify, renew, extend or amend (collectively called a "change") a high-cost home loan, or to defer any payment due under a high-cost home loan if:
  • After the change the loan is still a high-cost home loan or
  • Even if no longer a high-cost home loan, the APR has not been decreased by at least 2 percentage points.
  • If you lend "new money" in connection with any "change," you may charge points and fees in connection with any additional proceeds received by the borrower as a result of the "change" (over and above the current principal balance of the existing high-cost home loan), provided that any charges on the additional proceeds reflect your "typical point and fee structure for high-cost home loans."
• No Oppressive Mandatory Arbitration Clauses. The loan terms cannot contain any such clause that is unfair, unconscionable, or substantially in derogation of the rights of consumers. Note that this provision is likely preempted by the Federal Arbitration Act.
• No Financing Of Single Premium Insurance. You may not finance the cost of single premium credit insurance or related products. Debt cancellation or suspension agreements are included in this category of prohibited credit insurance. Note that premiums calculated and paid on a monthly basis are not considered " financed" by the lender and so are permitted.
• No "Loan Flipping." No lender or mortgage broker making or arranging a high-cost home loan may engage in "loan-flipping." This is defined as making a home loan to a borrower who refinances an existing home loan when the new loan does not have a "tangible net benefit" to the borrower considering all of the circumstances, including the terms of both the new and refinanced loans, the cost of the new loan and the borrower's situation. The term " tangible net benefit" is not defined.
• No Refinancing of Special Mortgages. Absent documentation by a HUD certified housing counselor or the original lender that the borrower has received counseling regarding the advantages and disadvantages of refinancing, you may not refinance an existing home loan that is a "special mortgage" into a high cost loan. A "special mortgage" is one originated, subsidized or guaranteed by or through a state, tribal, local government or nonprofit organization and which bears a below market interest rate at the time of origination or has non-standard payment terms beneficial to the borrower. The types of non-standard payment terms contemplated here include payments that vary based upon income or where no payments are required under certain conditions.
• No Lending Without Due regard To Repayment Ability. You are prohibited from making or arranging a high-cost home loan without due regard to repayment ability. Factors to consider include:
  • Current and expected income;
  • Current obligations;
  • Employment status; and
  • Other financial sources.

You may not consider the borrower's equity in the home. Such information must be "… verified by detailed documentation of all sources of income, as and corroborated by independent verification."

You have a "rebuttable presumption" that a loan was made with due regard to repayment ability if you can demonstrate that, at the time the loan was made, the borrower's total monthly debts, including amounts owed under the loan, did not exceed 50% of the borrower's monthly gross income, provided the lender also followed the residual income guidelines established by the Veterans Administration as set forth in 38 C.F.R. § 36.4337(e) and VA Form 26-6393.

• No Financing of "points and fees" in excess of 3% of the principal amount of the loan. Note: This 3% limit is of the principal loan amount, not the " Total Loan Amount," which would be a lower number.
• No Direct Payment of Home Improvement Contractors. You must make payments from the loan proceeds to a contractor under a home improvement contract by one of the following 3 methods:
  • By instrument payable to the borrower only,
  • By instrument payable jointly to the borrower and contractor, or
  • At the election of the borrower, through a third party escrow agent pursuant to the terms of a written agreement signed by the borrower, the lender and the contractor prior to the disbursement.
• No Encouragement Of Default. You may not recommend or encourage default on an existing loan or debt prior to or in connection with the closing or planned closing of a high-cost home loan that refinances all or some portion of that existing loan or debt.
• No Payments to Mortgage Brokers, Other Than For Reasonable Value Of Goods, Facilities or Services Actually Provided. No lender or broker may accept or give any "…fee, kickback, thing of value, proportion, split or percentage of charges, other than as payment for goods or facilities that were actually furnished or services that were actually performed." Payments must also be reasonably related to the value of the goods, facilities or services provided.
• No Points and Fees By Lender Refinancing A High-Cost Loan Held By It. You may not charge a borrower any points and fees in connection with a high cost loan, if the loan proceeds will be used to refinance an existing high cost home loan held by you or your affiliate.

Disclosures. The new act requires you to make the following disclosures.

Application Disclosures. At time of application, the lender or broker must deliver, mail, fax or electronically transmit the following notice - in at least 12-point type - to the borrower:

You should consider financial counseling prior to executing loan documents. The enclosed list of counselors is provided by the New York State Banking Department.

This disclosure must be on a separate form. The notice must be accompanied by the list of approved counselors, which is available from the New York Banking Department. If you take the application by telephone, you must provide the disclosure "immediately after receipt of the application by telephone." If you send the notice electronically, you must first obtain written or electronic permission from the borrower.

Pre-Closing Disclosure. You may not make or arrange a high-cost home loan unless the following notice is given in writing to the borrower within 3 days after you determine the loan is a high cost home loan, but no less than 10 days before closing.

CONSUMER CAUTION AND HOME COUNSELING NOTICE

If you obtain this loan, which pursuant to New York State Law is a High-Cost Home Loan, the lender will have a mortgage on your home. You could lose your home, and any money you have put into it, if you do not meet your obligations under the loan.

You should shop around and compare loan rates and fees. Mortgage loan rates and closing costs and fees vary based on many factors, including your particular credit and financial circumstances, your earnings history, the loan-to-value requested, and the type of property that will secure your loan. The loan rate and fees could vary based on which lender or mortgage broker you select. Higher rates and fees may be related to the individual circumstances of a particular consumer's application.

You should consider consulting a qualified independent credit counselor or other experienced financial adviser regarding the rate, fees, and provisions of this mortgage loan before you proceed. The enclosed list of counselors is provided by the New York State Banking Department.

You are not required to complete any loan agreement merely because you have received these disclosures or have signed a loan application. If you proceed with this mortgage loan, you should also remember that you may face serious financial risks if you use this loan to pay off credit card debts and other debts in connection with this transaction and then subsequently incur significant new credit card charges or other debts. If you continue to accumulate debt after this loan is closed and then experience financial difficulties, you could lose your home and any equity you have in it if you do not meet your mortgage loan obligations.

Property taxes and homeowner's insurance are your responsibility. Not all lenders provide escrow services for these payments. You should ask your lender about these services.

Your payments on existing debts contribute to your credit ratings. You should not accept any advice to ignore your regular payments to your existing creditors. Accordingly, it is important that you make regular payments to your existing creditors.

Notice that the form indicates that the list of counselors as provided by the New York Banking Department is "enclosed." However, the act instructs you to deliver the list with the application disclosure, not the pre-closing disclosure.

Mortgage Legend. You must insert a legend in 12-point type on the top of each mortgage that secures a high-cost home loan to indicate to any potential purchaser that the loan is a high cost loan. Unfortunately, the New York act does not provide the legend itself. Until contrary regulatory guidance appears, the following would seem to meet the statutory requirements:

THIS MORTGAGE SECURES A HIGH-COST HOME LOAN SUBJECT TO NEW YORK BANKING LAW §6-1.

Operational Requirements : Annual Reports to Credit Bureaus. Lenders making high-cost home loans are required to report both the favorable and unfavorable payment history of each borrower to a nationally recognized consumer credit bureau at least annually, for as long as lender holds or services the high-cost loan. Surprisingly, this requirement does not appear to apply to loan servicers who did not originate the loan.

Penalties/Remedies. Any person found "by a preponderance of the evidence" to have violated the law is liable to the borrower for the following:

• Actual damages - including consequential and incidental damages;
• Statutory damages as follows:
  • All interest, points and fees and closing costs charged on the loan must be refunded, and any amounts not yet earned must be forfeited. This appears to mean that the borrower is entitled to a cost-free loan. Or
  • The greater of: $5,000 per violation or twice the amount of points and fees and closing costs if the violation involves (a) the prohibitions against "loan flipping" or (b) the requirement to verify that the borrower has the "ability to repay" and the lender fails to demonstrate that it verified, by detailed documentation, all sources of the borrower's income and corroborated it with independent verification at the time the loan was made.
• Reasonable attorneys' fees
• A court may grant injunctive, declaratory or similar relief as the court deems appropriate in an action to enforce compliance with this law
• Upon a finding by a court of an intentional violation by the lender of this law or any implementing regulation, the home loan agreement is void and the lender may not "collect, receive, or retain" any principal, interest or other charges. The borrower may also recover any payments made.
• If a court finds that a high-cost loan violates any provision of the law, the loan transaction may be rescinded. The remedy of rescission is available as a defense, without time limitation.
• The statute expressly provides that the remedies provided for in the statute are not intended to be the exclusive remedies available to a borrower.

