Regulation Z Truth in Lending - Federal Reserve · 2009-09-25 · Regulation Z Truth in Lending...

Regulation ZTruth in Lending

Background

Regulation Z (12 CFR 226) implements the Truth inLending Act (TILA) (15 USC 1601 et seq.), whichwas enacted in 1968 as title I of the ConsumerCredit Protection Act (Pub. L. 90-321). Since itsimplementation, the regulation has been amendedmany times to incorporate changes to the TILA orto address changes in the consumer creditmarketplace.

Regulation Z was first revised in 1970 to prohibitcreditors from sending consumers unsolicited creditcards. Subsequent revisions to the regulation in the1970s implemented billing dispute provisions of theFair Credit Billing Act of 1974 and the ConsumerLeasing Act of 1976.

During the 1980s, Regulation Z was changedsignificantly, first in connection with the Truth inLending Simplification and Reform Act of 1980. In1981, all consumer leasing provisions in theregulation were transferred to the Board’s Regula-tion M. During the late 1980s, Regulation Z wasamended to implement the rate limitations forhome-secured loans set forth in section 1204 of theCompetitive Equality Banking Act of 1987 and torequire disclosures for adjustable-rate mortgageloans. Other Regulation Z amendments imple-mented the Fair Credit and Charge Card DisclosureAct of 1988 and the Home Equity Loan ConsumerProtection Act of 1988, which required disclosure ofkey terms at the time of application.

In the 1990s, Regulation Z was amended toimplement the Home Ownership and Equity Protec-tion Act of 1994, which imposed new disclosurerequirements and substantive limitations on certainhigher-cost closed-end mortgage loans andincluded new disclosure requirements for reversemortgage transactions. The regulation was alsorevised to reflect the 1995 Truth in Lendingamendments that dealt primarily with tolerances forloans secured by real estate and limitations onlenders’ liability for disclosure errors for these typesof loans. Regulation Z amendments resulting fromthe Economic Growth and Regulatory PaperworkReduction Act of 1996 simplified adjustable-ratemortgage disclosures.

In 2007, Regulation Z was updated to incorpo-rate guidance on the electronic delivery of disclo-sures consistent with the E-Sign Act.1

Applicability

In general, Regulation Z applies to individuals andbusinesses that offer or extend credit, when all thefollowing conditions are met:

• The credit is offered or extended to consumers

• The offering or extension of credit is doneregularly (see the definition of ‘‘creditor’’ insection 226.2(a))

• The credit is subject to a finance charge or ispayable by a written agreement in more than fourinstallments

• The credit is primarily for personal, family, orhousehold purposes

The regulation also includes special provisions forcredit offered by credit card issuers and specificrequirements for persons who are not creditors butwho provide applications for home equity loans.

Organization of Regulation Z

The disclosure rules of Regulation Z differ depend-ing on whether the credit is open-end (credit cardsand home equity lines, for example) or closed-end(such as car loans and mortgages). Regulation Z isstructured accordingly.

• Subpart A—Provides general information thatapplies to both open-end and closed-end credittransactions, including definitions, explanationsof coverage and exemptions, and rules fordetermining which fees are finance charges

• Subpart B—Covers open-end credit, includinghome equity loans and credit and chargeaccounts; sets forth rules for providing disclo-sures, resolving billing errors, calculating annualpercentage rates and credit balances, andadvertising; describes special rules for creditcard transactions (such as prohibitions on theissuance of credit cards and restrictions on theright to offset a cardholder’s indebtedness); andprovides special rules for home equity lines ofcredit (such as prohibitions against closingaccounts and changing account terms)

• Subpart C—Covers closed-end credit, includingresidential mortgage transactions, demand loans,and installment credit contracts (including directloans by banks and purchased dealer paper);sets forth rules for disclosures related to regularand variable-rate loans, refinancings and as-sumptions, and credit balances; also gives rulesfor calculating annual percentage rates andadvertising closed-end credit

1. The Electronic Signatures in Global and National CommerceAct, 15 USC 7001 et seq.

Consumer Compliance Handbook Reg. Z • 1 (11/08)

• Subpart D—For both open- and closed-endcredit, sets forth the duty of creditors to retainevidence of compliance with the regulation,clarifies the relationship between the regulationand state law, and requires creditors to set aninterest rate cap for variable-rate transactionssecured by a consumer’s dwelling

• Subpart E—Requires additional disclosures for,sets limits on, and prohibits specific acts andpractices in connection with certain home mort-gage transactions having rates or fees above acertain percentage or amount; also sets forthdisclosure requirements for reverse mortgagetransactions (both open- and closed-end credit)

• Appendixes—Provide model forms and clausesthat creditors may use when providing dis-closures; detailed rules for calculating APRs foropen- and closed-end credit; and instructionsfor computing the total annual loan cost ratefor reverse mortgage transactions, along withtables giving assumed loan periods for thosetransactions

• Official staff interpretations—Published in a com-mentary normally updated annually, in March;include mandates concerning disclosures notnecessarily explicit in the regulation and informa-tion on other actions required of creditors (Goodfaith compliance with the commentary protectscreditors from civil liability under the act; it isvirtually impossible to comply with the regulationwithout reference to, and reliance on, thecommentary.)

Note: This chapter does not attempt to discuss allof Regulation Z, but rather highlights areas thathave caused the most problems in relation tocalculation of the finance charge and the annualpercentage rate.

General Information (Subpart A)

Purpose of the TILA and Regulation Z

The Truth in Lending Act is intended to ensure thatcredit terms are disclosed in a meaningful way sothat consumers can compare credit terms morereadily and more knowledgeably. Before its enact-ment, consumers were faced with a vast array ofcredit terms and rates. It was difficult to compareloans because the terms and rates were seldompresented in the same format. Now, all creditorsmust use the same credit terminology and expres-sions of rates. In addition to providing a uniformsystem for disclosures, the act is designed to

• Protect consumers from inaccurate and unfaircredit billing and credit card practices

• Provide consumers with rescission rights

• Provide for rate caps on certain dwelling-secured loans

• Impose limitations on home equity lines of creditand certain closed-end home mortgages

The TILA and Regulation Z do not tell financialinstitutions how much interest they may charge orwhether they must grant a loan to a particularconsumer.

Coverage and Exemptions(§§ 226.1−226.3)

Lenders must carefully consider several factorswhen deciding whether a loan requires Truth inLending disclosures or is subject to other Regula-tion Z requirements. Broad coverage consider-ations are included in section 226.1(c) of theregulation, and relevant definitions appear insection 226.2. Coverage considerations areaddressed in more detail in the commentary to theregulation.

The following transactions are exempt fromRegulation Z under section 226.3:

• Credit extended primarily for a business, com-mercial, or agricultural purpose

• Credit extended to other than a natural person(including credit to government agencies orinstrumentalities)

• Credit in excess of $25,000 not secured by realor personal property used as the consumer’sprincipal dwelling

• Public utility credit

• Credit extended by a broker−dealer registeredwith the Securities and Exchange Commission orthe Commodity Futures Trading Commissioninvolving securities or commodities accounts

• Home fuel budget plans

• Certain student loan programs

Footnote 4 in Regulation Z provides that if acredit card is involved, credit that is generallyexempt from the requirements of Regulation Z (forexample, credit for a business or agriculturalpurpose) is still subject to requirements that governthe issuance of credit cards and liability for theirunauthorized use. (Credit cards must not be issuedon an unsolicited basis, and if a credit card is lostor stolen, the cardholder must not be held liable formore than $50 for the unauthorized use of thecard.)

When determining whether credit is for consumerpurposes, the creditor must evaluate the followingfive factors:

• Information obtained from the consumer describ-ing the purpose of the loan proceeds

– A statement that the proceeds will be used fora vacation trip, for example, would indicate aconsumer purpose.

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2 (11/08) • Reg. Z Consumer Compliance Handbook

– If the consumer states that the loan has amixed purpose (for example, that the pro-ceeds will be used to buy a car that will beused for both personal and business pur-poses), the lender must look to the primarypurpose of the loan to decide whether disclo-sures are necessary. A statement of purposeby the consumer will help the lender make thatdecision.

– A checked box indicating that the loan is for abusiness purpose could, absent any documen-tation showing the intended use of the pro-ceeds, be insufficient evidence that the loandoes not have a consumer purpose.

• The consumer’s primary occupation and how itrelates to the use of the loan proceeds

– The higher the correlation between the con-sumer’s occupation and the property pur-chased from the loan proceeds, the greaterthe likelihood that the loan has a businesspurpose. For example, proceeds used topurchase dental supplies for a dentist wouldindicate a business purpose.

• Personal management of the assets purchasedfrom the loan proceeds

– The less the borrower is personally involved inthe management of the investment or enter-prise purchased by the proceeds, the lesslikely the loan has a business purpose. Forexample, borrowing money to purchase stockin an automobile company by an individualwho does not work for that company wouldindicate a personal investment and a con-sumer purpose.

• The size of the transaction

– The larger the transaction, the more likely theloan has a business purpose. For example, aloan amount of $5,000,000 for a real estatetransaction might indicate a business pur-pose.

• The amount of income derived from the propertyacquired by the loan proceeds relative to theborrower’s total income

– The less the income derived from the acquiredproperty, the more likely the loan has aconsumer purpose. For example, if the bor-rower has an annual salary of $100,000,receiving about $500 in annual dividends fromthe acquired property would indicate a con-sumer purpose.

The lender must evaluate all five factors beforeconcluding that disclosures are not necessary.Normally, evidence suggested by a single factor is,by itself, insufficient to draw a conclusion aboutwhether the transaction is covered by Regulation Z.The diagram ‘‘Coverage Considerations under

Regulation Z’’ may be helpful in making thedetermination. In any case, the financial institutionmay choose to furnish disclosures to consumers.Disclosure under such circumstances does notcontrol whether the transaction is covered but canensure protection to the financial institution andcompliance with the law.

Determination of theFinance Charge and the APR

Finance Charge (Open-End andClosed-End Credit) (§ 226.4)

The finance charge is a measure of the cost ofconsumer credit represented in dollars and cents.Along with APR disclosures, the disclosure of thefinance charge is central to the uniform credit costdisclosure envisioned by the TILA.

Generally, the finance charge includes anycharges or fees payable directly or indirectly by theconsumer and imposed directly or indirectly by thefinancial institution either incident to or as acondition of an extension of consumer credit. Forexample, the finance charge on a loan alwaysincludes any interest charges and, often, othercharges, such as points, transaction fees, orservice fees.

Regulation Z provides examples, applicable toboth open-end and closed-end credit transactions,of what must, must not, or need not be included inthe disclosed finance charge (section 226.4(b)).

The finance charge does not include any chargeof a type payable in a comparable cash transac-tion, such as taxes, title fees, license fees, orregistration fees paid in connection with an auto-mobile purchase.

Calculation of the Finance Charge(Closed-End Credit)

One of the more complex tasks under Regulation Zis determining whether a charge associated with anextension of credit must be included in, or excludedfrom, the disclosed finance charge. The financecharge initially includes any charge that is, or willbe, connected with a specific loan. Chargesimposed by third parties are finance charges if theinstitution requires use of the third party. Chargesimposed by settlement or closing agents arefinance charges if the institution requires thespecific service that gave rise to the charge andthe charge is not otherwise excluded.

The ‘‘Finance Charges’’ diagram summarizesincluded and excluded charges and may behelpful in determining whether a loan-relatedcharge is a finance charge.

Truth in Lending


Coverage Considerations under Regulation Z

Is the amount

fi nanced or credit limit $25,000 or

less?

Yes

Yes

Is the credit for personal,

family, or household

use?

Regulation Z does not apply, except the rules concerning issu-ance of and unauthorized-use liability for credit cards. (Exempt credit includes loans with a business or agricultural purpose and certain student loans. Credit extended to acquire or im-prove rental property that is not owner-occupied is considered business-purpose credit.)

Is the credit extended to a

consumer?

Regulation Z does not apply. (Credit that is extended to a land trust is deemed to be credit extended to a consumer.)

Is the credit extended by a

creditor?

The institution is not a “creditor” and Regulation Z does not ap-ply unless at least one of the following tests is met:(1) The institution extends consumer credit regularly and

(a) The obligation is initially payable to the institution and(b) The obligation either is payable by written agreement

in more than four installments or is subject to a fi nance charge

(2) The institution is a card issuer that extends closed-end credit that is subject to a fi nance charge or is payable by written agreement in more than four installments

(3) The institution is a card issuer that extends open-end credit or credit that is not subject to a fi nance charge and is not payable by written agreement in more than four installments

For limited purposes, a person that honors a credit card may also be a creditor.

(Note: All persons, including noncreditors, must comply with the advertising provisions of Regulation Z.)

Is the loan

or credit plan secured by real property or by the consumer’s principal

dwelling?

Regulation Z does not apply, but it may apply later if the loan is refi nanced for $25,000 or less. If the principal dwelling is taken as col-lateral after consummation, rescission rights apply and, in the case of open-end credit, billing disclosures and other provisions of Regulation Z apply.

