In the last issue of The Compliance Wizard, the Compliance Department launched the first of its three-part series on the rudiments of the Finance Charge, as defined under the Truth in Lending Act1, to respond to a growing number of telephone calls from customers inquiring into whether a particular fee, cost or charge may be excluded from the calculation of a Finance Charge.

Last month's issue defined "Finance Charge" and explained, in general terms, which charges are generally included in the calculation of the Finance Charge relative to home equity lines of credit (HELOCs) and residential mortgage transactions. This issue will cover the types of charges, fees, and costs that must be excluded from the definition and calculation of a Finance Charge pursuant to Reg. Z Section 226.4 and the Official Board and Staff Interpretations issued by the Federal Reserve Board.

TILA's Reg. Section 226.4(c), among other paragraphs, prescribes which charges are excluded from the calculation of the Finance Charge. Those charges include, among other charges, (1) application fees, whether or not credit is extended; (2) charges for actual unanticipated late payment, for exceeding a credit limit, or for delinquency, default or similar occurrence; (3) charges imposed by a financial institution for paying items that overdraw an account, unless the payment of such items and the imposition of the charge were previously agreed upon in writing; (4) fees charged for participation in a credit plan, whether assessed on an annual or other periodic basis; (5) seller's points; and (6) interest forfeited as a result of an interest reduction required by law on a time deposit used as a security for an extension of credit.

Additionally, Section 226.4(d) states that provided certain conditions are satisfied, premiums for credit life, accident, health or loss-of-income insurance and fees or premiums for debt-cancellation coverage may be excluded from the Finance Charge.

With respect to a loan transaction secured by real property or in a residential mortgage transaction (including the purchase of a mobile home), Section 224(c)(7) addresses which fees may be excluded from the Finance Charge. Section 224(c)(7) provides that the following fees are to be excluded from the Finance Charge if the fees are bona fide and reasonable in amount:

1. Fees for title examination, abstract of title, title insurance, property survey, and similar purposes.
2. Fees for preparing loan-related documents, such as deeds, mortgages, and reconveyance or settlement documents.
3. Notary and credit report fees.
4. Property appraisal fees or fees for inspections to assess the value or condition of the property if the service is performed prior to closing, including fees related to pest infestation or flood hazard determinations.
5. Amounts required to be paid into escrow or trustee accounts if the amounts would not otherwise be included in the Finance Charge.

Even if the above services are performed by the creditor's employees rather than by a third party, the fees for these services are excluded from the Finance Charge. Additionally, the cost of verifying or confirming information connected to the charge is also excluded. The Federal Reserve Board's Official Staff Commentary on Section 226.4(c)(7) cites the cost of a credit report and verifying information in that report as an example.

The Official Staff Commentary to Paragraph 4(c)(7) also states that if a lump sum charged for several services includes a charge that is not excludable, a portion of the total should be allocated to that service and included in the Finance Charge. However, a lump sum charged for conducting or attending a closing would be excluded from the Finance Charge if the charge is primarily for services related to items listed in Section 226.4(c)(7), such as reviewing or completing documents, even if other incidental services such as explaining various documents or disbursing funds for the parties are performed. The entire charge is excluded even if a fee for the incidental services would be a Finance Charge if it were imposed separately.

Note that real estate or residential mortgage transaction charges excluded under Section 226.4(c)(7) are those charges that are imposed solely in connection with the initial decision to grant credit. For example, a fee to search for tax liens would be excluded from the Finance Charge. However, this exclusion does not apply to fees for services to be performed periodically during the loan term, regardless of when the fee is collected. The Official Staff Commentary cites as an example of a Finance Charge a fee for one or more determinations during the loan term of flood insurance requirements, whether or not the fee is paid at closing or when the service is performed. If a creditor is uncertain about what portion of a fee to be paid at consummation or loan closing is related to the initial decision to grant credit, the entire fee may be treated as a Finance Charge.

Certain Security Interest Charges

If itemized and disclosed, the following charges may be excluded from the Finance Charge:

1. Taxes and fees prescribed by law that actually are or will be paid to public officials for determining the existence of or for perfecting, releasing, or satisfying a security interest.
2. The insurance premium in lieu of perfecting a security interest to the extent that the premium does not exceed the fees described in Section 226.4(e)(1) of this section that otherwise would be payable.
3. Any tax levied on security instruments or on documents evidencing indebtedness if the payment of such taxes is a requirement for recording the instrument securing the evidence of indebtedness. (Reg. Z Section 226.4(e).)

In the "Charges" window of Our DocMagic software, the "APR" column automatically defaults to "Y" for "Yes" and "N" for "No" for the particular charge that is selected by the user. The defaults are based on Reg. Section 226.4, the Official Staff Commentary for Section 226.4 and any applicable case law. A "Y" indicates that the charge is included in the Finance Charge and will be a factor in determining the Annual Percentage Rate (APR). An "N" would indicate that the particular charge is excluded from the Finance Charge and, therefore, would not be a factor in determining the APR for the specific loan transaction.

Stay tuned for The Compliance Wizard's May issue for Part III of this series, for a discussion of those charges that are "gray areas" and tips for determining whether a particular cost or charge is a Finance Charge.

Melanie A. Feliciano is Assistant General Counsel of Document Systems, Inc. and a member of its Compliance Department.