Scope Of Penalty-Enforcement Provisions. The act applies to brokers and lenders that arrange for or make high cost mortgage loans, and to any person, who in bad faith attempts to avoid application of the law "by any subterfuge, including but not limited to splitting or dividing any loan transaction into separate parts for the purpose of evading the provisions of this section."

Assignee Liability. If an assignee brings an action to enforce a loan against a borrower who is in default more than 60 days or who is in foreclosure, the borrower may assert any claim under the provisions of this law in recoupment and defense to payment. In addition, as discussed above, the borrower has the right to rescind the loan at any time if he or she discovers that the lender or broker have violated the act.

Who Are The Enforcers? The act can be enforced by the state attorney general, the superintendent of banks, or any party to a high-cost loan.

Opportunity to Correct/Cure Violations? A lender, who, acting in good faith, nevertheless violates a provision of the law, will not be deemed to have violated the law:

• Provided within 30 days of the loan closing and prior to the institution of any action under this law, the borrower is notified of the "compliance failure," appropriate restitution is made and at the choice of the borrower, the necessary adjustments are made so that: i) the high-cost home loan complies with the law or ii) the terms of the loan are changed in a manner beneficial to the borrower so that the amended loan is no longer a high cost home loan; or
• If the "compliance failure" resulted from a bona fide error, notwithstanding the maintenance of procedures reasonable adopted to avoid such errors, and, within 60 days after the discovery of the violation, but before the commencement of an action under the law or receipt of written notice of the violation, the borrower is notified of the "compliance failure," appropriate restitution is made and at the choice of the borrower, the necessary adjustments are made so that: i) the high-cost home loan complies with the law or ii) the terms of the loan are changed in a manner beneficial to the borrower so that the amended loan is no longer a high cost home loan.

Crystal Ball Readings. At this point it's too early to predict whether Banking Law §6-1 will be launched as is, or whether lenders and investors will be successful in their efforts to have any amendments adopted. In addition to encouraging lawmakers to reconsider the potential chilling impact that some of the sweeping penalty provisions may have on the availability of mortgage credit for higher credit-risk borrowers in New York, it would make sense to have a uniform state law, rather than a patch-work quilt of laws and ordinances on state and local levels - so the addition of a preemption clause should surely be sought. The new law could benefit from a clarification or reconsideration of the use of a "bona fide discount points" to buy down the interest rate. Currently such discount points can only be excluded from the "points & fees" threshold for a conventional loan if the interest rate (which will be bought down by the points) does not exceed by more than 1 percentage point, the yield on United States Treasury Securities having comparable periods of maturity to the loan maturity. Stayed tuned for further developments.

For more information on NY Banking Law § 6-1, feel free to contact Grace Sterrett at (518) 383-9440.

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Basis Points® is a concise, easy-to-read, monthly legal update for the mortgage lending industry. Basis Points® addresses complex legal issues from an industry perspective and keeps you informed on new legal developments affecting your business. Written in plain English, Basis Points® provides familiar factual scenarios, identifies the legal issues involved, presents real court resolutions and suggests how you might avoid similar legal pitfalls. Topics featured in Basis Points® include: Predatory Lending; Yield-Spread Premiums; RESPA - Fee Splitting and Up charges; Privacy; RESPA - Joint Venture; Bankruptcy; Fair Lending and Discrimination; and Truth in Lending/ Regulation Z. Basis Points® is published by CounselorLibrary.com, LLC, an affiliate of the Hudson Cook, LLP law firm. The CounselorLibrary.com, LLC is also the publisher of CARLAW®, HouseLaw®, Spot Delivery®, and the Counselor Library Series. For more information, please visit: www.counselorlibrary.com.

HMDA Revised to Require Reporting Loans With "Higher Rates"

The following article is reprinted from Basis Points® , Vol. 1, Issue 8, Copyright © 2002, with the permission of CounselorLibrary.com, LLC. All Rights Reserved. Further reproduction is prohibited without permission.

The Federal Reserve Board has published revisions to its HMDA regulations, found at Regulation C. Those revisions address the following issues:

Reporting loans with "high" margins. You must report loans if the rate exceeds the corresponding Treasury yield by 3 percentage points (3%) for first lien loans or by 5 percentage points (5%) for junior lien loans.

Collect more information on telephone applications. You are required to ask applicants to identify their ethnicity, race, and sex in telephone applications.

Lien position. You are required to report lien position on all loans, except loans that you purchase.

Definition of "Manufactured Home." The definition of manufactured home has been clarified to track the federal building code for factory-built housing established by the Department of Housing and Urban Development ("HUD"). As a general rule, this definition captures homes that do not require much assembly after they leave the factory.

Background

The Home Mortgage Disclosure Act ("HMDA") has three purposes. One is to provide the public and government officials with data that will help show whether lenders are serving the housing needs of the neighborhoods and communities in which they are located. A second purpose is to help public officials target public investment to promote private investment where it is needed. A third purpose is to provide data that assist in identifying possible discriminatory lending patterns and enforcing antidiscrimination statutes.

HMDA requires lenders to collect, report, and publicly disclose data about originations and purchases of loans secured by residential real property and of home improvement loans. Lenders must also report data about applications that did not result in originations.

HMDA requires that lenders report data about:

• Each application or loan, including
  • The application date;
  • The action taken and the date of that action;
  • The loan amount; the loan type and purpose; and,
  • If the loan is sold, the type of purchaser;
• Each applicant or borrower, including ethnicity, race, sex, and income; and
• Each property, including location and occupancy status.

Lenders report this information to their supervisory agencies and must make it available to the public.

This past winter, the Board approved amendments to Regulation C after a comprehensive review of the regulation. Among other things, the new rule requires lenders to report the spread between the APR on loans and the yield on Treasury securities with comparable maturity periods, if the spread meets or exceeds certain thresholds specified by the Board. The Board asked for comments concerning whether the "threshold" should be.

Rate Spread Information

The Board has adopted the proposed thresholds of 3 and 5 percentage points for first- and subordinate-lien loans, respectively. The thresholds are intended to ensure, to the extent possible, that pricing data for higher-cost loans are collected and disclosed without capturing data on "prime loans." The data available to the Board when it proposed the thresholds indicated that these thresholds would exclude the vast majority of prime loans and include the vast majority of other loans. In January 2002, the Board adopted the requirement to report the spread only for loans over specific thresholds in order to adjust pricing data for changes in market conditions over time, focus on higher-cost loans, and limit reporting burden (because fewer loans would be subject to the reporting requirement). The data supplied by commenters tended to confirm the data available to the Board indicating that the proposed thresholds would avoid capturing the vast majority of prime loans while capturing the vast majority of other loans.

The Board had solicited comment on the appropriate thresholds before finalizing them. Information on the following specific issues and questions was also solicited:

• Whether the rule for determining coverage under the Home Ownership and Equity Protection Act (HOEPA) should be used to determine whether rate spread information must be reported under HMDA - specifically, whether the 15th day of the month preceding the month in which the application for the loan was received should be used for determining the APR spread.

• The proportion of loan originations (by number of loans) reported under HMDA that would fall above and below various thresholds, segregated by risk class (for example, A, A-minus, and B) and lien status.

