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Statement on Subprime Mortgage Lending

Bulletin
Monday, December 10, 2007
Banking Bulletin #32
File attachments: 
http://www.dfr.vermont.gov/sites/default/files/BUL-B-32.pdf

BANKING BULLETIN #32

December 10, 2007

STATEMENT ON SUBPRIME MORTGAGE LENDING

 

I. INTRODUCTION AND BACKGROUND

On June 29, 2007, the Federal Deposit Insurance Corporation (FDIC), the Board of Governors of the Federal Reserve System (Board), the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS), and the National Credit Union Administration (NCUA) (collectively, the Agencies) publicly released the Statement on Subprime Mortgage Lending (Subprime Statement).

The Agencies developed the Subprime Statement to address emerging risks associated with certain subprime mortgage products and lending practices. In particular, the Agencies are concerned about the growing use of adjustable rate mortgage (ARM) products1 that provide low initial payments based on a fixed introductory rate that expires after a short period, and then adjusts to a variable rate plus a margin for the remaining term of the loan. These products could result in payment shock to the borrower. The Agencies are concerned that these products, typically offered to subprime borrowers, present heightened risks to lenders and borrowers. Often, these products have additional characteristics that increase risk. These include qualifying borrowers based on limited or no documentation of income or imposing substantial prepayment penalties or prepayment penalty periods that extend beyond the initial fixed interest rate period. In addition, borrowers may not be adequately informed of product features and risks, including their responsibility to pay taxes and insurance, which might be separate from their mortgage payments.

These products originally were extended to customers primarily as a temporary credit accommodation in anticipation of early sale of the property or in expectation of future earnings growth. However, these loans have more recently been offered to subprime borrowers as “credit repair” or “affordability” products. The Agencies are concerned that many subprime borrowers may not have sufficient financial capacity to service a higher debt load, especially if they were qualified based on a low introductory payment. The Agencies are also concerned that subprime borrowers may not fully understand the risks and consequences of obtaining this type of ARM loan. Borrowers who obtain these loans may face unaffordable monthly payments after the initial rate adjustment, difficulty in paying real estate taxes and insurance that were not escrowed, or expensive refinancing fees, any of which could cause borrowers to default and potentially lose their homes.

Like the interagency Guidance on Nontraditional Mortgage Product Risks that was published in the Federal Register on October 4, 2006 (Volume 71, Number 192, Page 58609-58618), the interagency Subprime Statement applies to all banks and their subsidiaries, bank holding companies and their nonbank subsidiaries, savings associations and their subsidiaries, savings and loan holding companies and their subsidiaries, and credit unions.

Recognizing that the interagency Subprime Statement does not apply to subprime loan originations of all independent mortgage lenders and mortgage brokers (hereafter referred to as providers), on June 29, 2007 the Conference of State Bank Supervisors (CSBS), the American Association of Residential Mortgage Regulators (AARMR), and the National Association of Consumer Credit Administrators (NACCA)2 announced their intent to develop a parallel statement.

The Subprime Statement identifies many important standards for subprime lending. For instance, the Subprime Statement encourages depository institutions to consider a borrower’s housing-related expenses in the course of determining a borrower’s ability to repay the subprime mortgage loan. However, the Agencies did not explicitly encourage the consideration of total monthly debt obligations. Rather than create confusion or adopt a higher standard, CSBS, AARMR, NACCA, and the Vermont Department of Banking, Insurance, Securities and Health Care Administration (BISHCA) have determined to mirror the interagency statement.

In order to promote consistent application across the states, AARMR and CSBS are developing Model Examination Guidelines (MEGs) to implement the 2006 Guidance on Nontraditional Mortgage Product Risks (NTM Guidance) and the following Statement on Subprime Mortgage Lending. These guidelines are being developed as examination standards to assist state regulators in determining proper compliance with the NTM Guidance and the Subprime Statement. The MEGs will also be published as a public document to guide providers and their auditors in reviewing transactions covered by the NTM Guidance and the Subprime Statement. BISHCA is reviewing the MEGs and may incorporate all or a portion of the MEGs into its examination process.