No

No

No

Yes

Yes

No No

Regulation Z applies

Yes

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Finance Charges

FINANCE CHARGE = DOLLAR COST OF CONSUMER CREDIT: Includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as a condition of or incident to the extension of credit

CHARGES ALWAYS INCLUDED

(A)

Interest

Loan origination fees Consumer points

Credit-guarantee insurance premiums

Charges imposed on the creditor for

purchasing the loan that are passed on to

the consumer

Discounts for inducing payment

by means other than credit

Mortgage broker fees

Other examples: Fee for preparing TILA disclosures; real

estate construction loan inspection

fees; fees for post-consummation tax or fl ood insurance

requirements; required credit life insurance charges

CHARGES INCLUDED UNLESS CONDITIONS ARE

MET

(B)

Premiums for credit life, accident and health, or loss-of-income insurance

Premiums for property or liability

insurance

Premiums for vendor’s single interest (VSI)

insurance

Security interest charges (fi ling fees),

insurance in lieu of fi ling fees, and

certain notary fees

Charges imposed by third parties

Charges imposed by third-party closing

agents

Appraisal and credit-report fees

CONDITIONS FOR EXCLUSION

(Any loan)

(C)

Insurance not required, disclosures

are made, and consumer authorizes

Consumer selects insurance company and disclosures are

made

Insurer waives right of subrogation,

consumer selects insurance company, and disclosures are

made

The fee is for lien purposes, is

prescribed by law, is payable to a

public offi cial, and is itemized and

disclosed

Use of the third party is not required to obtain loan, and creditor does not retain the charge

Creditor does not require and does not retain the fee for the

particular service

Application fees, if charged to all

applicants, are not fi nance charges.

Application fees may include appraisal or

credit-report fees

EXCLUDABLE CHARGES* (Residential mortgage

transactions and loans secured by real

estate) (D)

Fees for title insurance, title

examination, property survey, etc.

Amounts required to be paid into escrow,

if not otherwise included in the fi nance charge

Notary fees

Pre-consummation fl ood and pest inspection fees

Appraisal and credit report fees

CHARGES NEVER INCLUDED

(E)

Charges payable in a comparable cash

transaction

Seller’s points

Participation or membership fees

Discount offered by the seller to induce payment by cash

or other means not involving the use of a

credit card

Interest forfeited as a result of interest reduction required

by law

Charges absorbed by the creditor as a cost

of doing business

Transaction fees

Debt-cancellation fees

Coverage not required, disclosures

are made, and consumer authorizes

Fees for preparing loan documents, mortgages, and other settlement

documentsOverdraft fees not agreed to in writing

Fees for unanticipated late

payments

*To be excludable, fees must be bona fi de and reasonable.

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• Charges always included (col. A)—Lists chargesgiven in the regulation or commentary asexamples of finance charges

• Charges included unless conditions are met(col. B)—Lists charges that must be included inthe finance charge unless the creditor meetsspecific disclosure or other conditions to excludethe charges from the finance charge

• Conditions for exclusion (col. C)—Notes theconditions that must be met if the charges listedin column B may be excluded from the financecharge. Although most charges in column B maybe considered part of the finance charge at thecreditor’s option, third-party charges and appli-cation fees must be excluded from the financecharge if the relevant conditions are met; how-ever, inclusion of appraisal and credit-reportcharges as part of the application fee isoptional.

• Excludable charges (col. D)—Identifies fees orcharges that may be excluded from the financecharge if they are bona fide and reasonable inamount and the credit transaction is secured byreal property or is a residential mortgage trans-action. For example, if a consumer loan issecured by a vacant lot or by commercialreal estate, any appraisal fees connected withthe loan may be excluded from the financecharge.

• Charges never included (col. E)—Lists chargesgiven in the regulation as examples of chargesthat automatically are not finance charges(for example, fees for unanticipated latepayments).

Prepaid Finance Charges (§ 226.18(b))

A prepaid finance charge is any finance chargethat (1) is paid separately to the financial institutionor to a third party, in cash or by check, before or atclosing, settlement, or consummation of a transac-tion or (2) is withheld from the proceeds of thecredit at any time. Prepaid finance charges effec-tively reduce the amount of funds available for theconsumer’s use, usually before or at the time thetransaction is consummated.

Examples of finance charges frequently prepaidby consumers are borrower’s points, loan origina-tion fees, real estate construction inspection fees,odd days’ interest (interest attributable to part of thefirst payment period when that period is longer thana regular payment period), mortgage guaranteeinsurance fees paid to the Federal Housing Admin-istration, private mortgage insurance paid to suchcompanies as the Mortgage Guaranty InsuranceCompany, and, in non-real-estate transactions,credit-report fees.

Precomputed Finance Charges

A precomputed finance charge includes, for exam-ple, interest added to the note amount that iscomputed by the add-on, discount, or simpleinterest method. If reflected in the face amount ofthe debt instrument as part of the consumer’sobligation, finance charges that are not viewed asprepaid finance charges are treated as precom-puted finance charges that are earned over the lifeof the loan.

Accuracy Tolerances (Closed-End Credit)(§§ 226.18(d) and 226.23(h))

The finance charge tolerances for closed-endcredit provided by Regulation Z are for legalaccuracy and should not be confused with thosetolerances provided in the TILA for reimbursementunder regulatory agency orders. As with disclosedAPRs, if a disclosed finance charge is legallyaccurate, it is not subject to reimbursement.

Generally, tolerances for finance charge errors ina closed-end transaction are $5 if the amountfinanced is $1,000 or less and $10 if the amountfinanced exceeds $1,000 (see diagrams on follow-ing pages). For certain transactions consummatedon or after September 30, 1995, the tolerances aredifferent, as noted below:

• Credit secured by real property or a dwelling(closed-end credit only):

– The disclosed finance charge is consideredaccurate if it does not vary from the actualfinance charge by more than $100.

– Overstatements are not violations.

• Rescission rights after the three-business-dayrescission period (closed-end credit only):

– The disclosed finance charge is consideredaccurate if it does not vary from the actualfinance charge by more than one-half of1 percent of the credit extended.

– The disclosed finance charge is consideredaccurate if it does not vary from the actualfinance charge by more than 1 percent of thecredit extended for the initial and subsequentrefinancings of residential mortgage transac-tions when the new loan is made at a differentfinancial institution. (This category excludeshigh-cost mortgage loans subject to section226.32, transactions in which there are newadvances, and new consolidations.)

• Rescission rights in foreclosure:

– The disclosed finance charge is consideredaccurate if it does not vary from the actualfinance charge by more than $35.

– Overstatements are not considered violations.

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– The consumer is entitled to rescind if amortgage broker fee is not included as afinance charge.

Note: Normally, the finance charge tolerance fora rescindable transaction is either 0.5 percent ofthe credit transaction or, for certain refinancings,1 percent of the credit transaction. However,in the event of a foreclosure, the consumer mayexercise the right of rescission if the disclosedfinance charge is understated by more than$35.

Neither the TILA nor Regulation Z provides anytolerances for finance charge errors in open-endcredit disclosures. Open-end credit disclosuresmust be accurate.

Annual Percentage Rate(Closed-End Credit) (§ 226.22)

Credit costs may vary depending on the interestrate, the amount of the loan and other charges, thetiming and amounts of advances, and the repay-ment schedule. The APR, which must be disclosedin nearly all consumer credit transactions, isdesigned to take into account all relevant factorsand to provide a uniform measure for comparingthe costs of various credit transactions.

The APR is a measure of the total cost of credit,expressed as a nominal yearly rate. It relates theamount and timing of value received by theconsumer to the amount and timing of paymentsmade by the consumer. The disclosure of the APRis central to the uniform credit cost disclosureenvisioned by the TILA.

The APR for closed-end credit must be disclosedas a single rate only, whether the loan has a singleinterest rate, a variable interest rate, a discountedvariable interest rate, or graduated paymentsbased on separate interest rates (step rates). Also,the APR must appear with the ‘‘segregated’’disclosures—disclosures grouped together andnot containing any information not directly relatedto the disclosures required under section 226.18.

As the APR is a measure of the total cost of credit,including such costs as transaction charges andpremiums for credit-guarantee insurance, it is notan interest rate as that term is generally used. APRcalculations do not rely on definitions of interest instate law and often include charges, such as acommitment fee paid by the consumer, that are notviewed by some state usury statutes as interest.Conversely, APR calculations might not includecharges, such as a credit-report fee in a realproperty transaction, that some state laws view asinterest for usury purposes. Furthermore, measur-ing the timing of value received and of paymentsmade, which is essential if APR calculations are to

be accurate, must be consistent with parametersunder Regulation Z.

The APR is often considered to be the financecharge expressed as a percentage. However, twoloans could have the same finance charge and stillhave different APRs because of differing values ofthe amount financed or differing payment sched-ules. For example, the APR on a loan with anamount financed of $5,000 and 36 equal monthlypayments of $166.07 each is 12 percent, while theAPR on a loan with an amount financed of $4,500and 35 equal monthly payments of $152.18 each,plus a final payment of $152.22, is 13.26 percent. Inboth cases the finance charge is $978.52. TheAPRs on these loans are not the same because anAPR reflects more than the finance charge. Itrelates the amount and timing of value received bythe consumer to the amount and timing of pay-ments made by the consumer.

The APR is a function of

• The amount financed, which is not necessarilyequivalent to the loan amount

– If the consumer must pay a separate 1 percentloan origination fee (a prepaid finance charge)on a $100,000 residential mortgage loan atclosing, the loan amount is $100,000 but theamount financed is $100,000 less the $1,000loan fee, or $99,000.

• The finance charge, which is not necessarilyequivalent to the total interest amount

– If the consumer must pay a $25 credit-reportfee for an auto loan, the fee must be includedin the finance charge. The finance charge inthis case is the sum of the interest on the loan(that is, the interest generated by the applica-tion of a percentage rate against the loanamount) plus the $25 credit-report fee.

– If the consumer must pay a $25 credit-reportfee for a home improvement loan secured byreal property, the credit-report fee must beexcluded from the finance charge. The financecharge in this case would be only the intereston the loan.

• Interest, which is defined by state or otherfederal law but not by Regulation Z

• The payment schedule, which does not neces-sarily include only principal and interest (P + I)payments

– If the consumer borrows $2,500 for a vacationtrip at 14 percent simple interest per annumand repays that amount with 25 equal monthlypayments beginning one month from consum-mation of the transaction, the monthly P + I

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Closed-End Credit: Accuracy Tolerances for Finance Charges

Does the refi nancing involve a

consolidation or new advance?

NoYes

Is this a

closed-end credit TILA

claim asserting rescission

rights?

Is the rescission

claim a defense to foreclosure

action?

Is the transaction secured by

real estate or a dwelling?

Did the transaction

originate before 9/30/95?

Finance charge tolerance is $35. An overstated fi nance charge is not considered a violation.

Yes

Finance charge tolerance is one-half of 1% of the loan amount or $100, whichever is greater. An overstated fi nance charge is not considered a violation.

Is the transaction a refi nancing?

Yes

No

Is the

transaction a high-cost

mortgage loan?*

No

No

Finance charge tolerance is 1% of the loan amount or $100, whichever is greater. An overstated fi nance charge is not considered a violation.

The fi nance charge is considered accurate if it is not more than $5 above or below the exact fi nance charge in a transaction involving an amount fi nanced of $1,000 or less, or not more than $10 above or below the exact fi nance charge in a transaction involving an amount fi nanced of more than $1,000.

Finance charge tolerance is $200 for understatements. An overstated fi nance charge is not considered a violation.

Finance charge tolerance is $100 for understatements. An overstated fi nance charge is not considered a violation.

No

YesNo

Yes

* See 15 USC 160(aa) and 12 CFR 226.32.

No

Yes

Yes

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Closed-End Credit: Accuracy Tolerances forOverstated Finance Charges

Is the loan secured by real estate or a dwelling?

Is the amount financed more than $1,000?

Finance charge violation

Is the disclosed finance charge, less $10, more than the correct finance charge?

Is the disclosed finance charge, less $5, more than the correct finance charge?

No violation Finance charge violation

YesNo

YesNo

YesNo

No violation

YesNo

No violation

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Closed-End Credit: Accuracy and Reimbursement Tolerances forUnderstated Finance Charges


Is the disclosed finance charge plus the finance charge reimbursement

tolerance (based on a one-quarter of 1 percentage point APR tolerance) less than the

correct finance charge?

Is the disclosed finance charge plus the finance charge reimbursement

tolerance (based on a one-eighth of 1 percentage point APR tolerance) less than the

correct finance charge?

Is the amount financed greater than $1,000?

Is the disclosed finance charge understated by more than $100 (or $200 if the loan originated before 9/30/95)?

Finance charge violation

Is the disclosed finance charge understated by more

than $10?

Is the disclosed finance charge understated by more

than $5?

No violation Finance charge violation No violation Finance charge

violation

Is the loan term more than 10 years?

Is the loan a regular loan?

No reimbursement

Subject to reimbursement

YesNo

YesNo

YesNo

YesNo

Yes No

YesNo

YesNo

Yes No YesNo

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payment would be $115.87, if all months areconsidered equal, and the amount financedwould be $2,500. If the consumer’s paymentsare increased $2.00 a month to pay anonfinanced $50 loan fee over the life of theloan, the amount financed would remain at$2,500 but the monthly payment wouldincrease to $117.87, the finance charge wouldincrease $50, and there would be a corre-sponding increase in the APR. This would bethe case whether or not state law defines the$50 loan fee as interest.

– If the loan in the preceding example has 55days to the first payment and the consumerprepays interest at consummation ($24.31 tocover the first 25 days), the amount financedwould be $2,500 less $24.31, or $2,475.69.Although the amount financed is reducedbecause the amount available to the con-sumer at consummation is less, the timeinterval during which the consumer has use ofthe $2,475.69—55 days to the first payment—isunchanged. To ease creditor compliance,Regulation Z allows creditors to disregardcertain minor irregularities in the first paymentperiod (see section 226.17(c)(4)). In this case,however, because the first payment periodexceeds the limitations of the regulation’s‘‘minor irregularities’’ provisions, the first pay-ment period of 55 days may not be treated as‘‘regular.’’ In calculating the APR, the firstpayment period must not be reduced 25 days(that is, the first payment period may not betreated as one month).

