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Loan Modifications – Careful, They May Trigger Different Compliance Requirements

Loan modifications are no doubt on the rise and, depending on the circumstances, certain regulations and provisions of regulations may or may not apply.  Accordingly, one may be asking more often “ What is required from a compliance perspective to extend a ballooning Home Equity Line of Credit (HELOC) for five more years versus converting it to a closed end mortgage?”  We have received numerous questions from our clients on what is required from a disclosure standpoint when modifying a loan.  As such, following we will explore several common loan modification examples.  We do not, however, intend for this to cover all situations; the purpose of this article is to demonstrate the complexity of compliance requirements and the need to thoroughly analyze each loan modification on its own.  In the examples noted below, the following assumption is made:  all loans are consumer purpose loans secured by the borrower’s principal residence.  Additionally, it should be noted that current regulatory guidance does not always specifically address the modification/renewal/extension/etc. situations banks face today.  Accordingly, we are providing to you the best information we have based on our research and the current interpretation of applicable regulations.

The following examples are provided:


Example 1 – Modification of a Fixed Rate Mortgage: A Rate Reduction with a Corresponding Change in Payment Schedule or Institution of a Stepped-Rate Feature that does not result in an increase to the APR (No new money)

  1. Truth in Lending Act (TILA) (Regulation Z) – While Regulation Z does not provide specific guidance for when new disclosures are required, some general guidance is provided.  For example, as it relates to providing new disclosures, Regulation Z speaks in terms of refinancing; what constitutes a refinancing and examples of what does not.  That is, per Section 226.20 of Regulation Z:

“A refinancing occurs when an existing obligation that was subject to this subpart is satisfied and replaced by a new obligation undertaken by the same consumer. A refinancing is a new transaction requiring new disclosures to the consumer. The new finance charge shall include any unearned portion of the old finance charge that is not credited to the existing obligation.

The following shall not be treated as a refinancing: (1) A renewal of a single payment obligation with no change in the original terms.  (2) A reduction in the annual percentage rate with a corresponding change in the payment schedule.  (3) An agreement involving a court proceeding. (4) A change in the payment schedule or a change in collateral requirements as a result of the consumer’s default or delinquency, unless the rate is increased, or the new amount financed exceeds the unpaid balance plus earned finance charge and premiums for continuation of insurance of the types described in Sec. 226.4(d).  (5) The renewal of optional insurance purchased by the consumer and added to an existing transaction, if disclosures relating to the initial purchase were provided as required by this subpart.”

Based on the above, it appears that in this situation, new disclosures would not be required as it does not meet the definition of a refinancing. In addition, as no new/additional funds are provided, then the transaction is not rescindable.

  1. Real Estate Settlement Procedures Act (RESPA) (HUD’s Regulation X) – Section 5 of HUD’s Regulation X (24 C.F.R. § 3500.5) covers the applicability and exemptions from RESPA.  Specifically, Section 3500.5(b)(6) states that “Any conversion of a federally related mortgage loan to different terms that are consistent with provisions of the original mortgage instrument, as long as a new note is not required, even if the lender charges an additional fee for the conversion,” is exempt from RESPA coverage.

Also, similar to the Truth in Lending Act, be careful not to assume that all modifications do not warrant additional disclosures as depending how the transaction is structured, under RESPA, it may fall into the definition of “refinancing.”  Per Section 3500.2(b) of RESPA, refinancing means:

“A transaction in which an existing obligation that was subject to a secured lien on residential real property is satisfied and replaced by a new obligation undertaken by the same borrower and with the same or a new lender. The following shall not be treated as a refinancing, even when the existing obligation is satisfied and replaced by a new obligation with the same lender (this definition of “refinancing” as to transactions with the same lender is similar to Regulation Z, 12 CFR 226.20(a)):

  1. A renewal of a single payment obligation with no change in the original terms;
  2. A reduction in the annual percentage rate as computed under the Truth in Lending Act with a corresponding change in the payment schedule;
  3. An agreement involving a court proceeding;
  4. A workout agreement, in which a change in the payment schedule or change in collateral requirements is agreed to as a result of the consumer’s default or delinquency, unless the rate is increased or the new amount financed exceeds the unpaid balance plus earned finance charges and premiums for continuation of allowable insurance; and
  5. The renewal of optional insurance purchased by the consumer that is added to an existing transaction, if disclosures relating to the initial purchase were provided.”