• Circumstances or special credit products that might be particularly subject to misclassification, as loans associated with a higher credit risk than prime loans, should the proposed thresholds be implemented. For example, are there product lines in which loans with very little credit risk nonetheless have high APRs? Alternatively, are there product lines in which loans with relatively high credit risk nonetheless have low APRs?

• Is the 2-percentage point difference between the proposed thresholds for first- and subordinate-lien loans appropriate?

Some industry commenters supported the thresholds of 3 and 5 percentage points, although they objected to reporting any pricing data. These commenters stated that, based on their experience, the tentative thresholds would exclude nearly all prime loans from the pricing-data reporting. Nearly all industry commenters - whether or not they supported thresholds of 3 and 5 percentage points - indicated that a 2-percentage point difference between thresholds is appropriate.

Many industry commenters argued that the proposed thresholds were too low, based on a belief that the thresholds would capture a significant number of prime loans. Some commenters stated that the proposed thresholds would include loans that they believe are not higher-priced loans, for example, short-term loans with balloon payments, loans involving manufactured homes, and FHA-insured and VA-guaranteed loans. These commenters did not, however, provide data to support their views. Industry commenters also expressed concern that stigma would attach to loans that meet the pricing thresholds and that "responsible" lenders may be driven out of the subprime industry.

Some commenters urged the Board to adopt the thresholds for HOEPA coverage (8 percentage points (8%) for first-lien loans and 10 percentage points (10%) for subordinate-lien loans) for reporting pricing information under HMDA. Others suggested thresholds of 5 percentage points (5%) and 7 percentage points (7%) for first- and subordinate-lien loans, respectively, so as to capture only what they believe to be higher-priced loans.

In addition to commenting on the proposed thresholds, many industry commenters urged the Board to reverse its decision to require lenders to report pricing information under HMDA. Some stated that, in the alternative, the Board should allow lenders the option of reporting the APR on a loan and having the Board calculate the spread. They said that reporting the spread would be more burdensome than reporting the APR, because lenders do not track the yield on Treasury securities and may have difficulty obtaining the correct information to use in calculating the spread. Commenters were concerned that lenders could make inadvertent errors in calculating the spread and, if the errors were pervasive, could incur the costs of resubmission of HMDA data or civil money penalties.

A few industry commenters urged the Board not to use the yield on Treasury securities for calculating the spread. They suggested that lenders be permitted to use other indices for calculating the spread, such as the LIBOR (London Inter-Bank Offered Rate) index, that they said play a more direct role in their pricing.

Still others - community groups, researchers, and state, local, and tribal officials - urged the Board to require pricing information on all loans reported under HMDA, and not just those that meet or exceed certain thresholds. These commenters believed that requiring pricing information only on higher-priced loans would allow discrimination and other abusive lending practices to go undetected in the prime market. Some of these commenters also argued that the APR, and not the spread, should be reported to facilitate fair lending enforcement. Some community groups, while preferring pricing information on all loans, stated that the thresholds of 3 and 5 percentage points were appropriate.

At the end of the day, the Board believed that the thresholds would not result in misclassification of the products mentioned by some commenters - for example, FHA-insured loans, VA-guaranteed loans and manufactured home loans. While the spread on many manufactured home loans may exceed the thresholds, these loans tend to have elevated credit risk and are generally not considered prime loans. The thresholds should exclude most FHA-insured loans and VA-guaranteed loans. Moreover, Regulation C requires lenders to distinguish FHA and VA loans from other loan types in their HMDA/LARs; and under the final rules, lenders are also required to distinguish loans for manufactured homes from loans for site-built homes. Thus, even if these loans are misclassified as higher-priced loans, data users can treat these loans as distinct product lines in their analyses.

The Board will take steps to minimize any difficulties lenders may have in calculating the spread and also to minimize the risk of errors. These steps include publishing the applicable Treasury yields for common maturity periods on the FFIEC's Internet web site, in addition to making the information available by fax upon request. Lenders will be required to use only the rates published by the Board - and not the H-15 or the Treasury auction results, which lenders may use for HOEPA purposes - to ensure consistent and accurate calculations for HMDA data collection and reporting. An interactive tool could also be available on the FFIEC Web site to calculate the rate spread for a loan, based on information supplied by the lender.

What date do you use to select the Treasury index?

The final regulation approved in January set an "application date" rule for determining whether the rate spread must be reported. That is, lenders would compare the APR on a loan at consummation with the yield on Treasury securities of comparable maturity as of the 15th day of the month preceding the month in which the loan application was received. This is the rule used to determine HOEPA coverage. The Board solicited comment on whether HOEPA's application date rule is appropriate in calculating the spread for HMDA purposes.

Many industry commenters, including the banking trade associations, supported use of the application date for identifying the applicable Treasury security yield. They noted that adopting the HOEPA rule would ease compliance burdens, as lenders whose loans are covered by HOEPA are already familiar with this rule. Other industry commenters suggested that the "lock date," or date that the lender sets the interest rate for the loan, would result in a more accurate determination of whether a loan was a prime loan or a higher-priced loan. A small number of industry commenters suggested using the date of origination or consummation.

Under the final rule, you must pick the index value that is published on the 15th-of-the-month prior to the date the final rate is set. For example, if the lender sets the interest rate for the final time before the loan closing on September 3, 2004, the relevant date for use of the Board's table is August 15, 2004. If the lender sets the rate for the final time before closing on September 17, 2004, the relevant date is September 15, 2004. If the rate is set on September 15, 2004, the relevant date is September 15, 2004. These instructions have been incorporated into Appendix A to Regulation C.

According to the Board's way of thinking, the date the final rate is set more accurately reflects the lender's pricing decision than a date related to the date of application or to the date of consummation. A date related to the date of application or consummation might reflect a different rate environment than existed when the final interest rate was established, and could result in inaccurate and misleading data for periods when interest rates are volatile.

Using the date the final rate is set may impose an additional burden on some lenders, as many lenders do not systematically track the date the interest rate is set or locked. In contrast, using the HOEPA rule (a date measured from the application date) may impose fewer burdens on lenders that currently make HOEPA loans or routinely monitor their loans for HOEPA coverage (although it does not pose that advantage for lenders that do not make HOEPA loans); and the dates of application and consummation also may be less burdensome because these dates are already collected and reported under HMDA. On balance, however, the Board believes that the benefits of increasing the accuracy of pricing information by selecting the date the final interest rate is set outweigh the compliance burdens associated with the requirement.

When you must comply

Lenders generally must comply with the revised rules for all applications upon which final action is taken on and after January 1, 2004. The Board plans to issue guidance later this year to alleviate the burden on lenders to "look back" at all applications taken in 2003 but acted on in 2004. For example, the Board could establish that for applications taken before a certain date - such as November 1, 2003 - a lender would not be required to use the revised rules.

Reporting Information on Telephone Applications

The Board proposed to conform the telephone application rule regarding ethnicity, race, and sex to the rule applicable to mail and Internet applications. Under the rules for applications received by Internet or mail, a lender is required to ask for this information, but is not required to report the information if the applicant does not provide it. These rules are different than those that apply to applications, taken in person. If the application is taken in person, you must ask for the data and, if the applicant refuses to supply it to you, you are required to note the refusal and, to the extent possible, complete the form based on visual observation or based on reasonable assumptions you can make from the applicant's surname.

According to the Board, there has been a substantial decline in response rates regarding race and ethnicity. From 1993 to 2000, the proportion of home mortgage loan applications of all types with missing race or ethnicity data increased from about 8 percent to about 28 percent. (Missing data about the applicant's sex have increased in a similar fashion.) At least part of this decline may be explained by an apparent increase in lenders' use of the telephone to take applications. The Board solicited comment on the benefits and burdens of this proposal.

Commenters were divided on whether lenders should be required to ask for ethnicity, race, and sex in telephone applications. Community groups, researchers, and state, local, and tribal officials urged the Board to require lenders to ask for such information on telephone applications. Many of these commenters pointed out that without the information, fair lending analyses based on HMDA data are less effective. These commenters also believe that the number of applications taken by telephone will continue to grow and, thus, that the rate of applications and loans missing information about ethnicity, race, and sex will increase as well. Some industry commenters supported the proposal, stating that it was simpler to have one rule on collection of ethnicity, race, and sex that applies regardless of the manner in which an application is taken.

