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).

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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.