Financial institutions may, if permitted by state orother law, precompute interest by applying a rateagainst a loan balance using a simple interest,add-on, discount, or other method and may earninterest using a simple-interest accrual system, theRule of 78s (if permitted by law), or some othermethod. Unless the financial institution’s internalinterest earnings and accrual methods involve asimple interest rate based on a 360-day year that isapplied over actual days (important only fordetermining the accuracy of the payment sched-ule), the institution’s method of earning interest isnot relevant in calculating an APR, because an APRis not an interest rate (as that term is commonlyused under state or other law). As the APR normallyneed not rely on the internal accrual systems of afinancial institution, it may always be computedafter the loan terms have been agreed on (as longas it is disclosed before actual consummation ofthe transaction).

Special Requirements for Calculating theFinance Charge and APR

Proper calculation of the finance charge and APR isvery important. Regulation Z requires that the terms‘‘finance charge’’ and ‘‘annual percentage rate,’’when required to be disclosed with a correspond-ing amount or percentage rate, be disclosed moreconspicuously than any other required disclosure.The finance charge and APR, more than any otherdisclosures, enable consumers to understand thecost of the credit and to comparison shop for credit.Failure to disclose those values accurately canresult in significant monetary damages to thecreditor, either from a class action lawsuit or from aregulatory agency’s order to reimburse consumersfor violations of law.

Footnote 45d to section 226.22 states that if anannual percentage rate or finance charge isdisclosed incorrectly, the error is not, in itself, aviolation of the regulation if

• The error resulted from a corresponding error ina calculation tool used in good faith by thefinancial institution

• Upon discovery of the error, the financial institu-tion promptly discontinues use of that calculationtool for disclosure purposes

• The financial institution notifies the FederalReserve Board in writing of the error in thecalculation tool

When a financial institution claims that it used acalculation tool in good faith, it assumes a reason-able degree of responsibility for ensuring that thetool in question provides the accuracy required bythe regulation. To check on the tool’s accuracy, theinstitution might verify the results obtained usingthe tool with figures obtained using a differentcalculation tool. It might also check that the tool, ifit is designed to operate under the actuarialmethod, produces figures similar to those providedby the examples in appendix J to the regula-tion. The calculation tool should be checked foraccuracy before it is first used and periodicallythereafter.

Open-End Credit (Subpart B)

This discussion does not address all the require-ments for open-end credit in the Truth in LendingAct and Regulation Z. Instead, it focuses on someof the more difficult issues presented in sections226.5 through 226.16 of the regulation. Additionalguidance is provided in the commentary for thesesections.

Truth in Lending


Finance Charge (§ 226.6(a))

Each finance charge imposed must be individuallyitemized. An aggregate amount of the financecharge need not be disclosed.

Determining the Balance andComputing the Finance Charge

To compute the finance charge, the examiner mustknow how to determine the balance to which theperiodic rate is applied. Common methods are theprevious balance method, the daily balancemethod, and the average daily balance method.

• Previous balance method—The balance to whichthe periodic rate is applied is the balanceoutstanding at the start of the billing cycle. Theperiodic rate is multiplied by this balance tocompute the finance charge.

• Daily balance method—The balance to whichthe periodic rate is applied is either the balanceon each day in the billing cycle or the sum of thebalances on each day in the cycle. If a dailyperiodic rate is multiplied by the balance oneach day in the billing cycle, the finance chargeis the sum of the products. If the daily periodicrate is multiplied by the sum of all the dailybalances, the finance charge is the product.

• Average daily balance method—The balance towhich the periodic rate is applied is the sum ofthe daily balances (either including or excludingcurrent transactions) divided by the number ofdays in the billing cycle. The periodic rate ismultiplied by the average daily balance todetermine the finance charge. If the periodic rateis a daily rate, the product of the rate multipliedby the average balance is multiplied by thenumber of days in the cycle.

In addition to those common methods, financialinstitutions have other ways of calculating thebalance to which the periodic rate is applied. Byreading the institution’s explanation, the examinershould be able to calculate the balance to whichthe periodic rate was applied. In some cases theexaminer may need to obtain additional informationfrom the institution to verify the explanation dis-closed. Any inability to understand the disclosedexplanation should be discussed with manage-ment, who should be reminded of Regulation Z’srequirement that disclosures be clear andconspicuous.

If the balance is determined without first deduct-ing all credits given and payments made during thebilling cycle, that fact, as well as the amounts of thecredits and payments, must be disclosed.

If the financial institution uses the daily balancemethod and applies a single daily periodic rate,

disclosure of the balance to which the rate wasapplied may be stated as any of the following:

• A balance for each day in the billing cycle—Thedaily periodic rate is multiplied by the balance oneach day, and the sum of the products is thefinance charge.

• A balance for each day in the billing cycle onwhich the balance in the account changes—Thedaily periodic rate is multiplied by the balance oneach day, and the sum of the products is thefinance charge, as above, but the statementshows the balance for only those days on whichthe balance changed.

• The sum of the daily balances during the billingcycle—The daily periodic rate is multiplied bythe sum of all the daily balances in the billingcycle, and that product is the finance charge.

• The average daily balance during the billingcycle—If this balance is the one disclosed, theinstitution must explain somewhere on the peri-odic statement or in an accompanying documentthat the finance charge is or may be determinedby multiplying the average daily balance by thenumber of days in the billing cycle rather thanby multiplying the product by the daily periodicrate.

If the financial institution uses the daily balancemethod but applies two or more daily periodicrates, the sum of the daily balances may not beused. Acceptable ways of disclosing the balancesinclude

• A balance for each day in the billing cycle

• A balance for each day in the billing cycle onwhich the balance in the account changed

• Two or more average daily balances—If thebalance is disclosed in this way, the institutionmust indicate on the periodic statement or in anaccompanying document that the finance chargeis or may be determined by (1) multiplying eachof the average daily balances by the number ofdays in the billing cycle (or if the daily rate varies,multiplying the number of days that the applica-ble rate was in effect), (2) multiplying each of theresults by the applicable daily periodic rate, and(3) summing the products.

In explaining the method used to determine thebalance on which the finance charge is computed,the financial institution need not reveal how itallocates payments or credits. That informationmay be disclosed as additional information, but allrequired information must be clear and conspicuous.

Truth in Lending


Finance Charge Resulting fromTwo or More Periodic Rates

Some financial institutions use more than oneperiodic rate in computing the finance charge. Forexample, one rate may apply to balances up to acertain amount and another rate to balances overthat amount. If two or more periodic rates apply, theinstitution must disclose all rates and conditions.The range of balances to which each rate appliesmust also be disclosed. It is not necessary,however, to break the finance charge into separatecomponents based on the different rates.

Annual Percentage Rate

Accuracy Tolerance (§ 226.14)

The disclosed annual percentage rate on anopen-end credit account is considered accurate ifit is within one-eighth of 1 percentage point of theAPR calculated under Regulation Z.

Determining the APR

Regulation Z describes two basic methods fordetermining the APR in open-end credit transac-tions. One method involves multiplying each peri-odic rate by the number of periods in a year. Thismethod is used for disclosing

• The corresponding APR in initial disclosures

• The corresponding APR on periodic statements

• The APR in early disclosures for credit cardaccounts

• The APR in early disclosures for home equityplans

• The APR in advertising

• The APR in oral disclosures

The corresponding APR is prospective. In otherwords, it is not based on the account’s actualoutstanding balance and the finance charges thatare imposed.

The other method is the quotient method, used incomputing the APR for periodic statements. Thequotient method reflects the annualized equivalentof the rate that was actually applied during a cycle.This rate, also known as the historical APR, willdiffer from the corresponding APR if the creditorapplies minimum, fixed, or transaction charges tothe account during the cycle.

If the finance charge is determined by applyingone or more periodic rates to a balance and doesnot include any of those charges (minimum, fixed,or transaction), the financial institution may com-pute the historical rate using the quotient method.In the quotient method, the total finance charge forthe cycle is divided by the sum of the balances to

which the periodic rates were applied, and thequotient (expressed as a percentage) is multipliedby the number of cycles in a year.

Alternatively, the financial institution may com-pute the historical APR using the method forcomputing the corresponding APR. In that method,each periodic rate is multiplied by the number ofperiods in one year. If the finance charge includesa minimum, fixed, or transaction charge, theinstitution must use the appropriate variation of thequotient method. When transaction charges areimposed, the financial institution should refer toappendix F to Regulation Z for computationalexamples.

Regulation Z also contains a computation rule forsmall finance charges. If the finance chargeincludes a minimum, fixed, or transaction chargeand the total finance charge for the cycle does notexceed 50 cents, the financial institution maymultiply each applicable periodic rate by thenumber of periods in a year to compute the APR.

Regulation Z also provides optional calculationmethods for accounts involving daily periodic rates(see section 226.14(d)).

Calculating the APR for Periodic Statements

Note: Assume monthly billing cycles for each of thecalculations.

I. APR when finance charge is determined solelyby applying one or more periodic rates

A. Monthly periodic rates

1. Monthly rate × 12 = APRor

2. (Total finance charge ÷ Applicable bal-ance) × 12 = APR2

The preceding calculations may be usedwhen different rates apply to differentbalances.

B. Daily periodic rates

1. Daily rate x 365 = APRor

2. (Total finance charge ÷ Average dailybalance) × 12 = APRor

3. (Total finance charge ÷ Sum of balances)× 365 = APR

II. APR when finance charge includes a minimum,fixed, or other charge that is not calculatedusing a periodic rate (and does not includecharges related to a specific transaction, suchas a cash advance fee)

A. Monthly periodic rates

2. If the applicable balance is zero, the APR cannot bedetermined.

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1. (Total finance charge ÷ Amount of appli-cable balance3) × 12 = APR4

B. Daily periodic rates

1. (Total finance charge ÷ Amount of appli-cable balance) × 365 = APR5, 6

2. The following may be used if at least aportion of the finance charge is deter-mined by the application of a dailyperiodic rate. If not, use the formulaabove.

a. (Total finance charge ÷ Average dailybalance) x 12 = APR7

or

b. (Total finance charge ÷ Sum of bal-ances) x 365 = APR8

C. Monthly and daily periodic rates

1. If the finance charge imposed during thebilling cycle does not exceed 50 centsfor a monthly or longer billing cycle (or aprorated part of 50 cents for a billingcycle shorter than one month), the APRmay be calculated by multiplying themonthly rate by 12 or the daily rate by365.

III. If the total finance charge includes a chargerelated to a specific transaction (such as a cashadvance fee), even if the total finance chargealso includes any other minimum, fixed, or othercharge not calculated using a periodic rate,then the monthly and daily APRs are calculatedas follows: (Total finance charge ÷ The greaterof (1) the transaction amounts that created thetransaction fees or (2) the sum of the balancesand other amounts on which a finance chargewas imposed during the billing cycle9) multi-plied by the number of billing cycles in a year(12) = APR.10

Closed-End Credit (Subpart C)

The information presented here does not provide acomplete discussion of the closed-end creditrequirements of the Truth in Lending Act. Instead, itis offered to clarify otherwise confusing terms and

requirements. Refer to sections 226.17 through226.24 of Regulation Z and related commentary fora more thorough understanding of the act.

Finance Charge (§ 226.17(a))

The total amount of the finance charge must bedisclosed. Each finance charge imposed need notbe individually itemized and must not be itemizedwith the segregated disclosures.

Annual Percentage Rate (§ 226.22)

Accuracy Tolerances

The disclosed APR on a closed-end transaction isconsidered accurate

• If for regular transactions (including any single-advance transaction with equal payments andequal payment periods or transactions with anirregular first or last payment and/or an irregularfirst payment period), the APR is within one-eighth of 1 percentage point of the APR calcu-lated under Regulation Z (section 226.22(a)(2))

• If for irregular transactions (including multiple-advance transactions and other transactions notconsidered regular), the APR is within one-quarter of 1 percentage point of the APRcalculated under Regulation Z (section226.22(a)(3))

• If for mortgage transactions, the APR is withinone-eighth of 1 percentage point for regulartransactions or one-quarter of 1 percentagepoint for irregular transactions and

− The rate results from the disclosed financecharge and

− The disclosed finance charge would be con-sidered accurate under section 226.18(d)(1)or section 226.23(g) or (h) of Regulation Z(section 226.22(a)(4))

Note: An additional tolerance is granted formortgage loans when the disclosed financecharge is calculated incorrectly but is con-sidered accurate under section 226.18(d)(1) orsection 226.23(g) or (h) of Regulation Z (sec-tion 226.22(a)(5)).

See the diagrams for more information on accuracytolerances.

Construction Loans (§ 226.17(c)(6)and Appendix D)

Construction loans and certain other multiple-advance loans pose special problems in comput-ing the finance charge and the APR. In manyinstances, the amount and dates of advances arenot predictable with certainty because they depend

3. See footnote 2.4. Loan fees, points, or similar finance charges that relate to the

opening of the account must not be included in the calculation ofthe APR.

5. See footnote 2.6. See footnote 4.7. See footnote 2.8. See footnote 2.9. The sum of the balances may include amounts computed by

either the average daily balance, adjusted balance, or previousbalance method. When a portion of the finance charge isdetermined by application of one or more daily periodic rates, thesum of the balances also means the average of daily balances.