As in this case, the example pertains to a reduction in the APR with a corresponding change in the payment schedule (#2 above), the transaction would not be subject to new disclosures under RESPA (e.g., GFE, HUD-1, escrow statement, as applicable, etc.).

National Flood Insurance Program (NFIP) (Section 208.25 of Regulation H) –The notification requirements under the NFIP apply when a lender makes, increases, renews, or extends, a loan secured by a structure located in a special flood hazard area.   In this example, other than the rate and payment amount, all other terms remain the same; therefore it does not appear that anything is triggered under the NFIP as a loan is not being made, increased, renewed, or extended.  Note:  If, through the modification agreement, a new loan number will be issued, you may need to obtain a new Standard Flood Hazard Determination (SFHD) form or otherwise notify the Bank’s third party service provider of the change in loan number.

Home Mortgage Disclosure Act (HMDA) (Regulation C) – In order for an application/loan to be reportable under HMDA, the purpose of the application/loan must be for home purchase, home improvement, or refinancing.  Under HMDA, the refinancing is defined as “any dwelling-secured loan that replaces and satisfies another dwelling-secured loan to the same borrower. The purpose of the loan being refinanced is not relevant to determining whether the new loan is a refinancing for HMDA purposes. Nor is the borrower’s intended use of any additional cash borrowed relevant to determining whether the loan is a refinancing, though the borrower’s intended use of the funds could make the transaction a home improvement loan or a home purchase loan.”  Accordingly, in this example, the dwelling-secured loan is not being satisfied and replaced; therefore, the loan would not be included on the Bank’s LAR.

Fair Credit Reporting Act/Fair and Accurate Credit Transactions Act (FCRA/FACTA) – If a new credit report is obtained as a result of the modification request, the borrower should be provided with a Notice to Home Loan Applicant/Credit Score Disclosure.

Documentary Stamp Taxes (Doc Stamps) – Per Section 201.09 of the Florida Statutes, and more specifically, 12B-4.052 of the Florida Administrative Code (FAC), doc stamps would not be due.  That is, under the FAC, this modification would be considered a renewal and as this renewal does not add obligor(s) and merely changes the interest rate (this would also be true if the maturity date, or the payment terms were changed), it is not subject to additional doc stamp tax, provided tax was paid on the original document and the original document is attached to the renewal.

Intangible Tax – Per Section 199.145 of the Florida Statutes:
“Where a note, bond, or other obligation upon which a nonrecurring tax has previously been paid is refinanced with the original obligee or its assignee:

No additional nonrecurring tax is due if the principal balance of the new obligation is less than or equal to the unpaid principal balance of the original obligation, plus accrued but unpaid interest, as of the refinancing.

Additional nonrecurring tax is due if the principal balance of the new obligation exceeds the principal balance of the original obligation, plus accrued but unpaid interest, as of the refinancing. If the original obligor is not liable to the obligee under the new obligation, the additional nonrecurring tax shall be computed on the entire principal balance of the new obligation; otherwise, the additional nonrecurring tax shall be computed on the excess of the principal balance of the new obligation over the principal balance of the original obligation, plus accrued but unpaid interest, as of the refinancing.”

In this example, the amount of the new (modified) obligation does not exceed the principal balance of the original obligation; therefore, additional intangible taxes are not required.

NOTE:  For the remaining examples see Example 1 for definitions, as applicable.

Example 2 – Modification of an Adjustable Rate Mortgage (ARM):  Conversion to a Fixed Rate (no new money)

Regulation Z – Presumably, this modification would be granted to hold or lower the interest rate that the borrower is being charged.  In this case, it does not appear that new disclosures would be warranted.

RESPA – While this example does not require new disclosures under Regulation Z, as the change in terms is not consistent with the original obligation, it appears that this transaction would be subject to RESPA.

NFIP –The notification requirements under the NFIP apply when a lender makes, increases, renews, or extends, a loan secured by a structure located in a special flood hazard area.   In this case, other than the rate and payment amount, all other terms remain the same; therefore it does not appear that anything is triggered under the NFIP as a loan is not being made, increased, renewed, or extended.  Note:  If, through the modification agreement, a new loan number will be issued, you may need to obtain a new Standard Flood Hazard Determination (SFHD) form or otherwise notify the Bank’s third party service provider of the change in loan number.