The following statement will assist BISHCA in promoting consistent regulation in the mortgage market and will clarify how providers can offer subprime loans in a safe and sound manner that clearly discloses the risks that borrowers may assume.

In order to maintain regulatory consistency, this statement substantially mirrors the interagency Subprime Statement, except for the removal of sections not applicable to non-depository institutions.

II. STATEMENT ON SUBPRIME MORTGAGE LENDING

This Statement on Subprime Mortgage Lending (Subprime Statement) was developed to address emerging issues and questions relating to subprime mortgage lending practices. The term “subprime” refers to the credit characteristics of individual borrowers. Subprime borrowers typically have weakened credit histories that include payment delinquencies, and possibly more severe problems such as charge-offs, judgments, and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, debt-to-income (DTI) ratios, or other criteria that may encompass borrowers with incomplete credit histories. “Subprime loans” are loans to borrowers displaying one or more of these characteristics at the time of origination or purchase. Such loans have a higher risk of default than loans to prime borrowers. Generally subprime borrowers will display a range of credit risk characteristics that may include one or more of the following:

· Two or more 30-day delinquencies in the last 12 months, or one or more 60-day delinquencies in the last 24 months;

· Judgment, foreclosure, repossession, or charge-off in the prior 24 months;

· Bankruptcy in the last 5 years;

· Relatively high default probability as evidenced by, for example, a credit bureau risk score (FICO) of 660 or below (depending on the product/collateral), or other bureau or proprietary scores with an equivalent default probability likelihood; and/or

· Debt service-to-income ratio of 50% or greater, or otherwise limited ability to cover family living expenses after deducting total monthly debt-service requirements from monthly income.

This list is illustrative rather than exhaustive and is not meant to define specific parameters for all subprime borrowers. Additionally, this definition may not match all market or institution specific subprime definitions, but should be viewed as a starting point from which BISHCA will expand examination efforts.3

CSBS, AARMR, NACCA, and BISHCA are concerned that borrowers may not fully understand the risks and consequences of obtaining products that can cause payment shock.4 In particular, CSBS, AARMR, NACCA and BISHCA are concerned with certain adjustable-rate mortgage (ARM) products typically 5 offered to subprime borrowers that have one or more of the following characteristics:

· Low initial payments based on a fixed introductory rate that expires after a short period and then adjusts to a variable index rate plus a margin for the remaining term of the loan;6

· Very high or no limits on how much the payment amount or the interest rate may increase (“payment or rate caps”) on reset dates;

· Limited or no documentation of borrowers’ income;

· Product features likely to result in frequent refinancing to maintain an affordable monthly payment; and/or

· Substantial prepayment penalties and/or prepayment penalties that extend beyond the initial fixed interest rate period. 7

Products with one or more of these features present substantial risks to both consumers and providers. These risks are increased if borrowers are not adequately informed of the product features and risks, including their responsibility for paying real estate taxes and insurance, which may be separate from their monthly mortgage payments. The consequences to borrowers could include: being unable to afford the monthly payments after the initial rate adjustment because of payment shock; experiencing difficulty in paying real estate taxes and insurance that were not escrowed; incurring expensive refinancing fees, frequently due to closing costs and prepayment penalties, especially if the prepayment penalty period extends beyond the rate adjustment date; and losing their homes. Consequences to providers may include unwarranted levels of credit, legal, compliance, reputation, and liquidity risks due to the elevated risks inherent in these products.

CSBS, AARMR, NACCA, and BISHCA note that many of these concerns are addressed in existing interagency guidance.8 CSBS, AARMR, NACCA, and BISHCA recognize that these guidance documents may not apply to state-supervised providers. However, CSBS, AARMR, NACCA, and BISHCA believe these guidelines provide sound principles for mortgage lending as a reference for state-supervised providers.