On the other hand, many other industry commenters opposed the proposal because they believe that applicants will resent the intrusion into an area they regard as confidential or sensitive. Some commenters believe that applicants will fear discrimination, and will not pursue an application, will refuse to supply the information, or will supply incorrect information. Still others said that requiring lenders to ask for information about ethnicity, race, and sex would raise the cost of taking telephone applications. A few commenters asked the Board to provide a script for requesting the information in telephone applications.

The final rule requires lenders to ask for applicants' ethnicity, race, and sex in telephone applications. The Board believes that this change will serve HMDA's fair lending enforcement purpose by improving the data obtained on ethnicity, race, and sex; the Board believes this benefit outweighs the costs of compliance.

The final rule conforms the procedures for requesting applicant information in telephone applications to those for applications taken by mail or on the Internet. You should advise loan applicants that lenders are required to ask for information about ethnicity, race, and sex is mandated by the federal government to assist in the enforcement of fair lending laws. In addition, you must advise applicants that lenders are prohibited from discriminating on the basis of the information provided, or on the basis of the applicant's choosing to provide or not provide the information.

For applications taken beginning January 1, 2003, you are required to ask telephone applicants for monitoring information using the national origin or race categories in the current Appendices A and B to Regulation C. For applications taken by telephone on or after January 1, 2004, lenders are required to ask for monitoring information using the ethnicity and race categories in revised Appendices A and B.

Definition of "Manufactured Home"

Commenters asked whether the definition of a manufactured home in Regulation C includes modular, panelized, and pre-cut homes. The definition refers to the federal building code for factory-built housing established by the Department of Housing and Urban Development ("HUD"). The HUD code requires generally that housing be essentially ready for occupancy upon leaving the factory and being transported to a building site. Modular homes that meet all of the HUD code standards are included in the definition because they are ready for occupancy upon leaving the factory. Other factory-built homes, such as panelized and pre-cut homes, generally do not meet the HUD code because they require a significant amount of construction on site before they are ready for occupancy. You should not identify loans and applications relating to manufactured homes that do not meet the HUD code as manufactured housing under HMDA.

Reporting Lien Status

The Board proposed to require lenders to report whether a loan is or would be (1) secured by a first lien on a dwelling; (2) secured by a subordinate lien on a dwelling; or (3) not secured by a lien on a dwelling. The Board solicited comment on these reporting categories (and also on whether reporting of lien status should be required for purchased loans). According to the Board, data on lien status may help explain some pricing disparities, because interest rates, and therefore APRs, vary according to lien status. Rates on first-lien loans are generally lower than rates on subordinate-lien or unsecured loans. In addition, lien status would enable data users to better analyze information on secured and unsecured home improvement loans.

Most industry commenters - although opposed generally to reporting more data under HMDA - stated that lien status was closely linked to pricing and that it would not be unduly burdensome for them to report this information for originations on their HMDA/LAR. Most industry commenters, however, opposed a requirement to collect and report these data for purchased loans, because they believe the additional burden is not warranted. Some commenters stated that lien status should not be required for applications that do not result in loans; they suggested that an application might be denied before the lender knows what the lien status of the loan would have been.

Other industry commenters opposed the requirement to report lien status even for originations as unduly burdensome. In a remarkable admission, these commenters stated that while they know when a loan they make is secured, they often do not know their lien position with certainty. They were concerned that a final rule would require title searches for all reportable loans. Some commenters stated that they generally assume they will have a first lien for all home purchase applications and loans. But for other home mortgages, often they do not know their lien position even if they base their pricing decisions on the assumption that they will have a subordinate lien. A few commenters suggested that the Board should allow lenders to report lien status based on these assumptions.

Community groups, researchers, and state, local, and tribal officials stated that lien status was critical to interpreting pricing data and distinguishing secured from unsecured home improvement loans, and many argued that lien status should be reported for purchased loans as well. Some of these commenters suggested that the data collection might serve to deter lenders from persuading consumers to consolidate a small first mortgage and unsecured debt into a new first mortgage (when a second mortgage or an unsecured loan might be more in the consumer's interest). Some also stated that data on lien status for purchased loans would facilitate monitoring of the activities of subprime lenders that purchase loans that may be unfairly priced, and for which little data are available.

The final rule requires lenders to report lien status on applications and originations, but not on purchased loans. The Board believes that capturing data on lien status on loan originations will help the public and the agencies interpret the pricing information. Collecting lien status on loan originations will enable data users to differentiate between secured and unsecured home improvement loans, and will facilitate fair lending data analysis.

Capturing data on lien status for applications that do not result in originations is critical in the analysis of acceptance and denial ratios for borrowers of different races. Disparities by race or ethnicity in acceptance and denial ratios that initially suggest unlawful discrimination are often explained by differences in the lien status of the loan for which application was made, but only after significant effort is expended to retrieve information on lien status from individual loan files.

You are required to report the lien status according to the best information readily available to you at the time you take final action on an application. You do not have to conduct a title search. You may rely on the title search you routinely require for home purchase loans. You may also rely on other information readily available to you and that you reasonably believe to be accurate, such as the applicant's credit report or the applicant's statement on the application. For example, you would report a loan origination as secured by a subordinate lien if the application states that there is a mortgage on the property (and the mortgage will not be paid off as part of the transaction). If the same application did not result in an origination - for example, because the application is denied or withdrawn - you would report the application as an application for a subordinate-lien loan.

You are not required to collect lien status information for loans that you purchase. As a general rule, HMDA does not require you to collect information on pricing, ethnicity, race, or sex for purchased loans.

Preapproval Issues

In the final rules, the instructions for completing the HMDA/LAR provide three codes for indicating whether a loan or application relates to a preapproval request as defined in the regulation. Codes 1 and 2 indicate whether the applicant requested a preapproval for a home purchase loan. Because only preapprovals for home purchase loans are covered under the final rule, you should use code 3, "not applicable," for refinancings, home improvement loans and for purchased loans of any type. Commenters asked what code should be used for home purchase applications and loans if a lender does not have a preapproval program. Appendix A has been changed to clarify that you should use code 3 for home purchase loans and applications if you do not offer covered preapprovals.

For more information, see 67 FR 43217 and 67 FR 43218 (June 27, 2002).

To view all other Basis Points Articles click here.

Basis Points® is a concise, easy-to-read, monthly legal update for the mortgage lending industry. Basis Points® addresses complex legal issues from an industry perspective and keeps you informed on new legal developments affecting your business. Written in plain English, Basis Points® provides familiar factual scenarios, identifies the legal issues involved, presents real court resolutions and suggests how you might avoid similar legal pitfalls. Topics featured in Basis Points® include: Predatory Lending; Yield-Spread Premiums; RESPA - Fee Splitting and Up charges; Privacy; RESPA - Joint Venture; Bankruptcy; Fair Lending and Discrimination; and Truth in Lending/ Regulation Z. Basis Points® is published by CounselorLibrary.com, LLC, an affiliate of the Hudson Cook, LLP law firm. The CounselorLibrary.com, LLC is also the publisher of CARLAW®, HouseLaw®, Spot Delivery®, and the Counselor Library Series. For more information, please visit: www.counselorlibrary.com.

Do You Know Your Applications From Your Prequalifications?

The following article is reprinted from Basis Points® , Vol. 1, Issue 5, Copyright © 2002, with the permission of CounselorLibrary.com, LLC. All Rights Reserved. Further reproduction is prohibited without permission.

Many mortgage lenders offer formal or informal information to prospective mortgage loan applicants before the consumer submits a written loan application. Those activities may include:

Time to Refresh Your Privacy Policies

The following article is reprinted from Basis Points® , Vol. 1, Issue 3, Copyright © 2002, with the permission of CounselorLibrary.com, LLC. All Rights Reserved. Further reproduction is prohibited without permission.