10. If the product is less than the highest periodic rate applied,expressed as an APR, the higher figure must be disclosed as theAPR.

Truth in Lending


Closed-End Credit: Accuracy Tolerances for Overstated APRs

Is this a “regular” loan?(12 CFR 226, footnote 46)

Is the disclosed APR more than the correct APR by more than one-quarter of

1 percentage point?

Is the disclosed APR more than the correct APR by more than one-eighth of

1 percentage point?


YesNo

YesNo

YesNoYes No

Is the disclosed finance charge more than the correct

finance charge?

APR violation

APR violation

Was the finance charge disclosure error the cause of

the APR disclosure error?

No Yes

APR violation No violation

Yes No

No violation

Truth in Lending


Closed-End Credit: Accuracy and Reimbursement Tolerancesfor Understated APRs

Is this a “regular” loan?

Is the disclosed APR understated by more than one-quarter

of 1 percentage point?

Is the disclosed APR understated by more than one-eighth of 1 percentage point?


YesNo

YesNo

YesNoYes No

Is the finance charge understated by more than• $100 if the loan originated on or after 9/30/95?• $200 if the loan originated before 9/30/95?

APR violation

APR violation

Was the finance charge disclosure error the cause of the APR disclosure error?

No Yes

APR violation No violation

YesNo

No violation

Is the loan term greater than 10 years?

Is the loan a “regular” loan?

Is the disclosed APR understated by more than one-eighth of 1 percentage point?

Is the disclosed APR understated by more than one-quarter of 1 percentage point?

No reimbursement

Subject to reimbursement

YesNo

YesNo

YesNo

NoYes

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on the progress of the work. Regulation Z providesthat, for disclosure purposes, the APR and financecharge for such loans may be estimated.

A financial institution may, at its option, rely on therepresentations of other parties to acquire neces-sary information (for example, it might look to theconsumer for the dates of advances). In addition, ifany of the amounts or the dates of advances areunknown (even if some of them are known), theinstitution may, at its option, refer to appendix D tothe regulation to make calculations and disclo-sures. The finance charge and payment scheduleobtained by referring to appendix D may be usedwith volume 1 of the Board’s APR tables or with anyother appropriate computation tool to determinethe APR (the Board’s APR tables are availablethrough the System publications catalog on theNew York Reserve Bank’s web site). If the institutionelects not to use appendix D, or if appendix Dcannot be applied to a loan (for example, appendixD does not apply to a combined construction–permanent loan if the payments for the permanentloan begin during the construction period), theinstitution must make its estimates under section226.17(c)(2) and calculate the APR using multiple-advance formulas.

For loans involving a series of advances underan agreement to extend credit up to a certainamount, a financial institution may treat all theadvances as a single transaction or disclose eachadvance as a separate transaction. If advances aredisclosed separately, disclosures must be pro-vided before each advance occurs, and thedisclosures for the first advance must be providedbefore consummation.

In a transaction that finances the construction ofa dwelling that may or will be permanently financedby the same financial institution, the construction–permanent financing phases may be disclosed inone of the following ways:

• As a single transaction, with one disclosurecovering both phases

• As two separate transactions, with one disclo-sure for each phase

• As more than two transactions, with one disclo-sure for each advance and one for thepermanent-financing phase

If two or more disclosures are furnished, buyer’spoints or similar amounts imposed on the con-sumer may be allocated among the transactions inany manner the financial institution chooses, aslong as the charges are not applied more thanonce. In addition, if the financial institution choosesto give two sets of disclosures and the consumer isobligated for both construction and permanentphases at the outset, both sets of disclosures must

be given to the consumer initially, before consum-mation of each transaction occurs.

If the creditor requires interest reserves forconstruction loans, special rules set forth in appen-dix D to Regulation Z apply that can make thedisclosure calculations quite complicated. Theamount of interest reserves included in the commit-ment amount must not be treated as a prepaidfinance charge.

If the lender uses appendix D for construction-only loans with required interest reserves, construc-tion interest must be estimated using the interest-reserve formula in appendix D. The lender’s owninterest-reserve values must be completely disre-garded for disclosure purposes.

If the lender uses appendix D for combinationconstruction–permanent loans, the calculationscan be much more complex. The appendix is usedto estimate the construction interest, which is thenmeasured against the lender’s contractual interestreserves.

If the interest-reserve portion of the lender’scontractual-commitment amount exceeds theamount of construction interest estimated underappendix D, the excess value is considered part ofthe amount financed if the lender has contracted todisburse those amounts, whether or not theyultimately are needed to pay for accrued construc-tion interest. If the lender will not disburse theexcess amount if it is not needed to pay for accruedconstruction interest, the excess amount must beignored for disclosure purposes.

Calculating the Annual Percentage Rate(§ 226.22)

The APR must be determined under one of thefollowing methods:

• The actuarial method, which is defined byRegulation Z and explained in appendix J to theregulation

• The U.S. Rule, which is permitted by RegulationZ and is briefly explained in appendix J to theregulation (The U.S. Rule is an accrual methodthat seems to have first surfaced officially in anearly nineteenth century U.S. Supreme Courtcase, Story v. Livingston (38 U.S. 359).)

Whichever method the financial institution uses, therate calculated will be considered accurate if it isable to ‘‘amortize’’ the amount financed whilegenerating the finance charge under the accrualmethod selected. Institutions also may rely onminor irregularities and accuracy tolerances in theregulation, both of which effectively permit thedisclosure of somewhat imprecise, but still legal,APRs.

Truth in Lending


360-Day and 365-Day Years(§ 226.17(c)(3))

Confusion often arises over whether to use a360-day or 365-day year in computing interest,particularly when the finance charge is computedby applying a daily rate to an unpaid balance.Many single-payment loans and loans payable ondemand are in this category. Also in this categoryare loans that call for periodic installment payments.

Regulation Z does not require the use of onemethod of interest computation in preference toanother (although state law may). It does, however,permit financial institutions to disregard the fact thatmonths have different numbers of days whencalculating and making disclosures. This meansthat financial institutions may base their disclosureson calculation tools that assume that all monthshave an equal number of days, even if theirpractice is to take account of the variations inmonths to collect interest. For example, an institu-tion may calculate disclosures using a financialcalculator based on a 360-day year with 30-daymonths when, in fact, it collects interest by applyinga factor of 1⁄365 of the annual interest rate to actualdays.

Disclosure violations may occur, however, whena financial institution applies a daily interest factorbased on a 360-day year to the actual number ofdays between payments. In those situations, theinstitution must disclose the higher values of thefinance charge, the APR, and the payment sched-ule resulting from this practice. For example, a12 percent simple interest rate divided by 360 daysresults in a daily rate of .033333 percent. If nocharges are imposed except interest and theamount financed is the same as the loan amount,applying the daily rate on a daily basis for a365-day year on a $10,000 one-year, single-payment, unsecured loan results in an APR of12.17 percent (.033333 × 365 = 12.17) and afinance charge of $1,216.67. There would be aviolation if the APR were disclosed as 12 percent orthe finance charge were disclosed as $1,200 (12%× $10,000). However, if no other charges exceptinterest are imposed, the application of a 360-day-year daily rate over 365 days on a regular loanwould not result in an APR in excess of theone-eighth of 1 percentage point APR toleranceunless the nominal interest rate is greater than9 percent. For irregular loans, with one-quarter of1 percentage point APR tolerance, the nominalinterest rate would have to be greater than18 percent to exceed the tolerance.

Variable-Rate Loans (§ 226.18(f))

If the terms of the legal obligation allow the financialinstitution, after consummation of the transaction, to

increase the APR, the financial institution mustfurnish the consumer with certain information onvariable rates. Graduated-payment mortgages andstep-rate transactions without a variable-rate fea-ture are not considered variable-rate transactions.In addition, variable-rate disclosures are not appli-cable to rate increases resulting from delinquency,default, assumption, acceleration, or transfer of thecollateral. Some of the more important transaction-specific variable-rate disclosure requirements undersection 226.18 follow:

• Disclosures for variable-rate loans must coverthe full term of the transaction and must bebased on the terms in effect at the time ofconsummation.

• If the variable-rate transaction includes either aseller buydown that is reflected in a contract or aconsumer buydown, the disclosed APR shouldbe a composite rate based on the lower rate forthe buydown period and the rate that is the basisfor the variable-rate feature for the remainder ofthe term.

• If the initial rate is not determined by the index orformula used to make later interest rate adjust-ments, as in a discounted variable-rate transac-tion, the disclosed APR must reflect a compositerate based on the initial rate for as long as it isapplied and, for the remainder of the term, therate that would have been applied using theindex or formula at the time of consummation(that is, the fully indexed rate).

– If a loan contains a rate or payment cap thatwould prevent the initial rate or payment, at thetime of the adjustment, from changing to thefully indexed rate, the effect of that rate orpayment cap needs to be reflected in thedisclosure.

– The index at consummation need not be usedif the contract provides for a delay in imple-mentation of changes in an index value (forexample, the contract indicates that futurerate changes are based on the index valuein effect for some specified period, suchas forty-five days before the change date).Instead, the financial institution may use anyrate from the date of consummation back tothe beginning of the specified period (forexample, during the previous forty-five-dayperiod).

• If the initial interest rate is set according to theindex or formula used for later adjustments but isset at a value as of a date before consummation,disclosures should be based on the initialinterest rate, even though the index may havechanged by the consummation date.

For variable-rate consumer loans that are notsecured by the consumer’s principal dwelling or

Truth in Lending


that are secured by the consumer’s principaldwelling but have a term of one year or less,creditors must disclose the circumstances underwhich the rate may increase, any limitations on theincrease, the effect of an increase, and an exampleof the payment terms that would result from anincrease (section 226.18(f)(1)).

For variable-rate consumer loans that are securedby the consumer’s principal dwelling and have amaturity of more than one year, creditors must statethat the loan has a variable-rate feature and thatdisclosures were previously given (section226.18(f)(2)). Extensive disclosures about the loanprogram must be provided when consumers applyfor such a loan (section 226.19(b)) and throughoutthe loan term when the rate or payment amount ischanged (section 226.20(c)).

Payment Schedule (§ 226.18(g))

The disclosed payment schedule must reflect allcomponents of the finance charge, including allscheduled payments to repay loan principal,interest on the loan, and any other finance chargepayable by the consumer after consummation ofthe transaction. Any finance charge paid sepa-rately before or at consummation (for example, odddays’ interest) is not to be treated as part of thepayment schedule; it is a prepaid finance chargeand must be reflected as a reduction in the value ofthe amount financed.

At the creditor’s option, the payment schedulemay include amounts beyond the amount financedand the finance charge (for example, certaininsurance premiums or real estate escrow amounts,such as taxes added to payments). However, thecreditor must disregard such amounts when calcu-lating the APR.

If the obligation is a renewable balloon-paymentinstrument that unconditionally obligates the finan-cial institution to renew the short-term loan at theconsumer’s option or to renew the loan subject toconditions within the consumer’s control, the pay-ment schedule must be disclosed using the longerterm of the renewal period or periods. The variable-rate feature for the long-term loan must bedisclosed.

If the instrument has no renewal conditions or thefinancial institution guarantees to renew the obliga-tion in a refinancing, the payment schedule mustbe disclosed using the shorter balloon-paymentterm. The short-term loan must be disclosed as afixed-rate loan, unless it contains a variable-ratefeature during the initial loan term.

Amount Financed (§ 226.18(b))

Definition

The amount financed is the net amount of creditextended for the consumer’s use. It should not beassumed that under the regulation, the amountfinanced is equivalent to the note amount, theproceeds, or the principal amount of the loan. Theamount financed normally equals the total ofpayments less the finance charge.

To calculate the amount financed, all amountsand charges connected with the transaction, eitherpaid separately or included in the note amount,must first be identified. Any prepaid, precomputed,or other finance charge must then be determined.

The amount financed must not include anyfinance charges. If finance charges have beenincluded in the obligation (either prepaid or pre-computed), they must be subtracted from the faceamount of the obligation when determining theamount financed. The resulting value must bereduced further by an amount equal to any prepaidfinance charge paid separately. The final resultingvalue is the amount financed.

When calculating the amount financed, financecharges (whether in the note amount or paidseparately) should not be subtracted more thanonce from the total amount of an obligation.Charges not in the note amount and not included inthe finance charge (for example, an appraisal feepaid separately, in cash, on a real estate loan) neednot be disclosed under Regulation Z and must notbe included in the amount financed.

In a multiple-advance construction loan, pro-ceeds placed in a temporary escrow account andawaiting disbursement to the developer in drawsare not considered part of the amount financed untilthey are actually disbursed. Thus, if the entirecommitment amount is disbursed into the lender’sescrow account, the lender must not base disclo-sures on the assumption that all funds weredisbursed immediately, even if the lender paysinterest on the escrowed funds.

Required Deposit (§ 226.18(r))

A required deposit, with certain exceptions, is onethat the financial institution requires the consumerto maintain as a condition of the specific credittransaction. It can include a compensating balanceor a deposit balance that secures the loan. Theeffect of a required deposit is not reflected in theAPR. Also, a required deposit is not a financecharge, as it is eventually released to the con-sumer. A deposit that earns at least 5 percent peryear need not be considered a required deposit.

