In this final part of our series on the rudiments of the Finance Charge, as defined under the Truth in Lending Act, we describe the process for determining whether a particular cost or fee is a Finance Charge. If you recall, in our March 2005 issue of The Compliance Wizard, we defined, in general terms, what a Finance Charge is relative to home equity lines of credit (HELOCs) and residential mortgage transactions. Our April 2005 issue discussed the types of charges, fees, and costs that must be excluded from the definition and calculation of a Finance Charge pursuant to Regulation Z Section 226.4 and the Official Board and Staff Interpretations issued by the Federal Reserve Board.

The Finance Charge and the Annual Percentage Rate (APR) are two of the most important disclosures required under the Truth in Lending Act (TILA). These two items are required by TILA to be disclosed more conspicuously than any other item.

An accurately calculated Finance Charge results in an accurately disclosed APR. In turn, the calculations for determining whether a federally-related mortgage transaction is a "Section 32" or "high-cost" loan will be accurate and, thus, would avoid any potential liability for the lender.

Failure to disclose an accurate Finance Charge within the tolerance levels permitted under TILA would subject the lender to potential liability. Therefore, it bodes well for the lender to apply the rules under TILA's Reg. Z Section 226.4 and, in the event of doubt, to designate a particular fee or cost as a Finance Charge. There is no liability for overdisclosing the Finance Charge.

So, when a cost or fee is not expressly included or excluded in Section 226.4, and there is uncertainty about whether that cost or fee is a Finance Charge, we suggest the following approach:

1. Ask the following questions:
   1. Is the charge payable directly or indirectly by the consumer?
   2. Was the charge imposed directly or indirectly by the creditor?
   3. Is the charge an incident to or a condition of the extension of credit?
   If your answer is "Yes" to each of the above questions, then the charge is a finance charge unless it is specifically excluded by TILA or TILA's Regulation Z, at Section 226.4, or it is a charge that is likewise payable in a comparable cash transaction.
2. The list of excludable charges is found mainly in Regulation Z, 12 CFR 226.4(c), (d) and (e). The charges to focus on in any real estate transaction are set forth in Section 226.4(c)(7) - real-estate related fees. These fees are excludable even if they are paid to the broker or the lender provided the charges are bona fide and reasonable in amount. All of the usual are mentioned here: appraisal fees, title examination fees, credit report fees, notary fees, document preparation fees, etc.

Believe it or not, this analysis takes care of the vast majority of fees. If you are not sure whether a particular charge is a Finance Charge or not, all you need to do is follow the above approach - it's a Finance Charge unless expressly excluded, then go look for the exclusion.

There are some gray areas that you should be aware of as explained immediately below:

1. "Upcharging" of otherwise excludable fees (e.g., charging $250 for document preparation while the true cost might be $35). Leaving aside the question of whether you should even engage in this practice (HUD has stated that such upcharges violate RESPA, and many state regulators cast a critical eye on the practice), in theory, you should include that portion that exceeds your true cost (in my example, $215) as a Finance Charge. In reality, most lenders will simply include the entire amount as there is no harm in overdisclosing Finance Charges and APR.
2. "Basic" or "Non-Life of Loan" Flood Hazard Determination costs are excludable under Section 4(c)(7). However, the exclusion does not apply to the cost of a "Life of Loan" flood determination because a portion of that cost is associated with the flood provider's ongoing obligation to notify the creditor of changes in the security property's flood status after loan closing. In this case, that portion of the cost of the flood determination that relates to that ongoing notification obligation is a Finance Charge and may not be excluded. 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 (and thus excludable), and what portion relates to post-closing obligations (and thus is not excludable), the entire fee may be treated as a Finance Charge.
3. Attorneys' fees "lump sum" exclusion - generally an attorney fee can be excluded if the charge is primarily for otherwise excludable 226.4(c)(7) charges (e.g., doc prep, title work, notary, etc.). This is a particularly common exception east of the Mississippi where attorneys tend to be more actively involved in the loan closing process. 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 (for example, by a lawyer or a title company) is excluded from the finance charge if the charge is primarily for services related to items listed in §226.4(c)(7) (for example, 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. Please note: to be excludable, the charges must be "primarily" for Section 4(c)(7) items. This is a fact-intensive determination that could change from one loan to the next.

And, finally, if you are still unsure about whether a particular charge is a Finance Charge after reviewing the exclusions, read the Official Commentary of the Staff of the Division of Consumer and Community Affairs of the Federal Reserve Board for further guidance.

We, at Document Systems, Inc., hope that this series on Finance Charges under TILA has been helpful. If there is any particular topic that you would like the Compliance Department to address in a future issue of The Compliance Wizard, we invite you to submit your suggestions to us, at melanie@docmagic.com.

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