While the 2006 CSBS-AARMR Guidance on Nontraditional Mortgage Product Risks (NTM Guidance) and BISHCA Baking Bulletin # 29 may not explicitly pertain to products with the characteristics addressed in this Statement, it outlines prudent underwriting and consumer protection principles that providers also should consider with regard to subprime mortgage lending. This Statement reiterates many of the principles addressed in existing guidance relating to prudent risk management practices and consumer protection laws. 9

Risk Management Practices

Predatory Lending Considerations

Subprime lending is not synonymous with predatory lending, and loans with features described above are not necessarily predatory in nature. However, providers should ensure that they do not engage in the types of predatory lending practices discussed in the Expanded Subprime Guidance. Typically, predatory lending involves at least one of the following elements:

· Making loans based predominantly on the foreclosure or liquidation value of a borrower’s collateral rather than on the borrower’s ability to repay the mortgage according to its terms;

· Inducing a borrower to repeatedly refinance a loan in order to charge high points and fees each time the loan is refinanced (“loan flipping”); or

· Engaging in fraud or deception to conceal the true nature of the mortgage loan obligation, or ancillary products, from an unsuspecting or unsophisticated borrower.

Loans to borrowers who do not demonstrate the capacity to repay the loan, as structured, from sources other than the collateral pledged may lack sufficient consumer protection safeguards and are generally considered unsafe and unsound. Examiners are instructed to criticize such lending practices in the Report of Examination. Further, examiners are instructed to refer any loans with the aforementioned characteristics for additional review.

Providers offering mortgage loans such as these face an elevated risk that their conduct will violate Section 5 of the Federal Trade Commission Act (FTC Act) or other state laws, which prohibit unfair or deceptive acts or practices. Additionally, providers face an elevated risk of violating state law prohibiting unconscionable conduct and conduct that takes advantage of a borrower's lack of bargaining power or lack of understanding of the terms or consequences of the transaction.

Underwriting Standards

The 1993 interagency Real Estate Guidelines provide underwriting standards for all real estate loans and state that prudently underwritten real estate loans should reflect all relevant credit factors, including the capacity of the borrower to adequately service the debt. Providers should refer to the 2006 NTM Guidance and BISHCA Banking Bulletin #29, which details similar criteria for qualifying borrowers for products that may result in payment shock.

Prudent qualifying standards recognize the potential effect of payment shock in evaluating a borrower’s ability to service debt. A provider’s analysis of a borrower’s repayment capacity should include an evaluation of the borrower’s ability to repay the debt by its final maturity at the fully indexed rate,10 assuming a fully amortizing repayment schedule.11

One widely accepted approach in the mortgage industry is to quantify a borrower’s repayment capacity by a debt-to-income (DTI) ratio. A provider’s DTI analysis should include, among other things, an assessment of a borrower’s total monthly housing-related payments (e.g., principal, interest, taxes, and insurance, or what is commonly known as PITI) as a percentage of gross monthly income.12

This assessment is particularly important if the provider relies upon reduced documentation or allows other forms of risk layering. Risk-layering features in a subprime mortgage loan may significantly increase the risks to both the provider and the borrower. Therefore, a provider should have clear policies governing the use of risk-layering features, such as reduced documentation loans or simultaneous second lien mortgages. When risk-layering features are combined with a mortgage loan, a provider should demonstrate the existence of effective mitigating factors that support the underwriting decision and the borrower’s repayment capacity.

Recognizing that loans to subprime borrowers present elevated credit risk, providers should verify and document the borrower’s income (both source and amount), assets and liabilities. Stated income and reduced documentation loans to subprime borrowers should be accepted only if there are mitigating factors that clearly minimize the need for direct verification of repayment capacity. Reliance on such factors also should be documented. Typically, mitigating factors arise when a borrower with favorable payment performance seeks to refinance an existing mortgage with a new loan of a similar size and with similar terms, and the borrower’s financial condition has not deteriorated. Other mitigating factors might include situations where a borrower has substantial liquid reserves or assets that demonstrate repayment capacity and can be verified and documented by the provider. However, a higher interest rate is not considered an acceptable mitigating factor.

Workout Arrangements

The June 26, 2007 CSBS-AARMR Consumer Alert: Mortgage Payment Increase, urged borrowers to:

· Seek information on the characteristics of their mortgage;

· Budget accordingly for the scheduled “recast” or “reset” of their loan’s interest rate;

· Contact their provider for assistance, if needed; and

· Inquire about possible solutions if payments are past due.