Truth in Lending


Calculating the Amount Financed

Suppose that a consumer signs a note secured byreal property in the amount of $5,435. The noteamount includes $5,000 in proceeds disbursed tothe consumer, $400 in precomputed interest, $25paid to a credit-reporting agency for a credit report,and a $10 service charge. Additionally, the con-sumer pays a $50 loan fee separately, in cash, atconsummation. The consumer has no other debtwith the financial institution. The amount financed is$4,975.

The amount financed may be calculated by firstsubtracting all finance charges included in the noteamount ($5,435 − $400 − $10 = $5,025). The $25credit-report fee is not a finance charge becausethe loan is secured by real property. The $5,025 isfurther reduced by the amount of prepaid financecharges paid separately, for an amount financed of$5,025 − $50 = $4,975. The answer is the samewhether finance charges included in the obligationare considered prepaid or precomputed financecharges.

The financial institution may treat the $10 servicecharge as an addition to the loan amount and notas a prepaid finance charge. If it does, the loanprincipal would be $5,000. The $5,000 loan princi-pal does not include either the $400 or the $10precomputed finance charge in the note. The loanprincipal is increased by other amounts financedthat are not part of the finance charge (the $25credit-report fee) and reduced by any prepaidfinance charges (the $50 loan fee, but not the $10service charge) to arrive at the amount financed of$5,000 + $25 − $50 = $4,975.

Other Calculations

In the preceding example, the financial institutionmay treat the $10 service charge as a prepaidfinance charge. If it does, the loan principal wouldbe $5,010. The $5,010 loan principal does notinclude the $400 precomputed finance charge. Theloan principal is increased by other amountsfinanced that are not part of the finance charge (the$25 credit-report fee) and reduced by any pre-paid finance charges (the $50 loan fee and the$10 service charge withheld from the loan pro-ceeds) to arrive at the same amount financed of$5,010 + $25 − $50 − $10 = $4,975.

Refinancings (§ 226.20)

When an obligation is satisfied and replaced by anew obligation to the original financial institution (ora holder or servicer of the original obligation) and isundertaken by the same consumer, it must betreated as a refinancing for which a complete set ofnew disclosures must be furnished. A refinancing

may involve the consolidation of several existingobligations, disbursement of new money to theconsumer, or the rescheduling of payments underan existing obligation. In any form, the newobligation must completely replace the earlier oneto be considered a refinancing under Regulation Z.The finance charge on the new disclosure mustinclude any unearned portion of the old financecharge that is not credited to the existing obligation(section 226.20(a)).

The following transactions are not consideredrefinancings even if the existing obligation hasbeen satisfied and replaced by a new obligationundertaken by the same consumer:

• A renewal of an obligation with a single paymentof principal and interest or with periodic interestpayments and a final payment of principal withno change in the original terms

• An APR reduction with a corresponding changein the payment schedule

• An agreement involving a court proceeding

• Changes in credit terms arising from the consum-er’s default or delinquency

• The renewal of optional insurance purchased bythe consumer and added to an existing transac-tion, if required disclosures were provided for theinitial purchase of the insurance

However, even if it is not accomplished by thecancellation of the old obligation and substitution ofa new one, a new transaction subject to newdisclosures results if the financial institution doeseither of the following:

• Increases the rate based on a variable-ratefeature that was not previously disclosed

• Adds a variable-rate feature to the obligation

If the rate is increased at the time a loan is renewed,the increase is not considered a variable-ratefeature. It is the cost of renewal, similar to a flat fee,as long as the new rate remains fixed during theremaining life of the loan. If the original debt is notcanceled in connection with such a renewal, newdisclosures are not required. Also, changing theindex of a variable-rate transaction to a compa-rable index is not considered adding a variable-rate feature to the obligation.

Miscellaneous Provisions (Subpart D)

Civil Liability (TILA § 130)

If a creditor fails to comply with any requirements ofthe TILA, other than with the advertising provisionsof chapter 3, it may be held liable to the consumerfor both

• Actual damage

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• The cost of any legal action together withreasonable attorney’s fees in a successful action

If the creditor violates certain requirements of theTILA, it may also be held liable for either of thefollowing:

• In an individual action, twice the amount of thefinance charge involved, but not less than $100or more than $1,000. However, in an individualaction relating to a closed-end credit transactionsecured by real property or a dwelling, twice theamount of the finance charge involved, but notless than $200 or more than $2,000.

• In a class action, such amount as the court mayallow. However, the total amount of recovery maynot be more than $500,000 or 1 percent of thecreditor’s net worth, whichever is less.

Civil actions that may be brought against acreditor may also be maintained against anyassignee of the creditor if the violation is apparenton the face of the disclosure statement or otherdocuments assigned, except when the assignmentwas involuntary.

A creditor that fails to comply with the TILA’srequirements for high-cost mortgage loans may beheld liable to the consumer for all finance chargesand fees paid to the creditor. Any subsequentassignee is subject to all claims and defenses thatthe consumer could assert against the creditor,unless the assignee demonstrates that it could notreasonably have determined that the loan wassubject to section 226.32 of Regulation Z.

Criminal Liability (TILA § 112)

Anyone who willingly and knowingly fails to complywith any requirement of the TILA will be fined notmore than $5,000 or imprisoned not more than oneyear, or both.

Administrative Actions (TILA § 108)

The TILA authorizes federal regulatory agencies torequire financial institutions to make monetary andother adjustments to a consumer’s account whenthe true finance charge or APR exceeds thedisclosed finance charge or APR by more than aspecified accuracy tolerance. That authorizationextends to unintentional errors, including isolatedviolations (for example, an error that occurred onlyonce or errors, often without a common cause, thatoccurred infrequently and randomly).

Under certain circumstances, the TILA requiresfederal regulatory agencies to order financialinstitutions to reimburse consumers when under-statement of the APR or finance charge involves

• Patterns or practices of violations (for example,

errors that occurred, often with a common cause,consistently or frequently, reflecting a pattern inrelation to a specific type or types of consumercredit)

• Gross negligence

• Willful noncompliance intended to mislead theperson to whom the credit was extended

Any proceeding that may be brought by aregulatory agency against a creditor may bemaintained against any assignee of the creditorif the violation is apparent on the face of thedisclosure statement or other documents assigned,except when the assignment was involuntary (TILAsection 131).

Federal Reserve examiners follow the FFIEC’sinteragency Regulation Z policy guide when deter-mining the applicability and amount of any reim-bursements. Although the policy guide appears torequire reimbursement only in cases in which apattern or practice was discovered, System policyrequires banks to make reimbursements whenisolated cases are discovered as well. Unlike thediscovery of a pattern or practice of violations,which requires the bank to conduct a file search todetermine the extent of the pattern or practice, thediscovery of an isolated instance does not require afile search. Isolated violations are technical andnonsubstantive in nature, are not cited in theexamination report, and may be communicated inan informal manner.

Relationship to State Law (TILA § 111)

State laws providing rights, responsibilities, orprocedures for consumers or financial institutionsfor consumer credit contracts may be

• Preempted by federal law

• Appropriate under state law and not preemptedby federal law

• Substituted in lieu of TILA and Regulation Zrequirements

State law provisions are preempted to the extentthat they contradict the requirements in the follow-ing chapters of the TILA and the implementingsections of Regulation Z:

• Chapter 1, ‘‘General Provisions,’’ which containsdefinitions and acceptable methods for determin-ing finance charges and annual percentagerates. For example, a state law would bepreempted if it required a bank to include in thefinance charge any fees that the federal lawexcludes, such as seller’s points.

• Chapter 2, ‘‘Credit Transactions,’’ which containsdisclosure requirements, rescission rights, andcertain credit card provisions. For example, a

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state law would be preempted if it required abank to use the term ‘‘nominal annual interestrate’’ in lieu of ‘‘annual percentage rate.’’

• Chapter 3, ‘‘Credit Advertising,’’ which containsrules for consumer credit advertising and require-ments for the oral disclosure of annual percent-age rates.

Conversely, state law provisions may be appro-priate and are not preempted under federal law ifthey call for, without contradicting chapters 1, 2, or3 of the TILA or the implementing sections ofRegulation Z, either of the following:

• Disclosure of information not otherwise required.A state law that requires disclosure of theminimum periodic payment for open-end credit,for example, would not be preempted because itdoes not contradict federal law.

• Disclosures more detailed than those required. Astate law that requires itemization of the amountfinanced, for example, would not be preempted,unless it contradicts federal law by requiring theitemization to appear with the disclosure of theamount financed in the segregated closed-endcredit disclosures.

Two preemption standards apply to TILA chap-ter 4. One applies to section 161 (Correction ofBilling Errors) and 162 (Regulation of CreditReports), the other to the remaining provisions ofchapter 4 (sections 163–171).

State law provisions are preempted if they differfrom the rights, responsibilities, or procedurescontained in section 161 or 162 of the TILA. Anexception is made, however, for state law thatallows a consumer to inquire about an account andrequires the bank to respond to such inquirybeyond the time limits provided by federal law.Such a state law would not be preempted for theextra time period.

State law provisions are preempted if they resultin violations of sections 163 through 171 ofchapter 4 of the TILA. For example, a state law thatallows the card issuer to offset the consumer’scredit card indebtedness against funds held by thecard issuer would be preempted, as it would violatesection 226.12(d) of Regulation Z. Conversely, astate law that requires periodic statements to besent more than fourteen days before the end of afree-ride period would not be preempted, as noviolation of federal law is involved.

A bank, state, or other interested party may askthe Federal Reserve Board to determine whetherstate law contradicts chapters 1 through 3 of theTILA or Regulation Z. They may also ask if the statelaw is different from, or would result in violations of,chapter 4 of the TILA and the implementingprovisions of Regulation Z. If the Board determines

that a disclosure required by state law (other than arequirement relating to the finance charge, theannual percentage rate, or the disclosures requiredunder section 226.32 of the regulation) is substan-tially the same in meaning as a disclosure requiredunder the act or the regulation, generally, creditorsin that state may make the state disclosure in lieu ofthe federal disclosure.

Special Rules for Certain HomeMortgage Transactions (Subpart E)

General Rules (§ 226.31)

The requirements and limitations of subpart E are inaddition to and not in lieu of those contained inother subparts of Regulation Z. The disclosures forhigh-cost and reverse mortgage transactions mustbe made clearly and conspicuously in writing, in aform that the consumer can keep.

Certain Closed-End Home Mortgages(§ 226.32)

The requirements of section 226.32 apply to aconsumer credit transaction secured by the con-sumer’s principal dwelling in which either

• The APR at consummation will exceed by morethan 8 percentage points for first-lien mortgageloans, or by more than 10 percentage points forsubordinate-lien mortgage loans, the yield onTreasury securities having periods of maturitycomparable to the loan’s maturity (as of the 15thday of the month immediately preceding themonth in which the application for the extensionof credit is received by the creditor)

• The total points and fees (see definition below)payable by the consumer at or before loanclosing will exceed the greater of 8 percent of thetotal loan amount or a dollar amount that isadjusted annually on the basis of changes in theconsumer price index (See staff commentary tosection 226.32(a)(1)(ii) of Regulation Z for ahistorical list of dollar amount adjustments. Forcalendar year 2005, the dollar amount was$510.) (section 226.32(a)(1))

Exemptions

The following are exempt from section 226.32:

• Residential mortgage transactions (generally,purchase money mortgages)

• Reverse mortgage transactions subject to sec-tion 226.33 of Regulation Z

• Open-end credit plans subject to subpart B ofthe regulation

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Points and Fees

Points and fees include the following:

• All items required to be disclosed under sections226.4(a) and (b) of Regulation Z except interestor the time–price differential

• All compensation paid to mortgage brokers

• All items listed in section 226.4(c)(7) other thanamounts held for future taxes, unless all of thefollowing conditions are met:

– The charge is reasonable

– The creditor receives no direct or indirectcompensation in connection with the charge

– The charge is not paid to an affiliate of thecreditor

• Premiums or other charges, paid at or beforeclosing whether paid in cash or financed, foroptional credit life, accident, health, or loss-of-income insurance, and other debt-protection ordebt-cancellation products written in connectionwith the credit transaction (section 226.32(b)(1))

Reverse Mortgages (§ 226.33)

A reverse mortgage is a non-recourse transactionsecured by the consumer’s principal dwelling thatties repayment (other than upon default) to thehomeowner’s death or permanent move from, ortransfer of the title of, the home.

Specific Defenses—TILA Section 108

Defense against Civil, Criminal, andAdministrative Actions

A financial institution in violation of the TILA mayavoid liability by doing all of the following:

• Discovering the error before an action is broughtagainst the institution, or before the consumernotifies the institution, in writing, of the error

• Notifying the consumer of the error within sixtydays of discovery

• Making the necessary adjustments to the con-sumer’s account, also within sixty days ofdiscovery (The consumer will pay no more thanthe lesser of the finance charge actually dis-closed or the dollar equivalent of the APRactually disclosed.)

Taking these three actions may also allow thefinancial institution to avoid a regulatory order toreimburse the customer.

An error is ‘‘discovered’’ if it is

• Discussed in a final, written report of examination

• Identified through the financial institution’s ownprocedures

• An inaccurately disclosed APR or finance chargeincluded in a regulatory agency notification tothe financial institution

When a disclosure error occurs, the financialinstitution is not required to re-disclose after a loanhas been consummated or an account has beenopened. If the institution corrects a disclosure errorby merely re-disclosing required information accu-rately, without adjusting the consumer’s account,the financial institution may still be subject to civilliability and an order from its regulator to reimburse.

The circumstances under which a financialinstitution may avoid liability under the TILA do notapply to violations of the Fair Credit Billing Act(chapter 4 of the TILA).