HMDA – In this example, the modification would not be reportable on the Bank’s LAR as the original obligation was not satisfied and replaced.

FCRA/FACTA – If a new credit report is obtained as a result of the modification request, the borrower should be provided with a Notice to Home Loan Applicant/Credit Score Disclosure.

Doc Stamps – In this example, doc stamps would not be due as the modification does not involve the addition/change in obligor(s) or an increase the amount owed over the original amount of the note.

Intangible Tax – In this example, additional intangible taxes would not be due as the amount of the new (modified) obligation does not exceed the principal balance of the original obligation.

Example 3 – Modification of a HELOC (during the draw period):  Conversion to ARM (no new money)

Regulation Z – Under Section 226.5b of the OSC to Section 226.5b (#5, second bullet) states, “If the consumer and creditor enter into an agreement during the draw period to repay all or part of the principal balance and the amount of available credit will not be replenished as the principal balance is repaid, the creditor must give closed-end credit disclosures pursuant to subpart C of Regulation Z for that new agreement. In such cases, subpart B, including the substantive rules, does not apply to the closed-end credit transaction, although it will continue to apply to any remaining open-end credit available under the plan.”  Therefore, for this example, the Bank must provide the ARM disclosure, early TIL (see next item), and final TIL, as applicable.  (Remember to test to see if the loan meets the criteria for an HPML).

RESPA – As the change in terms is not consistent with the original obligation, it appears that this transaction would be subject to RESPA.

NFIP – As the ultimate maturity date is being extended, if the property securing the loan is located in a special flood hazard area (SFHA), then the customer must receive notice of this.  Note:  While the Bank may rely on a SFHD form that is less than seven (7) years old, a prior notice to the borrower may not be relied upon; a new notice must be provided.

HMDA – In this example, the modification would not be reportable on the Bank’s LAR as the original obligation was not satisfied and replaced.

FCRA/FACTA – If a new credit report was obtained, then Notice to Home Applicant/Credit Score Disclosure would be required.

Doc Stamps – In this example, doc stamps would not be due as the modification does not involve the addition/change in obligor(s) or an increase the amount owed over the original amount of the note.

Intangible Tax – In this example, additional intangible taxes would not be due as the amount of the new (modified) obligation does not exceed the principal balance of the original obligation.

Example 4 – HELOC – Convert to Fixed Rate Mortgage (no new money)

Regulation Z – Under Section 226.5b of the OSC to Section 226.5b (#5, second bullet) states, “If the consumer and creditor enter into an agreement during the draw period to repay all or part of the principal balance and the amount of available credit will not be replenished as the principal balance is repaid, the creditor must give closed-end credit disclosures pursuant to subpart C for that new agreement. In such cases, subpart B, including the substantive rules, does not apply to the closed-end credit transaction, although it will continue to apply to any remaining open-end credit available under the plan.”  Based on this, the Bank must provide the early TIL (see next item regarding applicability with RESPA), and final TIL, as applicable.  (Remember to test to see if the loan meets the criteria for an HPML).

RESPA – As the change in terms is not consistent with the original obligation, it appears that this transaction would be subject to RESPA.

NFIP – As the ultimate maturity date is being extended, if the property securing the loan is located in a special flood hazard area (SFHA), then the customer must receive notice of this.  Note:  While the Bank may rely on a SFHD form that is less than seven (7) years old, a prior notice to the borrower may not be relied upon; a new notice must be provided.

HMDA – In this example, the modification would not be reportable on the Bank’s LAR as the original obligation was not satisfied and replaced.

FCRA/FACTA – If a new credit report was obtained, then Notice to Home Applicant/Credit Score Disclosure would be required.

Doc Stamps – In this example, doc stamps would not be due as the modification does not involve the addition/change in obligor(s) or an increase the amount owed over the original amount of the note.

Intangible Tax – In this example, additional intangible taxes would not be due as the amount of the new (modified) obligation does not exceed the principal balance of the original obligation.

Example 5 – HELOC – Extend Term

Regulation Z – If the line has not matured, the Bank can make the specified change, as long as the consumer agrees to it in writing at that time (e.g., achieved by the bank executing a change in terms agreement, which is signed by the customer).   However, if the line has already matured, this would be considered a new program/plan and therefore a new program disclosure would be warranted.