Last year, it was the big thing. Everyone scrambled to try to make sense of incredibly complicated privacy rules. Now may be a good time to go back and re-examine some of the basic decisions and assumptions you made in putting your privacy policies in place. Why? The Federal Trade Commission staff (FTC) has developed a set of Frequently Asked Questions (FAQs) to assist you in complying with the privacy provisions of the Gramm-Leach-Bliley Act (GLB Act) and the Commission's financial privacy regulation. The FAQs are a response to the thousands of questions that the FTC and the Banking Agencies have fielded about the Privacy Rules over the last 18 months.

The following collection of questions and answers addresses some of the more important comments that affect the mortgage industry.

Who is Covered?

Who must comply with the Privacy Rule?

The rules cover any mortgage lender, any mortgage broker, and most parties involved in making, acquiring, brokering or servicing loans, such as escrow companies, appraisers, credit reporting companies, title abstractors, insurance companies and notaries. All of these people are lumped together under the general heading "financial institution." Any financial institution that provides financial products or services to consumers must comply with the privacy provisions of Subtitle A of Title V of the Gramm-Leach-Bliley Act ("GLB Act") (codified at 15 U.S.C. §§ 6801-09) and the Privacy Rules. You have consumers if you provide your financial products or services to individuals, not businesses, to be used primarily for personal, family, or household purposes.

Why does the Privacy Rule sometimes refer to consumers and other times to customers? Aren't customers also consumers?

All rabbits are mammals, but all mammals are not rabbits. Likewise, under the Privacy Rules, all customers are consumers, but not all consumers are customers. A consumer is an individual who obtains a financial product or service from you that is primarily for personal, family, or household purposes. A financial product or service includes the evaluation or brokerage of information collected in connection with a request or application, such as a bank's review of loan application materials to determine whether an applicant qualifies for a loan.

A customer is a type of consumer, namely, an individual who has an ongoing relationship with you under which you provide a financial product or service. Note that neither a business nor an individual who obtains a financial product or service for business purposes is a consumer or a customer under the Privacy Rule.

The rule distinguishes consumers from customers because your responsibilities to provide notices to consumers and to customers differ in several respects.

• You must give all your customers initial privacy notices.
• You must give initial notices (or short form notices) to consumers who are not your customers only if you intend to disclose nonpublic personal information about those consumers to nonaffiliated third parties.
• You must give annual privacy notices to your customers as long as they remain your customers.
• You are never required to send annual notices to consumers who are not your customers.

It is important to remember that all consumers are entitled to the same protection from disclosures of nonpublic personal information under this regulation regardless of whether they are customers. As a result, you may not disclose the nonpublic personal information of any consumer or any customer to any nonaffiliated third party outside specific circumstances listed under the regulation unless you provide a privacy notice and a reasonable opportunity to opt out, and the consumer or customer does not opt out.

I occasionally make business loans to sole proprietors. Do I have to provide them with a privacy notice?

Although a sole proprietor is an individual, if the sole proprietor obtains a loan from you for business purposes he or she is not a "consumer" for purposes of the Privacy Rule. Therefore, you do not have to provide any privacy notices to the sole proprietor.

Is a guarantor or an endorser of a consumer loan considered my consumer or customer?

A guarantor or endorser is your customer because the individual assumes secondary liability on the loan he or she guarantees or endorses and thereby receives an extension of credit from you. You may, however, treat the primary borrower and the guarantor or endorser as joint account holders. The Privacy Rules permit you to deliver a single privacy notice to joint account holders under most circumstances. If you disclose information to nonaffiliated third parties outside of the exceptions set forth in the rule, you must also provide the primary borrower and the guarantor/endorser with an opportunity to opt out. You may deliver a single opt out notice to the joint account holders.

Non-U.S. resident consumers conduct business at my U.S. offices. Do the privacy regulations apply in cases where consumers live in another country?

Yes. The privacy regulations apply to all United States offices of financial institutions that are subject to the FTC authority under the GLB Act, regardless of where the consumer lives.

Is a person who only browses my web site my consumer?

No. The person does not obtain a financial product or service from you merely by browsing your web site.

Notices: Delivery and Content Issues

I issue credit cards to consumers. Very often, I take credit card applications by telephone and approve them within minutes. My customers wish to begin using their new accounts right away. When must I deliver initial notices in these cases?

You cannot deliver your privacy notice solely by explaining it over the telephone. However, you may provide an initial notice within a reasonable time after establishing a customer relationship if (i) providing it when you establish that relationship would substantially delay the customer's transaction, and (ii) the customer agrees to a later delivery. In the case of approving a credit card application by telephone, waiting until you have time to mail the notice would substantially delay the customer's use of a new credit account. As long as your new customer agrees to receive the notice later, you may deliver it within a reasonable time after establishing the customer relationship. Notwithstanding that exception, delayed delivery of an initial notice does not alter the restrictions on disclosing nonpublic personal information. That is, if you delay delivering your initial notice to a customer, you may not disclose that customer's nonpublic personal information to any nonaffiliated third party before you provide the notices and a reasonable opportunity to opt out.

I am a financial institution with several subsidiaries. Must each affiliated financial institution issue a separate privacy notice? If affiliated financial institutions are permitted to combine their notices, how may we identify them in the notice?

You and your subsidiaries may share common privacy policies and practices and you may combine your respective privacy notices into a joint notice. However, any joint notice must be accurate as to each institution, must be clear and conspicuous, and must identify which institutions it covers.

You do not have to list each financial institution by its particular legal name. Instead, if each institution shares the "ABC" name, then the joint notice could state that it applies to all institutions "with the ABC name" or "in the ABC family of companies." Conversely, if an affiliated institution does not have ABC in its name, then your notice must separately identify that institution.

My privacy notice must identify "categories" of nonpublic personal information I collect and categories of affiliates and nonaffiliated third parties with which I share that information. How detailed do the categories need to be?

The Privacy Rule does not require your privacy notices to describe in detail the information you collect or disclose. Moreover, you are not required to identify by name parties to whom you may make disclosures. Rather, you may describe the types, or categories, of information you collect and disclose, and the types of third parties to whom you disclose the information. These categories must be representative of your policies and practices.

Because the examples in the rule that describe categories of information and parties to whom you disclose information are not exclusive, you may describe the items that apply to you by using other reasonably understandable language that informs a consumer about your privacy policies and practices. You also may use different language and may provide additional detail as appropriate to explain your policies and practices to your consumers. In addition, the Privacy Rule requires you to address only those items that apply to you. Your initial notice must accurately describe your policies and procedures as of the time you provide the notice to a consumer or customer. A notice also may be accurate even if it reflects anticipated as well as current policies and practices.

After I provide an initial privacy notice to my customer, the Privacy Rule requires me to deliver privacy notices to that customer not less than annually during the continuation of the customer relationship. What does "annually" mean?

"Annually" means at least once in any period of 12 consecutive months during which a customer relationship exists. If you use the calendar year as your notice period, you have the flexibility to give the first annual notice to a customer at any point in the calendar year following the year in which the customer relationship is established. Thereafter, you are expected to provide annual notices on a consistent basis. Any period of more than 12 consecutive months between annual notices should have an appropriate business justification.

Can I combine my privacy notice with other consumer disclosures, such as those under the Truth in Lending Act (Regulation Z) or the escrow account reporting rules under RESPA?

The Privacy Rule permits you to combine your privacy notices with other information. However, you must still comply with all applicable requirements, such as those governing form, content, and delivery of notices. For example, if you combine your privacy notice with a disclosure under Regulation Z, each component of the combined notice/disclosure must comply with the "clear and conspicuous" requirements in the regulation governing that component.

I do not disclose any nonpublic personal information about my customers to any affiliates or nonaffiliated third parties, except under the conditions described in the exceptions to notice and opt out requirements. What aspects of my privacy policies and practices must my notice address?