Additional Defenses against Civil Actions

A financial institution may avoid liability in a civilaction if it shows, by a preponderance of evidence,that the violation was not intentional and resultedfrom a bona fide error that occurred despite themaintenance of procedures to avoid the error.

A bona fide error may be a clerical, calculation,programming, or printing error or a computermalfunction. It does not include an error of legaljudgment.

Showing that a violation occurred unintentionallycould be difficult if the financial institution is unableto produce evidence that explicitly indicates that ithas an internal controls program designed toensure compliance. The financial institution’s dem-onstrated commitment to compliance and its adop-tion of policies and procedures to detect errorsbefore disclosures are furnished to consumerscould strengthen its defense.

Statute of Limitations—TILA Sections 108 and 130

Civil actions may be brought within one year afterthe violation occurred. After that time, and ifallowed by state law, the consumer may still assertthe violation as a defense if a financial institutionbrings an action to collect the consumer’s debt.Criminal actions are not subject to the TILAone-year statute of limitations.

Regulatory administrative enforcement actionsalso are not subject to the one-year statute oflimitations. However, enforcement actions underthe FFIEC policy guide involving erroneously dis-closed APRs and finance charges are subject totime limitations by the TILA. Those limitations rangefrom the date of the most recent regulatoryexamination of the financial institution to as far backas 1969, depending on when the loan was made,

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when the violation was identified, whether theviolation was a repeat violation, and other factors.

There is no time limitation on willful violationsintended to mislead the consumer. The followingsummarize the various time limitations:

• For open-end credit, reimbursement applies toviolations not older than two years.

• For closed-end credit, reimbursement is gener-ally applied to loans with violations occurringsince the immediately preceding examination.

Rescission Rights (Open-Endand Closed-End Credit)—Sections 226.15 and 226.23

The TILA provides that for certain transactionssecured by a consumer’s principal dwelling, theconsumer has three business days after becomingobligated on the debt to rescind the transaction.The right of rescission allows the consumer time toreexamine the credit agreement and cost disclo-sures and to reconsider whether he or she wants toplace his or her home at risk by offering it assecurity for the credit. Transactions exempt fromthe right of rescission include residential mortgagetransactions (section 226.2(a)(24)) and refinanc-ings or consolidations with the original creditorwhen no ‘‘new money’’ is advanced.

If a transaction is rescindable, a consumer mustbe given a notice explaining that the creditor has asecurity interest in the consumer’s home, that theconsumer may rescind, how the consumer mayrescind, the effects of rescission, and the date therescission period expires.11

To rescind a transaction, the consumer mustnotify the creditor in writing by midnight of the third

business day after the latest of three events:(1) consummation of the transaction, (2) delivery ofmaterial TILA disclosures, or (3) receipt of therequired notice of the right to rescind. For purposesof rescission, business day means every calendarday except Sundays and legal public holidays(section 226.2(a)(6)). Material disclosures is definedin section 226.23(a)(3) to mean the requireddisclosures of the annual percentage rate, thefinance charge, the amount financed, the total ofpayments, the payment schedule, and the disclo-sures and limitations referred to in sections226.32(c) and 226.32(d).

The creditor may not disburse any monies(except into an escrow account) and may notprovide services or materials until the three-dayrescission period has elapsed and the creditor isreasonably satisfied that the consumer has notrescinded. If the consumer rescinds the transac-tion, the creditor must refund all amounts paid bythe consumer (even amounts disbursed to thirdparties) and terminate its security interest in theconsumer’s home.

A consumer may waive the three-day rescissionperiod and receive immediate access to loanproceeds if he or she has a ‘‘bona fide personalfinancial emergency.’’ The consumer must give thecreditor a signed and dated waiver statement thatdescribes the emergency, specifically waives theright, and bears the signatures of all consumersentitled to rescind the transaction. The consumerprovides the explanation for the bona fide personalfinancial emergency, but the creditor decides thesufficiency of the emergency.

If the required rescission notice or material TILAdisclosures are not delivered or if they are inaccu-rate, the consumer’s right to rescind may beextended from three days after becoming obli-gated on a loan to up to three years.11. A creditor may provide this notice in written (paper copy) or

electronic format. If a paper copy of the right to rescind is used,the creditor must deliver two copies of the notice to eachconsumer entitled to rescind. If an electronic format is used, thecreditor may provide only one copy to each consumer entitled torescind in accordance with the consumer-consent and otherapplicable provisions of the E-Sign Act.

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Regulation ZExamination Objectives and Procedures

EXAMINATION OBJECTIVES

1. To appraise the quality of the financial institu-tion’s compliance management system for theTruth in Lending Act and Regulation Z

2. To determine the reliance that can be placedon the financial institution’s compliance man-agement system, including internal controlsand procedures performed by the person(s)responsible for monitoring the financial institu-tion’s compliance review function for the Truthin Lending Act and Regulation Z

3. To determine the financial institution’s compli-ance with the Truth in Lending Act andRegulation Z

4. To initiate corrective action when policies orinternal controls are deficient, or when viola-tions of law or regulation are identified

5. To determine whether the institution will berequired to make adjustments to consumeraccounts under the restitution provisions of theact

EXAMINATION PROCEDURES

General Procedures

1. Obtain information pertinent to the area ofexamination from the financial institution’scompliance management system program (his-torical examination findings, complaint informa-tion, and significant findings from compliancereviews and audits).

2. Through discussions with management andreview of the following documents, determinewhether the financial institution’s internal con-trols are adequate to ensure compliance in thearea under review. Identify procedures useddaily to detect errors and violations promptly.Also, review the procedures used to ensurecompliance when changes occur (for exam-ple, changes in interest rates, service charges,computation methods, and software programs).

• Organization charts

• Process flow charts

• Policies and procedures

• Loan documentation and disclosures

• Checklists, worksheets, and review docu-ments

• Computer programs

3. Review compliance reviews and audit work-papers and determine whether

a. The procedures used address all regula-tory provisions (see ‘‘Transaction Testing’’section, later in these procedures)

b. Steps are taken to follow up on previouslyidentified deficiencies

c. The procedures used include samples thatcover all product types and decision centers

d. The work performed is accurate (by review-ing some transactions)

e. Significant deficiencies, and the root causeof the deficiencies, are included in reportsto management and the board

f. Correctiveactionsare timely andappropriate

g. The area is reviewed at an appropriateinterval

Disclosure Forms

4. Determine whether the financial institution haschanged any preprinted TILA disclosure formsor if there are forms that have not beenpreviously reviewed for accuracy. If so, verifythe accuracy of each preprinted disclosure byreviewing the following:

• Note and/or contract forms (including thosefurnished to dealers)

• Standard closed-end credit disclosures(§§ 226.17(a) and 226.18)

• ARM disclosures (§ 226.19(b))

• High-cost mortgage disclosures(§ 226.32(c))

• Initial disclosures (§§ 226.6(a)−(d)) and, ifapplicable, additional home equity line ofcredit (HELC) disclosures (§ 226.6(e))

• Credit card application and solicitationdisclosures (§§ 226.5a(b)−(e))

• HELC disclosures (§§ 226.5b(d) and226.5b(e))

• Statement of billing rights and change-in-terms notice (§ 226.9(a))

• Reverse mortgage disclosures (§ 226.33(b))

Forms for Closed-End Credit

a. Determine that the disclosures are clear,conspicuous, grouped, and segregated.The terms ‘‘finance charge’’ and ‘‘APR’’should be more conspicuous than otherterms. (§ 226.17(a))


b. Determine that the disclosures include thefollowing, as applicable: (§ 226.18)

(1) Identity of the creditor

(2) Brief description of the finance charge

(3) Brief description of the APR

(4) Variable-rate verbiage (§ 226.18(f)(1)or 226.18(f)(2))

(5) Payment schedule

(6) Brief description of the total ofpayments

(7) Demand feature

(8) For a credit sale, description of totalsales price

(9) Prepayment penalties or rebates

(10) Late-payment amount or percentage

(11) Description of security interest

(12) Various insuranceverbiage (§226.4(d))

(13) Statement referring to the contract

(14) Statement regarding assumption ofthe note

(15) Statement regarding required deposits

c. Determine whether all variable-rate loanswith a maturity of more than 1 year securedby a principal dwelling are given thefollowing disclosures at the time of applica-tion: (§ 226.19)

(1) Consumer handbook on adjustable-rate mortgages, or a substitute

(2) Statement that interest rate paymentsand terms can change

(3) The index or formula and a source ofinformation

(4) Explanation of the interest rate, pay-ment determination, and margin

(5) Statement that the consumer shouldask for the current interest rate andmargin

(6) Statement that the interest rate isdiscounted, if applicable

(7) Frequency of interest rate and paymentchanges

(8) Rules relating to all changes

(9) Either (1) a historical example, basedon a $10,000 loan amount, illustratinghow payments and the loan balancewould have been affected by interestrate changes implemented accordingto the terms of the loan program overthe past 15 years or (2) the initial andmaximum interest rates and paymentsfor a $10,000 loan, along with astatement that the periodic paymentmay substantially increase or decrease

and a statement of a maximum interestrate and payment

(10) Explanation of how to compute theloan payment, and an example

(11) Demand feature, if applicable

(12) Statement regarding the content andtiming of adjustment notices

(13) Statement that other variable-rate loanprogram disclosures are available, ifapplicable

d. Determine that the disclosures required forhigh-cost mortgage transactions clearlyand conspicuously include the followingitems: (§ 226.32(c); see form H-16 inappendix H to Regulation Z)

(1) The required statement ‘‘You are notrequired to complete this agreementmerely because you have receivedthese disclosures or have signed aloan application. If you obtain thisloan, the lender will have a mortgageon your home. You could lose yourhome, and any money you have putinto it, if you do not meet yourobligations under the loan.’’

(2) Annual percentage rate

(3) Amount of the regular monthly (orother periodic) payment and amountof any balloon payment. The regularpayment should include amounts forvoluntary items, such as credit lifeinsurance or debt-cancellation cover-age, only if the consumer has previ-ously agreed to the amount. (See staffcommentary to § 226.32(c)(3).)

(4) For variable-rate loans, a statementthat the interest rate may increase,and the amount of the single maximummonthly payment, based on the maxi-mum interest rate allowed under thecontract, if applicable

(5) For mortgage refinancings, the totalamount borrowed, as reflected by theface amount of the note; and if theamount borrowed includes premiumsor other charges for optional creditinsurance or debt-cancellation cover-age, a statement to that effect (groupedtogether with the amount borrowed)

Forms for Open-End Credit

a. Determine that the initial disclosure state-ment is provided before the first transactionunder the account and includes the follow-ing items, as applicable: (§ 226.6)

Truth in Lending: Examination Objectives and Procedures


(1) Statement of when a finance chargewould accrue and whether a graceperiod exists

(2) Statement of the periodic rates andthe corresponding APR

(3) Explanation of the method of determin-ing the balance on which the financecharge may be computed

(4) Explanation of how the finance chargewould be determined

(5) Statement of the amount of any othercharges

(6) Statement of the creditor’s securityinterest in the property

(7) Statement of billing rights (§§ 226.12and 226.13)

(8) Certain home equity plan information,if not provided with the application,in a form the consumer can keep(§ 226.6(e)(7))

b. Determine that the following credit carddisclosures were made clearly and con-spicuously on or with a solicitation oran application. Disclosures in 12-pointtype are deemed to comply with therequirements. See commentary to sec-tion 226.5a(a)(2)-1. The APR for purchases(other than an introductory rate that is lowerthan the rate that will apply after theintroductory rate expires) must be in at least18-point type. (§ 226.5a)

(1) APR for purchases, cash advances,and balance transfers, including pen-alty rates that may apply. If the rate isvariable, the index or formula and themargin must be identified.

(2) Fee for issuance of the card

(3) Minimum finance charge

(4) Transaction fees

(5) Length of the grace period

(6) Balance-computation method

(7) Statement that charges incurred byusing the charge card are due whenthe periodic statement is received

Note: Items 1−7 must be provided in aprominent location in the form of a table.The following items (8–10) may be includedin the same table or clearly and conspicu-ously elsewhere in the same document.An explanation of specific events that mayresult in the imposition of a penalty ratemust be placed outside the table, with anasterisk inside the table (or other means)directing the consumer to the additionalinformation.