RESPA – See the requirements set forth for Regulation Z above; per RESPA, if the Bank satisfies the applicable requirements under Regulation Z, it is considered to have satisfied the requirements under RESPA.

NFIP – As the ultimate maturity date is being extended, if the property securing the loan is located in a special flood hazard area (SFHA), then the customer must receive notice of this.  Note:  While the Bank may rely on a SFHD form that is less than seven (7) years old, a prior notice to the borrower may not be relied upon; a new notice must be provided.

HMDA – This modification would not be reportable either 1) because the Bank has opted not to report its lines of credit or 2) if the Bank does report lines of credit, it does not satisfy and replace the existing obligation, therefore does not meet the definition of refinancing.

FCRA/FACTA – If a new credit report was obtained, then Notice to Home Applicant/Credit Score Disclosure would be required.

Doc Stamps – In this example, doc stamps would not be due as the modification does not involve the addition/change in obligor(s) or an increase the amount owed over the original amount of the note.

Intangible Tax – In this example additional intangible taxes would not be due as the amount of the new (modified) obligation does not exceed the principal balance of the original obligation.

Example 6 – Modification of a Fixed or Adjustable Rate Mortgage: Addition of an obligor (no new money)

Regulation Z – Under Section 226.20(b) of Regulation Z, “An assumption occurs when a creditor expressly agrees in writing with a subsequent consumer to accept that consumer as a primary obligor on an existing residential mortgage transaction. Before the assumption occurs, the creditor shall make new disclosures to the subsequent consumer, based on the remaining obligation.” In addition, Section 226.20 of the Official Staff Commentary to Regulation Z indicates that the retention of the original consumer as an obligor in some capacity does not prevent the change from being an assumption, provided the new consumer becomes a primary obligor. But the mere addition of a guarantor to an obligation for which the original consumer remains primarily liable does not give rise to an assumption. However, if neither party is designated as the primary obligor but the creditor accepts payment from the subsequent consumer, an assumption exists for purposes of §226.20(b).  Therefore, in this example, new disclosures, based on the remaining obligation, should be provided (Remember to test to see if the loan meets the criteria for an HPML).

RESPA – Like Regulation Z, RESPA also has language regarding assumptions.  While an “assumption” is not defined, Section 3500.5(b)(5) of RESPA indicates that “any assumption in which the lender’s permission is both required and obtained is covered by RESPA and this part, whether or not the lender charges a fee for the assumption.”  In this case, the bank’s permission to add an obligor appears to be required and obtained, therefore, new disclosures would be warranted.

NFIP –The notification requirements under the NFIP apply when a lender makes, increases, renews, or extends, a loan secured by a structure located in a special flood hazard area.   In this case, all of the terms remain the same; therefore it does not appear that anything is triggered under the NFIP as a loan is not being made, increased, renewed, or extended.  Note:  If, through the modification agreement, a new loan number will be issued, you may need to obtain a new Standard Flood Hazard Determination (SFHD) form or otherwise notify the Bank’s third party service provider of the change in loan number.

HMDA – In this example, the modification would not be reportable on the Bank’s LAR as the original obligation was not satisfied and replaced.

FCRA/FACTA – If a new credit report is obtained as a result of the modification request, the borrower should be provided with a Notice to Home Loan Applicant/Credit Score Disclosure.

Doc Stamps – As there is an additional obligor; doc stamps would need to be collected.

Intangible Tax – Per Section 199.145(3) of the Florida Statues, additional taxes would not need to be collected on the assumption of a note if the nonrecurring tax has previously been paid and the amount of the indebtedness remains the same, whether or not the original obligor is released from liability.

It may seem like you are negotiating a minefield of regulations when modifying loans.  Again, while the examples provided may not address each specific situation, they may be used as guidelines.  Remember though, it will likely work better for the bank (and customer) if the old school of thought, that is “When in doubt, disclose”, is applied.  Also, to help ensure that the bank does not trigger legal implications when modifying loans, it is recommended that the bank’s legal counsel is apprised of the banks actions regarding modifying loans.

Finally, many aspects of the regulations are date sensitive, so be sure to have appropriate procedures in place to document when a request for modification is made, decision rendered, disclosures provided, etc.

Please continue to submit your questions and we will provide additional guidance on these and other hot topics facing banks today.

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