In this case, you may use a simplified notice. A simplified notice is sufficient if it:

• Describes the categories of nonpublic personal information you collect;
• States the fact that you do not share nonpublic personal information about your customers or former customers to affiliates or nonaffiliated third parties, except as authorized by law; and
• Describes your policies and practices for protecting the confidentiality and security of consumers' nonpublic personal information (under § 501(b) of the GLB Act).

I have a loan with co-borrowers. They share the same address. When notice is required, may I mail just one privacy notice?

Yes, you may mail one notice to two or more joint borrowers at the same address, unless one or more of the joint borrowers requests separate notices.

What if those same borrowers have different addresses?

You still may mail one notice to all borrowers jointly at one account borrower's address, unless one or more individual requests a separate notice.

One borrower, A, maintains with me a single loan account and a joint loan account with another consumer, X. What are my obligations to send privacy notices to A and X? Can I satisfy the initial privacy notice requirement by sending just one notice?

In some cases, one notice may be sufficient. For example, if A and X open the joint account first and A subsequently opens an individual account, you need not provide an additional initial notice to A if the most recent notice you provided to A as part of the joint account is accurate as to the individual account.

If A already has an individual account with you but X becomes your customer at the time the joint account is opened, you must provide an initial notice to X with respect to the joint account. However, you may deliver the initial notice either to A or to X by providing one notice to those consumers jointly (unless either or both requests separate notices). For example, you may deliver one notice addressed to both A and X. You subsequently may satisfy the annual and revised notice requirements by sending one notice regarding the joint account either to A or X.

One borrower, A, has two different joint accounts, one with X and the other with Y. When annual or revised notices are required as to both accounts, how many notices must I provide?

Annual and revised notices pertaining to each of the joint accounts may be provided either to A or to both of the other account holders respectively (unless one or more requests separate notices). Thus, one notice to A is sufficient, as long as the notice is accurate as to both accounts. The Privacy Rule does not require you to mail two identical notices to A, one for each account.

However, you may not disclose to X that A has a joint account with Y or disclose to Y that A has a joint account with X, unless these facts are publicly available. The fact that a consumer is a financial institution's customer is nonpublic personal information, unless you have a reasonable basis to believe that the customer relationship is a matter of public record.

Managing the Opt Out Process

I have two borrowers who hold one account jointly. Must I deliver a separate opt out notice to each account holder and allow each of them to opt out individually? Suppose I mail only one opt out notice for that account, and one of the joint holders checks "I opt out" and returns it to me. To whom does the opt out decision apply?

You may deliver either a single opt out notice to one of the account holders or a separate notice to each account holder. In either case, the notice must permit one joint account holder to opt out on behalf of all holders of the account. So long as your notice fulfills this requirement, you also may permit joint account holders to opt out individually.

The answer to your second question depends upon how you have designed your opt out notice. Your notice must permit one joint account holder to opt out on behalf of all holders of that account. However, you have several ways to do this. For example, your notice may contain one box that, when checked, will result in an opt out by the person checking the box and all other individuals on the account. Alternatively, the opt out notice may provide boxes that enable each individual on the account to opt out separately, as well as a box that permits one account holder to opt out on behalf of everyone on the account.

With either option your notice must clearly and conspicuously describe how each applicable opt out selection will be treated. For example, the opt out selection for all account holders should disclose that the customer making that selection is opting out for all account holders with respect to information concerning that joint account. Similarly, the "individual" opt out selection should explain that the selection applies only to the customer making the selection.

If you already are disclosing nonpublic personal information because you did not receive an opt out direction after sending your initial notice, each joint account holder still may choose to opt out at a later date. You must abide by any subsequent opt out decision as soon as reasonably practicable after you receive it, and you must not delay complying with one individual account holder's opt out direction until the remaining account holder(s) opt out.

Once a consumer opts out, whether during the initial opt out period or subsequently, you must not share the consumer's nonpublic personal information to which the opt out applies unless and until the consumer subsequently revokes his or her opt out direction.

I allow joint account holders X and Y to make independent opt out elections. For opt outs, I use reply forms with check-off boxes. Must I mail two opt out response forms for one joint account?

No, only one is necessary. However, you must allow each account holder a reasonable amount of time to opt out before disclosing any nonpublic personal information about him or her. For example, suppose you normally allow each consumer 30 days to opt out, and you immediately receive an opt out instruction from X but not from Y. You still must allow Y the standard 30 days to opt out before you may disclose any nonpublic personal information relating to the joint account. You may disclose nonpublic personal information about Y if Y does not opt out within the reasonable opt out period, but only to the extent such a disclosure would not reveal nonpublic personal information about X.

I allow joint account holders to make independent opt out elections. May I require each account holder to opt out in a separate response?

No. You must allow both account holders a reasonable opportunity to opt out in one response, such as one opt out form or in one call to your toll-free opt out line.

I allow joint account holders, X and Y, to make independent opt out elections. Suppose that X opted out, but Y did not respond. What nonpublic personal information about X and Y may I disclose?

Because X has opted out, you must not disclose any nonpublic personal information about X. In addition, you must not disclose nonpublic personal information about Y except as permitted by an exception if the disclosure of that information also would disclose nonpublic personal information about X. For example, suppose that X and Y are married, share the same surname, reside at the same address, and jointly hold a loan account with you. You may disclose nonpublic personal information relating to that account about Y, such as the average monthly balance in the account, as long as that disclosure does not include any nonpublic personal information about X. Further, you must not disclose the fact that Y holds the joint account together with X.

Must I provide opt out notices if I do not disclose nonpublic personal information to nonaffiliated third parties, except as permitted under one of the exceptions?

No. If you disclose nonpublic personal information only under one or more of those exceptions, you need not provide any opt out notices. Nonetheless, be aware that if you disclose nonpublic personal information to service providers or in joint marketing arrangements, then you must provide an initial notice that includes a separate statement that describes that disclosure. Also, you must provide an annual notice to your customers regardless of your disclosure policies and practices.

What are some reasonable means of allowing consumers an opportunity to opt out?

You may provide various opt out methods that are reasonable, depending on the circumstances surrounding the financial product or service. For example, for new customers who open credit card accounts, you may deliver a form with a check-off box that they can check and return to you. If you use this method, you must deliver the check-off form with your opt out notice. You also may provide a toll-free telephone number that consumers can call to opt out.

The Privacy Rule provides that you may require a consumer to opt out through a specific means if that means is reasonable for that particular consumer. For example, you may require a consumer who has agreed to the electronic delivery of notices to opt out by using a process available on your web site if that consumer uses your web site to access financial products or services. You also may require a consumer who conducts an isolated transaction at your branch or office in person to decide whether to opt out as a necessary part of completing the transaction and to use the means you specify to effect his or her opt out direction.

Note that you may allow any consumer to opt out by e-mail or by using a process available on your web site, but you may not require the consumer to use an electronic method if the consumer has not agreed to electronic delivery of notices. Under these circumstances, you must provide other reasonable methods for the consumer to opt out.

No particular method described in an example in the Privacy Rule is strictly required and there may be other reasonable methods for allowing a consumer to opt out of disclosures. Some methods to opt out, however, are unreasonable. For instance, you must not require consumers to write their own letters to opt out as the only opt out method.

If I allow my customers to mail a form to indicate their opt out election, am I required to provide my customers with a postage-paid envelope so they can mail the form back?

No. You are not required to provide an individual with a postage-paid envelope to meet the requirement that you provide a reasonable means for consumers to opt out.

In our initial and annual notices, our company would like to provide a tear-off opt out form and its privacy policies on the front and back of a single sheet of paper. Is this permissible?

Yes, provided the opt out form may be detached without removing text from your privacy policy. However, if by detaching the opt out form the customer removes text from the privacy policy, the practice may not be workable. A financial institution must provide its privacy notices in a form in which a customer can retain them or obtain them later. If the customer would remove text from your privacy policy by detaching the opt out notice, then you should either redesign the privacy notice or have procedures in place to provide a customer with the complete text of your privacy notice upon request.