(8) Cash-advance fees

(9) Late-payment fees

(10) Fees for exceeding the credit limit

c. Determine that the disclosure of items 1−7in ‘‘b,’’ above, are made orally for creditor-initiated telephone applications and pre-approved solicitations. Also, determine forapplications or solicitations made to thegeneral public that the card issuer makesoneof theoptional disclosures. (§§226.5a(d)and 226.5a(e))

d. Determine that the following home equityinformation was provided clearly and con-spicuously at the time of application:(§ 226.5b)

(1) Home equity brochure

(2) Statement that the consumer shouldretain a copy of the disclosure

(3) Statement of the time the specificterms are available

(4) Statement that terms are subject tochange before the plan opens

(5) Statement that the consumer mayreceive a full refund of all fees

(6) Statement that the consumer’s dwell-ing secures the credit

(7) Statement that the consumer couldlose the dwelling

(8) Statement of the creditor’s right tochange, freeze, or terminate theaccount

(9) Statement that information about con-ditions for adverse action is availableupon request

(10) Statement of payment terms, includingthe length of the draw and repaymentperiods, how the minimum payment isdetermined, the timing of payments,and an example based on $10,000and a recent APR

(11) A recent APR imposed under the planand a statement that the rate does notinclude costs other than interest (fixed-rate plans only)

(12) Itemization of all fees to be paid to thecreditor

(13) Estimate of any fees payable to thirdparties to open the account and astatement that the consumer mayreceive a good-faith itemization ofthird-party fees

(14) Statement regarding negative amorti-zation, as applicable

(15) Statement of transaction requirements



(16) Statement that the consumer shouldconsult a tax advisor regarding thedeductibility of interest and chargesunder the plan

(17) For variable-rate home equity plans,disclosures including

i. That the APR, payment, or termmay change

ii. That theAPR excludes costs otherthan interest

iii. The index and its source

iv. How the rate will be determined

v. That the consumer should requestinformation on the current indexvalue, margin, discount, premium,or APR

vi. That the initial rate is discounted,and the duration of the discount, ifapplicable

vii. Frequency of APR changes

viii. Rules relating to changes in theindex, APR, and payment amount

ix. Lifetime rate cap and any annualcaps, or that there is no annuallimitation

x. The minimum payment require-ment, using the maximum APR,and when the maximum APR maybe imposed

xi. A table, based on a $10,000balance, reflecting all significantplan terms

xii. That rate information will be pro-vided on or with each periodicstatement

e. Determine when the last statement of billingrights was furnished to customers andwhether the institution used the short-formnotice with each periodic statement.(§ 226.9(a))

f. Determine that the notice of any change interms was provided 15 days prior to theeffective date of the change. (§ 226.9(b))

g. Determine that items 1−7 in ‘‘b,’’ above, aredisclosed when the account is renewed.This disclosure must also state how andwhen the cardholder may terminate thecredit to avoid paying the renewal fee.(§ 226.9(e))

h. Determine that a statement regarding themaximum interest rate that may be imposedduring the term of the obligation is made forany loan for which the APR may increaseduring the plan. (§ 226.30(b))

Forms for Reverse Mortgages(Both Open- and Closed-End)

a. Determine that the disclosures required forreverse mortgage transactions are substan-tially similar to the model form in appendix Kto Regulation Z and include the followingitems:

(1) A statement that the consumer is notobligated to complete the reversemortgage transaction merely becausehe or she has received the disclosuresor signed an application

(2) A good-faith projection of the total costof the credit expressed as a table of‘‘total annual loan cost rates,’’ includ-ing payments to the consumer, addi-tional creditor compensation, limita-tions on consumer liability, assumedannual appreciation, and the assumedloan period

(3) An itemization of loan terms, charges,the age of the youngest borrower, andthe appraised property value

(4) An explanation of the table of totalannual loan cost rates

Note: Forms that include or involve currenttransactions, such as change-in-terms no-tices, periodic billing statements, rescissionnotices, and billing-error communications,should be verified for accuracy when thefile review worksheets are completed.

Timing of Disclosures

5. Review financial institution policies, proce-dures, and systems to determine, either sepa-rately or when completing the actual filereview, whether the applicable disclosureslisted below are furnished when required byRegulation Z. Take into account products thathave different features, such as closed-endloans or credit card accounts that are fixed orvariable rate.

a. Credit card application and solicitationdisclosures—On or with the application(§ 226.5a(b))

b. HELC disclosures—At the time the applica-tion is provided or within 3 business daysunder certain circumstances (§ 226.5b(b))

c. Open-end credit initial disclosures—Beforethe first transaction is made under the plan(§ 226.5(b)(1))

d. Periodic disclosures—At the end of a billingcycle if the account has a debit or creditbalance of $1 or more or if a finance chargehas been imposed (§ 226.5(b)(2))



e. Statement of billing rights—At least once ayear (§ 226.9(a))

f. Supplemental credit devices—Before thefirst transaction under the plan (§ 226.9(b))

g. Open-end credit change in terms—15 daysprior to theeffective changedate (§ 226.9(c))

h. Finance charge imposed at time oftransaction—Prior to imposing any fee(§ 226.9(d))

i. Disclosures upon renewal of credit orcharge card—30 days or 1 billing cycle,whichever is less, before the delivery of theperiodic statement on which the renewalfee is charged. Alternatively, notice may bedelayed until the mailing or delivery of theperiodic statement on which the renewalfee is charged to the accounts if the noticemeets certain requirements. (§ 226.9(e))

j. Change in credit account insuranceprovider—Certain information 30 days be-fore the change in provider occurs, andcertain information 30 days after the changein provider occurs. The institution mayprovide a combined disclosure 30 daysbefore the change in provider occurs.(§ 226.9(f))

k. Closed-end credit disclosures—Before con-summation (§ 226.17(b))

l. Disclosures for certain closed-end homemortgages—3 business days prior to con-summation (§ 226.31(c)(1))

m. Disclosures for reverse mortgages—3 daysprior to consummation of a closed-endcredit transaction or prior to the first trans-action under an open-end credit plan(§ 226.31(c)(2))

n. Disclosures for adjustable-rate mortgages—At least once each year during which aninterest rate adjustment is implementedwithout an accompanying payment change,and at least 25, but no more than 120,calendar days before a new paymentamount is due, or in accordance with othervariable-rate subsequent-disclosure regula-tions issued by a supervisory agency(§ 226.20(c))

Electronic Disclosures

Note: Disclosures may be provided to the con-sumer in electronic form, subject to compliancewith the consumer consent and other applicableprovisions of the Electronic Signatures in Globaland National Commerce Act (E-Sign Act) (15 USC7001 et seq.). The E-Sign Act does not mandatethat institutions or consumers use or acceptelectronic records or signatures. It permits institu-

tions to satisfy any statutory or regulatory require-ments by providing the information electronicallyafter obtaining the consumer’s affirmative consent.Before consent can be given, consumers must beprovided with the following information:

• Any right or option to have the informationprovided in paper or non-electronic form;

• The right to withdraw the consent to receiveinformation electronically and the consequences,including fees, of doing so;

• The scope of the consent (for example, whetherthe consent applies only to a particular transac-tion or to identified categories of records thatmay be provided during the course of theparties’ relationship);

• The procedures to withdraw consent and toupdate information needed to contact the con-sumer electronically; and

• The methods by which a consumer may obtain,upon request, a paper copy of an electronicrecord after consent has been given to receivethe information electronically and whether anyfee will charged.

The consumer must consent electronically orconfirm consent electronically in a manner that‘‘reasonably demonstrates that the consumer canaccess information in the electronic form that willbe used to provide the information that is thesubject of the consent.’’ After the consent, if aninstitution changes the hardware or softwarerequirements such that a consumer may beprevented from accessing and retaining informa-tion electronically, the institution must notify theconsumer of the new requirements and must allowthe consumer to withdraw consent without charge.

6. If the financial institution makes its disclosuresavailable to consumers in electronic form,determine that the forms comply with theappropriate sections—226.5(a)(1); 226.5a(a)(2)(v); 226.5b(a)(3); 226.15(b); 226.16(c);226.17(a)(1); 226.17(g); 226.19(c); 226.23(b)(1); 226.24(d); and 226.31(b).

Record Retention

7. Review the financial institution’s record-retention practices to determine whether evi-dence of compliance (for other than theadvertising requirements) is retained for atleast 2 years after the disclosure was requiredto be made or other action was required to betaken. (§ 226.25)



Transaction Testing

Note: When verifying APR accuracies, use theOCC’s APR calculation model or other acceptablecalculation tool.

Advertising

8. Sample advertising copy, including any Inter-net advertising, since the previous examinationand verify that the terms of credit are specific.If triggering terms are used, determine that therequired disclosures are made. (§§ 226.16 and226.24)

For advertisements for closed-end credit,determine,

• If a rate of finance charge was stated, that itwas stated as an APR

• If an APR will increase after consummation,that a statement to that effect is made

Closed-End Credit

9. For each type of closed-end loan being tested,determine the accuracy of the disclosures bycomparing the disclosures with the contractand other financial institution documents.(§ 226.17)

10. Determine whether the required disclosureswere made before consummation of the trans-action, and ensure the presence and accuracyof the items below, as applicable. (§ 226.18)

a. Amount financed

b. Itemization of the amount financed (RESPAgood-faith estimate may be substituted)

c. Finance charge

d. APR

e. Variable-rate verbiage, as follows, for loansnot secured by a principal dwelling or loanswith terms of 1 year or less:

(1) Circumstances that permit a rateincrease

(2) Limitations on the increase (periodicor lifetime)

(3) Effects of the increase

(4) Hypothetical example of new paymentterms

f. Payment schedule, including amount, tim-ing, and number of payments

g. Total of payments

h. Total sales price (credit sale)

i. Description of security interest

j. Credit life insurance premium is included inthe finance charge, unless all three of the

following conditions are met:

(1) Insurance is not required

(2) Premium for the initial term is disclosed

(3) Consumer signs or initials an affirma-tive written request for the insurance

k. Property insurance available from the credi-tor is excluded from the finance charge ifthe premium for the initial term of theinsurance is disclosed

l. Required deposit

11. Determine, for adjustable-rate mortgage loansthat are secured by the borrower’s principaldwelling and have maturities of more than1 year, that the required early and subsequentdisclosures are complete, accurate, and timely.Early disclosures required by section 226.19(a)are verified during the closed-end credit formsreview. Subsequent disclosures should includethe items below, as applicable: (§ 226.20(c))

a. Current and prior interest rates

b. Index values used to determine current andprior interest rates

c. Extent to which the creditor has foregone anincrease in the interest rate

d. Contractual effects of the adjustment (newpayment and loan balance)

e. Payment required to avoid negative amorti-zation

Note: The accuracy of the adjusted interestrates and indexes should be verified bycomparing them with the contract and withearly disclosures. Refer to the ‘‘AdditionalVariable-Rate Testing’’ section of theseexamination procedures.

12. Determine, for each type of closed-end rescind-able loan being tested, whether 2 copies of therescission notice are provided to each personwhose ownership interest is or will be subjectto the security interest. The rescission noticemust disclose the following items: (§ 226.23(b))

a. Security interest taken in the consumer’sprincipal dwelling

b. Consumer’s right to rescind the transaction

c. How to exercise the right to rescind, with aform for that purpose, stating the address ofthe creditor’s place of business

d. Effects of rescission

e. Date the rescission period expires

13. Ensure that funding was delayed until therescission period expired. (§ 226.23(c))

14. Determine if the institution has received anyrequests to waive the 3-day right to rescindsince the previous examination. If applicable,test rescission waivers. (§ 226.23(e))



15. Determine whether the maximum interest ratein the contract is disclosed for any adjustable-rate consumer credit contract secured by adwelling. (§ 226.30(a))

Open-End Credit

16. For each open-end credit product tested,determine the accuracy of the disclosures bycomparing the disclosures with the contractsand other financial institution documents.(§ 226.5(c))

17. Review the financial institution’s policies, pro-cedures, and practices to determine whether itprovides appropriate disclosures for creditor-initiated direct mail applications and solicita-tions to open charge card accounts, telephoneapplications and solicitations to open chargecard accounts, and applications and solicita-tions made available to the general public toopen charge card accounts. (§§ 226.5a(b)–(d))

18. Determine, for all home equity plans with avariable rate, that the APR is based on anindependent index. Further, ensure that homeequity plans are terminated or terms arechanged only if certain conditions exist.(§ 226.5b(f))

19. Determine that if any consumer rejected ahome equity plan because a disclosed termchanged before the plan was opened, all feeswere refunded. Verify that nonrefundable feeswere not imposed until 3 business days afterthe consumer received the required disclo-sures and brochure. (§§ 226.5b(g) and226.5b(h))

20. Review consecutive periodic billing statementsfor each major type of open-end credit activityoffered (overdraft and home equity lines ofcredit, credit card programs, and so forth).Determine whether disclosures were calcu-lated accurately and are consistent with theinitial disclosure statement furnished in connec-tion with the accounts (or any subsequentchange-in-terms notice) and the underlyingcontractual terms governing the plan(s). Theperiodic statement must disclose the followingitems, as applicable: (§ 226.7)

a. Previous balance

b. Identification of transactions

c. Dates and amounts of any credits

d. Periodic rates and corresponding APRs; forvariable-rate plans, that the periodic ratesmay vary

e. Balance on which the finance charge iscomputed, and an explanation of how thebalance is determined

f. Amount of the finance charge, with anitemization of each of the components ofthe finance charge

g. Annual percentage rate

h. Itemization of other charges

i. Closing date and balance

j. Payment date, if there is a ‘‘free ride’’ period

k. Address for notice of billing errors

21. Verify that the institution credits a payment toan open-end account as of the date of receipt.(§ 226.10)

22. Determine how the institution handles creditbalances. Specifically, if an account’s creditbalance is in excess of $1, the institution musttake the following actions: (§ 226.11)

a. Credit the amount to the consumer’s account

b. Refund any part of the remaining creditbalance within 7 business days from receiv-ing a written request from the consumer

c. Make a good-faith effort to refund theamount of the credit to a deposit account ofthe consumer if the credit remains for morethan 6 months

23. Review samples of billing-error-resolution filesand correspondence from consumers assert-ing a claim or defense against the financialinstitution for a credit card dispute regardingproperty or services. Verify the following:(§§ 226.12 and 226.13)

a. Credit cards are issued only upon request

b. Liability for unauthorized credit card use islimited to $50

c. Disputed amounts are not reported asdelinquent unless remaining unpaid afterthe dispute has been settled

d. Offsetting credit card indebtedness isprohibited

e. Errors are resolved within two completebilling cycles

24. Determine, for each type of open-end rescind-able loan being tested, that two copies of therescission notice are provided to each personwhose ownership interest is or will be subjectto the security interest and follow procedures11, 12, and 13 in the section ‘‘Closed-EndCredit.’’