The June 26, 2007 CSBS-AARMR Industry Letter: Mortgage Payment Increase encouraged providers to reach out to consumers to provide information on their loans and to work with consumers to avoid foreclosure.13 Prudent workout arrangements that are consistent with safe and sound lending practices are generally in the long-term best interest of both the provider and the borrower.

Providers should follow prudent underwriting practices in determining whether to consider a loan modification or a workout arrangement.14 Such arrangements can vary widely based on the borrower’s financial capacity. For example, a provider might consider modifying loan terms, including converting loans with variable rates into fixed-rate products to provide financially stressed borrowers with predictable payment requirements.

BISHCA will not criticize providers that pursue reasonable workout arrangements with borrowers. Further, existing supervisory guidance and applicable accounting standards do not require providers to immediately foreclose on the collateral underlying a loan when the borrower exhibits repayment difficulties. For those providers that portfolio loans, they should identify and report credit risk, maintain an adequate allowance for loan losses, and recognize credit losses in a timely manner.

Consumer Protection Principles

Fundamental consumer protection principles relevant to the underwriting and marketing of mortgage loans include:

· Approving loans based on the borrower’s ability to repay the loan according to its terms; and

· Providing information that enables consumers to understand material terms, costs, and risks of loan products at a time that will help the consumer select a product.

Communications with consumers, including advertisements, oral statements, and promotional materials, should provide clear and balanced information about the relative benefits and risks of the products. This information should be provided in a timely manner to assist consumers in the product selection process, not just upon submission of an application or at consummation of the loan. Providers should not use such communications to steer consumers to these products to the exclusion of other products offered by the provider for which the consumer may qualify.

Information provided to consumers should clearly explain the risk of payment shock and the ramifications of prepayment penalties, balloon payments, and the lack of escrow for taxes and insurance, as necessary. The applicability of prepayment penalties should not exceed the initial reset period. In general, borrowers should be provided a reasonable period of time (typically at least 60 days prior to the reset date) to refinance without penalty.15

Similarly, if borrowers do not understand that their monthly mortgage payments do not include taxes and insurance, and they have not budgeted for these essential homeownership expenses, they may be faced with the need for significant additional funds on short notice.16[16] Therefore, mortgage product descriptions and advertisements should provide clear, detailed information about the costs, terms, features, and risks of the loan to the borrower. Consumers should be informed of:

  • Payment Shock . Potential payment increases, including how the new payment will be calculated when the introductory fixed rate expires.17
  • Prepayment Penalties . The existence of any prepayment penalty, how it will be calculated, and when it may be imposed. 18
  • Balloon Payments . The existence of any balloon payment.
  • Cost of Reduced Documentation Loans . Whether there is a pricing premium attached to a reduced documentation or stated income loan program.
  • Responsibility for Taxes and Insurance . The requirement to make payments for real estate taxes and insurance in addition to their loan payments, if not escrowed, and the fact that taxes and insurance costs can be substantial.

Control Systems

Providers should develop strong control systems to monitor whether actual practices are consistent with their policies and procedures. Systems should address compliance and consumer information concerns, as well as safety and soundness, and encompass both institution personnel and applicable third parties, such as mortgage brokers or correspondents.

Important controls include establishing appropriate criteria for hiring and training loan personnel, entering into and maintaining relationships with third parties, and conducting initial and ongoing due diligence on third parties. Providers also should design compensation programs that avoid providing incentives for originations inconsistent with sound underwriting and consumer protection principles, and that do not result in the steering of consumers to these products to the exclusion of other products for which the consumer may qualify.

Providers should have procedures and systems in place to monitor compliance with applicable laws and regulations, third-party agreements and internal policies. A provider’s controls also should include appropriate corrective actions in the event of failure to comply with applicable laws, regulations, third-party agreements or internal policies. In addition, providers should initiate procedures to review consumer complaints to identify potential compliance problems or other negative trends.