I would like to disclose to nonaffiliated third parties different types of nonpublic personal information about my customers, such as their addresses and their account information. The nonaffiliated third parties are not financial institutions with which I have a joint agreement. I realize that I must allow my customers to opt out of all these disclosures, but may I give them the choice to opt out of disclosures of certain categories of information as well as all categories of information to nonaffiliated third parties?

Yes. You must allow your customers to opt out of all these disclosures to nonaffiliated third parties. Additionally, you may allow your customers to choose to opt out of some types of disclosures, rather than simply all of those disclosures. For example, you may allow your customers to opt out of disclosures of account information and provide a separate opportunity for customers to opt out of disclosures of their addresses.

I make consumer loans. I would like to disclose my customer list to nonaffiliated clothing retailers and to nonaffiliated automobile dealers. These nonaffiliated third parties are not financial institutions with which I have a joint agreement. I realize that I must allow my customers to opt out of all these disclosures. But may I also give them the choice to opt out of disclosures to certain kinds of nonaffiliated third parties without having to opt out of disclosures to all kinds of third parties?

Yes. You must allow your customers to opt out of all these disclosures. Additionally, you may allow your customers to choose to opt out of disclosures to some kinds of nonaffiliated third parties instead of simply all of those parties. For example, you may allow your customers to opt out of disclosures to clothing retailers and allow a separate opportunity for the same customers to opt out of disclosures to automobile dealers.

We deliver opt out notices by mail and allow our new customers 30 days to opt out before we begin sharing their information with nonaffiliated third parties. The Privacy Rules provide that a financial institution must comply with a consumer's opt out direction as soon as reasonably practicable after the financial institution receives it. It may take our company up to five weeks to process an opt out direction. If we mail a new customer a privacy and opt out notice on September 1 and we receive the customer's opt out direction on September 15, may we share that individual's nonpublic personal information between September 15 and October 22 - the date by which we can process the opt out?

No. The Privacy Rule provides that a financial institution may not share a consumer's nonpublic personal information unless the institution has given the consumer an initial privacy notice, an opt out notice, and a reasonable opportunity to opt out, and the consumer has not opted out. If your customer opts out at any point within the 30-day period in your example, then you would not be able to disclose that individual's information to nonaffiliated third parties unless the customer subsequently revoked the opt out direction.

Because the Privacy Rule permits consumers to opt out at any time, it provides an institution with a reasonable period of time to process an existing consumer's opt out election before the institution must cease disclosing the consumer's information. The institution must process the opt out election as soon as reasonably practicable. For example, following the 30-day period that you provide initially for your customers to opt out, you may disclose the nonpublic personal information of those individuals who have not exercised their right to opt out. However, you must honor any subsequent opt out election by any of those customers "as soon as reasonably practicable."

Disclosure of Nonpublic Information - Things Consumers Can Not Opt Out Of

I am a mortgage lender, but a nonaffiliated third party ("Servicer") services my loans. I disclose nonpublic personal information to the Servicer under an exception for that purpose. I have the following questions.

I disclose nonpublic personal information about my customers to the Servicer so the Servicer can process transactions that the customers have requested. May the Servicer disclose the information it collects from me about my customers to a retail merchant that is not affiliated with me?

Generally, no. When the Servicer receives nonpublic personal information about your customers under an exception to the notice and opt out provisions, such as in connection with servicing your loans, the Servicer's use and disclosure of that information is limited. The Servicer must not disclose any nonpublic personal information to a retail merchant not affiliated with you unless the Servicer may do so under an applicable exception. For example, the Servicer may not provide information about your customers to the retail merchant for marketing purposes.

May the Servicer disclose the nonpublic personal information to my affiliate?

Yes. The Privacy Rule explicitly provides that the Servicer may disclose the information to your affiliate.

May the Servicer disclose the information to the Servicer's affiliate?

Yes, but the Servicer's affiliate may disclose and use the information only as the Servicer could disclose and use it. The Servicer's affiliate therefore may use the information to service your loans. The affiliate also may disclose the information under an applicable exception in the ordinary course of business to carry out the activity covered by the exception under which the Servicer received the information.

Disclosure of Nonpublic Information - When the Consumer does not Opt Out

I am a mortgage lender and am affiliated with a property insurer. In my privacy notices I inform consumers that I disclose nonpublic personal information to my affiliated insurance company. My privacy notice also states that, if a consumer does not opt out, I may disclose nonpublic personal information about the consumer to nonfinancial companies, such as retailers.

Among the nonaffiliated third parties to whom I disclose information are an automobile dealer and a residential plumbing company. The plumbing company is affiliated with a company that sells air conditioning products and services. I have the following questions about disclosing information about consumers who do not opt out.

I disclose information about my customers who do not opt out to a residential plumbing company. Can the plumbing company use the information for marketing purposes?

Yes. This is permissible because you disclosed nonpublic personal information to the plumbing company in accordance with the notice and opt out provisions of the GLB Act. In other words, you disclosed information about a consumer consistent with your privacy notice and the consumer's choice not to opt out.

As illustrated in the following questions and answers, when the plumbing company receives from you nonpublic personal information about a consumer who has not elected to opt out, the company is free to use the information for marketing or other purposes. However, the plumbing company may disclose the nonpublic personal information it receives from you only if such a disclosure is consistent with the restrictions on disclosure of the information described in your privacy policy. The plumbing company therefore is required to honor any subsequent opt out elections made by consumers pursuant to your privacy policy and accordingly must have a mechanism through which it can monitor and implement subsequent opt out elections you receive.

One of my affiliates sells insurance. May the plumbing company, who received my customers' information outside an exception, disclose that information to my affiliated insurer?

Yes. The Privacy Rule explicitly provides that the plumbing company may disclose the information to your affiliate.

I disclosed information to the plumbing company outside an exception. The plumbing company is affiliated with an air conditioning company. The air conditioning company is not affiliated with me. May the plumbing company disclose my consumers' nonpublic personal information to that air conditioning company?

Yes. The Privacy Rule permits a party that receives nonpublic personal information outside of an exception to disclose that information to its affiliates. In this case, therefore, the plumbing company may disclose the information to its affiliated air conditioning company. However, the affiliated air conditioning company may, in turn, disclose the information only to the extent that the plumbing company may, consistent with your privacy notice.

I disclosed information to the plumbing company outside an exception. May the plumbing company disclose my consumers' nonpublic personal information to a nonaffiliated automobile parts retailer?

Yes. The Privacy Rule permits a party that receives nonpublic personal information outside of an exception to disclose that information to another nonaffiliated third party, provided that it would be lawful for the original financial institution to make that disclosure directly to that party.

Under your privacy notice, it would be lawful for you to disclose nonpublic personal information about those consumers who chose not to opt out to the automobile parts retailer. However, the plumbing company could not disclose nonpublic personal information obtained from you to other nonaffiliated retailers if your privacy policy would not permit such disclosures.

Special Issues Related to Account Numbers

I am a financial institution. I transform my customers' account numbers into encrypted forms that can be used solely to identify those customers. I enter into an arrangement with a third party telemarketing firm whereby I disclose my customers' names, telephone numbers, and encrypted identifying numbers. The third party telemarketing firm uses that information to market products (other than products I offer) to those customers. For those customers who agree to purchase the products, the third party telemarketing firm submits their encrypted identifying numbers to me, and I decrypt them into account numbers. At the end of this process, am I permitted to disclose the customers' actual account numbers to the third party telemarketing firm so that the telemarketing firm can initiate the charges to the customers' accounts?

No. The Privacy Rule generally prohibits you from disclosing credit card, deposit, or other transaction account numbers "for use in telemarketing, direct mail marketing, or other marketing through electronic mail to the consumer." Accordingly, you must not provide your customers' account numbers to the third party telemarketing firm "for use in telemarketing."

The Privacy Rule provides only three exceptions. A financial institution may disclose its customers' account numbers to:

• a consumer reporting agency;
• its agent to market the institution's own products or services, provided that the agent is not authorized to directly initiate charges to the account; or
• another participant in a private label credit card or an affinity or similar program involving the institution.