Additional Variable-Rate Testing

25. Verify that when accounts were opened orloans were consummated, the loan contractterms were recorded correctly in the financialinstitution’s calculation systems (for example,its computer). Determine the accuracy of the



following recorded information:

a. Index value

b. Margin and method of calculating ratechanges

c. Rounding method

d. Adjustment caps (periodic and lifetime)

26. Using a sample of periodic disclosures foropen-end variable-rate accounts (for example,home equity accounts) and closed-end rate-change notices for adjustable-rate mortgageloans,

a. Compare the rate-change date and rate onthe credit obligation with the actual rate-change date and rate imposed.

b. Determine that the index disclosed andimposed is based on the terms of thecontract. (Example: The weekly averageof 1-year Treasury constant maturities, asof 45 days before the change date.)(§§ 226.7(g) and 226.20(c)(2))

c. Determine that the new interest rate iscorrectly disclosed by adding the correctindex value with the margin stated in thenote, plus or minus any contractual frac-tional adjustment. (§§ 226.7(g) and 226.20(c)(1))

d. Determine that the new payment disclosed(section 226.20(c)(4)) was based on aninterest rate and loan balance in effect atleast 25 days before the payment changedate (consistent with the contract).(§ 226.20(c))

Certain Home Mortgage Transactions

27. Determine whether the financial institutionoriginates consumer credit transactions sub-ject to subpart E of Regulation Z, specifically,certain closed-end home mortgages (high-cost mortgages (section 226.32) and reversemortgages (section 226.33)).

28. Examiners may use the worksheet at the end ofthese examination procedures as an aid inidentifying and reviewing high-cost mortgages.

29. Review both high-cost and reverse mortgagesto ensure that

a. Required disclosures are provided to con-sumers in addition to, not in lieu of, thedisclosures contained in other subparts ofRegulation Z (§ 226.31(a))

b. Disclosures are clear and conspicuous, inwriting, and in a form that the consumer cankeep (§ 226.31(b))

c. Disclosures are furnished at least 3 busi-ness days prior to consummation of a

mortgage transaction covered by section226.32 or a closed-end reverse mortgagetransaction (or at least 3 business daysprior to the first transaction under anopen-end reverse mortgage) (§ 226.31(c))

d. Disclosures reflect the terms of the legalobligation between the parties (§ 226.31(d))

e. The institution abides by the disclosurerules for multiple consumers and multiplecreditors. If the obligation involves multipleconsumers, the disclosures may be pro-vided to any consumer who is primarilyliable on the obligation. However, forrescindable transactions, the disclosuresmust be provided to each consumer whohas the right to rescind. If the transactioninvolves more than one creditor, only onecreditor should provide the disclosures.(§ 226.31(e))

f. The APR is accurately calculated anddisclosed in accordance with the require-ments and within the tolerances allowed insection 226.22 (§ 226.31(g))

30. For high-cost mortgages (section 226.32),ensure that

a. In addition to other required disclosures,the creditor gives the following at least 3business days prior to consummation (seethe model disclosure in appendix H-16):

(1) Notice containing the prescribed lan-guage (§ 226.32(c)(1))

(2) Annual percentage rate (§226.32(c)(2))

(3) Amount of regular loan payment andamount of any balloon payment(§ 226.32(c)(3))

(4) For variable-rate loans, a statementthat the interest rate and monthlypayment may increase, and theamount of the single maximum monthlypayment allowed under the contract(§ 226.32(c)(4))

(5) For mortgage refinancings, the totalamount the consumer will borrow (theface amount), and if this amountincludes premiums or other chargesfor optional credit insurance or debt-cancellation coverage, that fact. Thisdisclosure is to be treated as accu-rate if the disclosed face amount iswithin $100 of the actual amount.(§ 226.32(c)(5))

(6) A new disclosure is required if subse-quent to providing the additional dis-closure but prior to consummation,there are changes in any terms thatmake the disclosures inaccurate. For



example, if a consumer purchasesoptional credit insurance and, as aresult, the monthly payment differsfrom the payment previously dis-closed, redisclosure is required and anew 3-day waiting period applies.(§ 226.31(c)(1)(i))

(7) If a creditor provides new disclosuresby telephone when the consumerinitiates a change in terms, then atconsummation (§ 226.31(c)(1)(ii))

• The creditor must provide new writ-ten disclosures and both partiesmust sign a statement that thesenew disclosures were provided bytelephone at least 3 days prior toconsummation.

(8) If a consumer waives the right to a3-day waiting period to meet a bonafide personal financial emergency, theconsumer’s waiver must be a datedwritten statement (not a preprintedform) describing the emergency andbearing the signature of all entitled tothe waiting period (a consumer maywaive only after receiving the requireddisclosures and prior to consumma-tion). (§ 26.31(c)(1)(iii))

b. High-cost mortgage transactions do notinclude any of the following terms:

(1) Balloon payment (if the term is lessthan 5 years, with exceptions)(§§ 226.32(d)(1)(i) and 226.32(d)(1)(ii))

(2) Negative amortization (§ 226.32(d)(2))

(3) Advance payments from the proceedsof more than two periodic payments(§ 226.32(d)(3))

(4) Increased interest rate after default(§ 226.32(d)(4))

(5) A rebate of interest, arising from aloan acceleration due to default, thatis calculated by a method less favor-able than the actuarial method(§ 226.32(d)(5))

(6) Prepayment penalties (but permittedin the first 5 years if certain conditionsare met) (§§ 226.32(d)(6) and226.32(d)(7))

(7) A due-on-demand clause permittingthe creditor to terminate the loan inadvance of maturity and acceleratethe balance, with certain exceptions(§ 226.32(d)(8))

c. The creditor is not engaged in the followingacts and practices for high-cost mortgages:

(1) Home improvement contracts—Paying

a contractor under a home improve-ment contract from the proceeds of amortgage unless certain conditionsare met (§ 226.34(a)(1))

(2) Notice to assignee—Selling or other-wise assigning a high-cost mortgagewithout furnishing the required state-ment to the purchaser or assignee(§ 226.34(a)(2))

(3) Refinancing within 1 year of extendingcredit—Within 1 year of making ahigh-cost mortgage loan, a creditormay not refinance any high-cost mort-gage loan to the same borrower intoanother high-cost mortgage loan thatis not in the borrower’s interest. Thisrestriction also applies to assigneesthat hold or service the high-costmortgage loan. Commentary to sec-tion 226.34(a)(3) has examples thatapply the refinancing prohibition andaddress ‘‘borrower’s interest.’’

(4) Consumer’s ability to repay—Engagingin a pattern or practice of extendinghigh-cost mortgages based on theconsumer’s collateral without regardto repayment ability, including theconsumer’s current and expectedincome, current obligations, and em-ployment. A violation is presumed ifthere is a pattern or practice of makingsuch mortgage loans without verifyingand documenting the consumer’srepayment ability.

A. A creditor may consider anyexpected income of the consumer,including

i. Regular salary or wages

ii. Gifts

iii. Expected retirement payments

iv. Income from self-employment

B. Equity income that would be real-ized from the collateral may not beconsidered.

C. Creditors may verify and docu-ment a consumer’s income andobligations through any reliablesource that provides the creditorwith a reasonable basis for believ-ing that there are sufficient funds tosupport the loan. Reliable sourcesinclude

i. Credit reports

ii. Tax return

iii. Pension statements

iv. Payment records for employ-



ment income

D. If a loan transaction includes adiscounted introductory rate, thecreditor must consider the consum-er’s ability to repay on the basis ofthe nondiscounted or fully indexedrate.

Note: Commentary to section226.34(a)(4) contains guidance onincome that may be considered, on‘‘pattern or practice,’’ and on ‘‘verify-ing and documenting’’ income andobligations.

31. Ensure that the creditor does not structure ahome-secured loan as an open-end plan(‘‘spurious open-end credit’’) to evade therequirements of Regulation Z. See staff com-mentary to section 226.34(b) for factors to beconsidered.

Administrative Enforcement

32. If there is noncompliance involving under-stated finance charges or understated APRssubject to reimbursement under the FFIECPolicy Guide on Reimbursement, continue withprocedure 32.

33. Document the date on which the administra-tive enforcement of the TILA policy statementwould apply for reimbursement purposesby determining the date of the precedingexamination.

34. If the noncompliance involves indirect (third-party paper) disclosure errors and affectedconsumers have not been reimbursed,

a. Prepare comments, discussing the need forimproved internal controls, to be included inthe report of examination.

b. Notify your supervisory office for follow upwith the regulator that has primary respon-sibility for the original creditor.

If the noncompliance involves direct credit,

c. Make an initial determination as to whetherthe violation is a pattern or practice.

d. Calculate the reimbursement for the loansor accounts in an expanded sample of theidentified population.

e. Estimate the total impact on the populationbased on the expanded sample.

f. Inform management that reimbursementmay be necessary under the law and theFFIEC policy guide, and discuss all sub-stantive facts, including the sample loansand calculations.

g. Inform management of the financial institu-tion’s options, under section 130 of the

TILA, for avoiding civil liability and of itsoption under the policy guide and section108(e)(6) of the TILA for avoiding a regula-tory agency’s order to reimburse affectedborrowers.



HIGH-COST-MORTGAGE (§ 226.32) WORKSHEET

Borrower’s name Loan number

COVERAGE Yes No

Is the loan secured by the consumer’s principal dwelling?

(§§ 226.2(a)(19) and 226.32(a)(1))

If the answer is No, STOP HERE

Is the loan for the following purpose?

1 Residential mortgage transaction (§ 226.2(a)(24))

2 Reverse mortgage transaction (§ 226.33)

3 Open-end credit plan (Subpart B)

(Note prohibition against structuring loans as open-end plansto evade sections 226.32−226.34(b))

If the answer is Yes in Box 1, 2, or 3, STOP HERE. If No, continue to Test 1.

TEST 1: CALCULATION OF APR

A Disclosed APR

B Treasury security yield of comparable maturity

Obtain the Treasury constant maturities yield from the Board’s H.15 statistical release,‘‘Selected Interest Rates’’ (on the Board’s web site (www.federalreserve.gov/releases/h15/data.htm), the ‘‘Business’’ links display daily yields). Use the yield that has thematurity most comparable to the loan term and is from the 15th day of the month thatimmediately precedes the month of the application. If the 15th is not a business day,use the yield for the business day immediately preceding the 15th. If the loan termis exactly halfway between two published security maturities, use the lower of thetwo yields. Note: Creditors may use the interest rates in the H.15 release or theactual auction results. See staff commentary to Regulation Z for further details.(§ 226.32(a)(1)(i))

C Treasury security yield of comparable maturity (from Box B)

Plus: 8 percentage points for first-lien loan or10 percentage points for subordinate-lien loan

Yes No

D Is Box A greater than Box C?

If Yes, the transaction is a high-cost mortgage. If No, continue to Test 2.



HIGH-COST MORTGAGE (§ 226.32) WORKSHEET—continued

TEST 2: CALCULATION OF POINTS AND FEES

STEP 1: Identify all charges paid by the consumer at or before loan closing

A Finance charges (§§ 226.4(a) and (b))(Interest, including per-diem interest, and time–price differential are excluded from these amounts.)

Fee

Loan points

Mortgage broker fee

Loan service fees

Required closing agent/third-party fees

Required credit insurance

Private mortgage insurance

Life-of-loan charges (flood, taxes, etc.)

Any other fees considered finance charges

Subtotal

B Certain non-finance charges under section 226.4(c)(7)

Include fees paid by consumers only if the amount of the fee is unreasonable, the creditor receivesdirect or indirect compensation from the charge, or the charge is paid to an affiliate of the bank.(See the example in section 226.32(b)(1)(ii) of the commentary for further explanation.)

Fee

Title examination

Title insurance

Property survey

Document preparation charge

Credit report

Appraisal

Fee for ‘‘initial’’ flood hazard determination

Pest inspection

Any other fees not considered finance charges

Subtotal

C Premiums or other charges for optional credit life, accident,health, or loss-of-income insurance or debt-cancellationcoverage Subtotal

D Total points and fees: Add subtotals for Boxes A, B, and C



HIGH-COST MORTGAGE (§ 226.32) WORKSHEET—continued

TEST 2—continued

STEP 2: Determine the total loan amount for cost calculation (§ 226.32(a)(1)(ii))

A Determine the amount financed (§ 226.18(b))

Principal loan amount

Plus: Other amounts financed by the lender (not already included in the principaland not part of the finance charge)

Less: Prepaid finance charges (§ 226.2(a)(23))

EQUALS: Amount financed

B Deduct costs included in the points and fees under sections 226.32(b)(1)(iii) and(iv) (Step 1, Box B and Box C) that are financed by the creditor

C Total loan amount (Step 2, Box A minus Box B)

STEP 3: Perform high-fee cost calculation

A 8 percent of the total loan amount (from Step 2, Box C)

B Annual adjustment amount (§ 226.32(a)(1)(ii))

1999 $4412000 $4512001 $4652002 $480

2003 $4882004 $4992005 $5102006 $528

(Use the dollar amount corresponding to the year of the loan’s origination.)

C Total points and fees (from Step 1, Box D)

Yes No

In Step 3, does Box C exceed the greater of Box A or Box B?

If Yes, the transaction is a high-cost mortgage. If No, the transaction is not a high-cost mortgageunder Test 2.



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