Supervisory Review

BISHCA will carefully review risk management and consumer compliance processes, policies, and procedures. BISHCA will take action against providers that exhibit predatory lending practices, violate consumer protection laws or fair lending laws, engage in unfair or deceptive acts or practices, or otherwise engage in unsafe or unsound lending practices. Furthermore, providers that fail to adhere to the standards set forth in this Bulletin face an elevated risk of violating state law that prohibits unconscionable conduct or conduct that takes advantage of the borrower's lack of bargaining power or lack of understanding of the terms or consequences of the transaction.



1 For example, ARMs known as “2/28” loans feature a fixed rate for two years and then adjust to a variable rate for the remaining 28 years. The spread between the initial fixed interest rate and the fully indexed interest rate in effect at loan origination typically ranges from 300 to 600 basis points.

2 The Vermont Department of Banking, Insurance, Securities and Health Care Administration is a member of CSBS, AARMR, and NACCA. CSBS, AARMR and NACCA strongly support the purpose of the Subprime Statement and are committed to promoting uniform application of the Statement’s origination and underwriting standards for all mortgage brokers and lenders. CSBS, AARMR, and NACCA support additional efforts to enhance subprime lending oversight. CSBS, AARMR, and NACCA will continue to work with the Agencies and with their state members to improve industry-wide mortgage lending practices.

3 “Subprime” and “subprime loans” are defined by the 2001 Interagency Expanded Guidance for Subprime Lending Programs. To promote consistency and uniformity, CSBS, AARMR, NACCA, and BISHCA support these definitions for the purposes of this bulletin.

4 Payment shock refers to a significant increase in the amount of the monthly payment that generally occurs as the interest rate adjusts to a fully indexed basis. Products with a wide spread between the initial interest rate and the fully indexed rate that do not have payment caps or periodic interest rate caps, or that contain very high caps, can produce significant payment shock.

5 As noted by Agencies in the final statement, the Subprime Statement focuses on subprime borrowers; however, the statement applies to ARM products that have one or more characteristics that can cause payment shock. Providers should look to the principles of this statement when such ARM products are offered to non-subprime borrowers.

6 For example, ARMs known as “2/28” loans feature a fixed rate for two years and then adjust to a variable rate for the remaining 28 years. The spread between the initial fixed interest rate and the fully indexed interest rate in effect at loan origination typically ranges from 300 to 600 basis points.

7 Although this bulletin lists prepayment penalties as a characteristic of subprime loans that is of national concern, prepayment penalties are prohibited under Vermont law. 9 V.S.A. §45; 8 V.S.A. §2232a.

8 The most prominent are the 1993 Interagency Guidelines for Real Estate Lending (Real Estate Guidelines), the 1999Interagency Guidance on Subprime Lending, and the 2001 Expanded Guidance for Subprime Lending Programs (Expanded Subprime Guidance).

9 As with the Interagency Guidance on Nontraditional Mortgage Product Risks, 71 FR 58609 (October 4, 2006), the interagency Subprime Statement applies to all banks and their subsidiaries, bank holding companies and their nonbank subsidiaries, savings associations and their subsidiaries, savings and loan holding companies and their subsidiaries, and credit unions. This statement, developed by CSBS, AARMR, and NACCA, is applicable to all state-supervised mortgage providers.

10 The fully indexed rate equals the index rate prevailing at origination plus the margin to be added to it after the expiration of an introductory interest rate. For example, assume that a loan with an initial fixed rate of 7% will reset to the six-month London Interbank Offered Rate (LIBOR) plus a margin of 6%. If the six-month LIBOR rate equals 5.5%, providers should qualify the borrower at 11.5% (5.5% + 6%), regardless of any interest rate caps that limit how quickly the fully indexed rate may be reached.

11 The fully amortizing payment schedule should be based on the term of the loan. For example, the amortizing payment for a “2/28” loan would be calculated based on a 30-year amortization schedule. For balloon mortgages that contain a borrower option for an extended amortization period, the fully amortizing payment schedule can be based on the full term the borrower may choose.

12 A prudent practice used by the industry is to include a borrower’s total monthly debt obligations as a percentage of gross monthly income in the DTI analysis.