Because none of these exceptions applies in your case, you must not provide your customers' account numbers to a third party telemarketing firm so that it can initiate the charges to the customers' accounts.

I would like to enter an arrangement with a nonaffiliated insurance agency that markets its products to my customers through direct mail solicitations. The proposed arrangement contemplates that I would disclose a customer's account number to the insurance agency's affiliate. The affiliate then would use the account number to debit the purchase price from my customer's account in response to these solicitations. The affiliate's only role in the arrangement would be initiating the charges. Does the Privacy Rule allow me to disclose a customer's account number to the insurance agency's affiliate under these circumstances?

No. The Privacy Rule prohibits you from disclosing your customers' account numbers to any nonaffiliated third party for use in marketing. Although the affiliate in your hypothetical does not distribute marketing materials but only initiates charges, its conduct of that activity is an integral part of your marketing arrangement with the insurance company. The disclosure of a customer's account number to the insurance company's affiliate under these circumstances therefore would be a disclosure for use in marketing that violates the Privacy Rule.

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Basis Points® is a concise, easy-to-read, monthly legal update for the mortgage lending industry. Basis Points® addresses complex legal issues from an industry perspective and keeps you informed on new legal developments affecting your business. Written in plain English, Basis Points® provides familiar factual scenarios, identifies the legal issues involved, presents real court resolutions and suggests how you might avoid similar legal pitfalls. Topics featured in Basis Points® include: Predatory Lending; Yield-Spread Premiums; RESPA - Fee Splitting and Up charges; Privacy; RESPA - Joint Venture; Bankruptcy; Fair Lending and Discrimination; and Truth in Lending/ Regulation Z. Basis Points® is published by CounselorLibrary.com, LLC, an affiliate of the Hudson Cook, LLP law firm. The CounselorLibrary.com, LLC is also the publisher of CARLAW®, HouseLaw®, Spot Delivery®, and the Counselor Library Series. For more information, please visit: www.counselorlibrary.com.

FTC to Mortgage Brokers: You are Subject to New Privacy Rules

The following article is reprinted from Basis Points® , Vol. 2, Issue 2, Copyright © 2003, with the permission of CounselorLibrary.com, LLC. All Rights Reserved. Further reproduction is prohibited without permission.

The FTC has recently published new guidance on the obligations imposed on mortgage brokers under the new privacy rules.

Are mortgage brokers subject to the Privacy Rule? Yes. Mortgage brokers are financial institutions because brokering loans is a "financial activity" as defined in section 4(k)(4)(F) of the Bank Holding Company Act. Mortgage brokers are subject to the FTC's enforcement authority, its Privacy Rule, and its Safeguards Rule.

The Privacy Rule applies when an individual seeks your assistance in obtaining mortgage loans that are primarily for personal, family, or household purposes. Under the Privacy Rule, you establish a customer relationship when an individual enters into an agreement or understanding with you and you undertake to arrange or broker a residential mortgage loan for him or her. You also establish a customer relationship when an individual provides any personally identifiable financial information to you in an effort to obtain a residential mortgage loan through you. Personally identifiable financial information means any information:

• A consumer provides to you to obtain a financial product or service from you;
• About a consumer resulting from any transaction involving a financial product or service between you and a consumer; or
• You otherwise obtain information about a consumer in connection with providing a financial product or service to that consumer.

Personally identifiable financial information includes:

• Information a consumer provides to you on an application to obtain a loan, credit card, or other financial product or service;
• Account balance information, payment history, overdraft history, and credit or debit card purchase information;
• The fact that an individual is or has been one of your customers or has obtained a financial product or service from you;
• Any information about your consumer if it is disclosed in a manner that indicates that the individual is or has been your consumer;
• Any information that a consumer provides to you or that you or your agent otherwise obtain in connection with collecting on, or servicing, a credit account;
• Any information you collect through an Internet "cookie" (an information collecting device from a web server); and
• Information from a consumer report.

Personally identifiable financial information does not include:

• A list of names and addresses of customers of an entity that is not a financial institution; and
• Aggregate information or blind data that does not contain personal identifiers such as account numbers, names, or addresses.

Can I provide the Privacy Notice after I take an application? No. The Privacy Rule requires that you provide an initial privacy notice no later than when the customer relationship is established. A customer relationship is established as soon as an individual provides personally identifiable financial information to you in an effort to obtain a mortgage loan through you. As a result, you must deliver a privacy notice before or at the same time as the individual provides application information to you. You cannot wait until a day or two later.

What about online applications? May I deliver an initial privacy notice at the same time as individuals submit their application information online? Yes. The Privacy Rule requires that you provide an initial privacy notice no later than when the customer relationship is established. The customer relationship is established as soon as an individual submits application information to you. As a result, you must deliver the privacy notice not later than when the customer submits the information online.

You may deliver a notice to online applicants by posting your current privacy notice clearly and conspicuously on your website if you require each applicant to acknowledge its receipt not later than when he or she first submits the application information. You must also provide the notice in a format that permits your customer to retain it or obtain it later. One way of doing this is to make your current privacy notice available on your website for online applicants who agree to receive the notice at the website.

What if I take residential mortgage applications over the phone without meeting the applicant face-to-face. Under the Privacy Rule may I deliver an initial privacy notice after these individuals give me their personally identifiable financial information? Subsequent delivery is permitted under certain circumstances. The Privacy Rule permits you to deliver the notice within a reasonable time after you establish a customer relationship if:

• You would substantially delay the customer's transaction if you had to provide notice before or not later than when you establish the customer relationship would, and
• The customer agrees to receive the notice at a later time.

Note, however, that if you delay delivering your initial notice to a customer, you may not disclose that customer's nonpublic personal information to any nonaffiliated third party (except as permitted by the exceptions under §§ 313.14 and 313.15 of the Privacy Rule) before you provide the notices and a reasonable opportunity to opt out, in accordance with §§ 313.7 and 313.10 of the Privacy Rule.

Do I need to provide an annual privacy notice to an individual who has obtained a mortgage loan through me if we're no longer in communication? No. An individual who has obtained a loan through you becomes a former customer when you no longer provide any statements or notices to the customer concerning that relationship. (Likewise, a customer who ceases using your services without obtaining a loan through you becomes a former customer.) You are not required to provide an annual notice to a former customer. However, you may need to provide a revised privacy notice and opt out notice if you intend to disclose nonpublic personal information about a former customer other than as described in the initial privacy notice that you provided.

In order to obtain loans for my customers, I share nonpublic personal information with lenders and credit reporting agencies, and my privacy notice notifies my customers that I make disclosures as permitted by law. Am I required to allow my customers to opt out of this type of information sharing? No. The Privacy Rule allows you to disclose nonpublic personal information about your customers without providing them a reasonable opportunity to opt out under certain circumstances. These exceptions to the opt out requirement are described at §§ 313.13 through 313.15 of the Privacy Rule.

Pursuant to § 313.14, you do not need to allow your customers to opt out of disclosures that are necessary for processing or administering financial transactions that they have requested or authorized. This would include, for example, disclosures to a prospective lender where your customer has authorized you to look for a mortgage loan and the disclosure is necessary to broker the loan. Further, the exceptions under § 313.15 include disclosures of information to a consumer reporting agency that are made in accordance with the Fair Credit Reporting Act.

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Basis Points Articles

Basis Points® is a concise, easy-to-read, monthly legal update that you can depend on to provide timely answers to legal questions you face every day. Basis Points addresses complex legal issues from an industry perspective; it also keeps you informed on new legal developments affecting your business.

Basis Points® provides authoritative, reliable information in easy-to-read, plain English. The newsletter provides familiar factual scenarios, identifies the legal issues involved and presents real court resolutions and suggestions on how you might avoid similar legal pitfalls. This practical, useful publication will provide you and your management team with valuable knowledge designed to increase awareness of legal consequences attendant to everyday business decisions.