13 The CSBS-AARMR Consumer Alert and Industry Letter can be found at the CSBS web site: http://www.csbs.org/Content/NavigationMenu/RegulatoryAffairs/MortgagePolicy/RecastStatements/Recast_Statements.htm .

14 For those providers that portfolio loans, they may need to account for workout arrangements as troubled debt restructurings and should follow generally accepted accounting principles in accounting for these transactions.

15 As noted in footnote 7, prepayment penalties are not permitted in Vermont.

16 Providers generally can address these concerns most directly by requiring borrowers to escrow funds for real estate taxes and insurance.

17 To illustrate: a borrower earning $42,000 per year obtains a $200,000 “2/28” mortgage loan. The loan’s two-year introductory fixed interest rate of 7% requires a principal and interest payment of $1,331. Escrowing $200 per month for taxes and insurance results in a total monthly payment of $1,531 ($1,331 + $200), representing a 44% DTI ratio. A fully indexed interest rate of 11.5% (based on a six-month LIBOR index rate of 5.5% plus a 6% margin) would cause the borrower’s principal and interest payment to increase to $1,956. The adjusted total monthly payment of $2,156 ($1,956 + $200 for taxes and insurance) represents a 41% increase in the payment amount and results in a 62% DTI ratio.

18 As noted in footnote 7, prepayment penalties are not permitted in Vermont.

Property Insurance for Prospective Borrowers

Bulletin
Monday, August 27, 2007
Banking Bulletin #31
File attachments: 
http://www.dfr.vermont.gov/sites/default/files/BUL-B-31.pdf

BANKING BULLETIN # 31

August 27, 2007

PROPERTY INSURANCE FOR PROSPECTIVE BORROWERS

 

This bulletin is provided to restate a January 18, 1989 Memorandum originally issued by Commissioner Gretchen Babcock to the Vermont Bankers Association.

The Banking Division is aware that some mortgage lenders have requested borrowers to over insure their property in order to obtain a real estate loan. Apparently, some institutions are asking borrowers to insure the full amount of the mortgage loan even though the value of the structure(s) actually insured is considerably less due to a high land valuation.

The insurance industry does not permit individuals or businesses to obtain property insurance above the value of the property subject to loss. To do so would create the potential for unjust and possibly fraudulent insurance recoveries.

Thus, an insurance policy will not insure or pay for damages that do not exist and the face value of an insurance policy is not necessarily the amount that will be paid in the event of a loss. The value of underlying land is almost never subject to loss.

Accordingly, this bulletin is to advise mortgage lenders that borrowers cannot be required to obtain property insurance beyond the value of the structures and other improvements actually insured.

Guidance To Vermont Licensees On Nontraditional Mortgage Products

Bulletin
Monday, November 27, 2006
Banking Bulletin #29
File attachments: 
http://www.dfr.vermont.gov/sites/default/files/BUL-B-29.pdf

BANKING BULLETIN # 29

November 27, 2006

GUIDANCE TO VERMONT LICENSEES ON

NONTRADITIONAL MORTGAGE PRODUCTS

I. INTRODUCTION

On October 4, 2006, the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Board), the Federal Deposit Insurance Corporation (FDIC), the Office of Thrift Supervision (OTS), and the National Credit Union Administration (NCUA) (collectively, the Agencies) published final guidance in the Federal Register (Volume 71, Number 192, Page 58609-58618) on nontraditional mortgage product risks (“interagency guidance”). The interagency guidance applies to all banks and their subsidiaries, bank holding companies and their nonbank subsidiaries, savings associations and their subsidiaries, savings and loan holding companies and their subsidiaries, and credit unions.

Recognizing that the interagency guidance does not cover a majority of loan originations, on June 7, 2006 the Conference of State Bank Supervisors (CSBS) and the American Association of Residential Mortgage Regulators (AARMR) announced their intent to develop parallel guidance. Both CSBS and AARMR strongly support the purpose of the guidance adopted by the Agencies and are committed to promote uniform application of its consumer protections for all borrowers.

The following guidance covers licensees, such as mortgage brokers, licensed lenders, and mortgage companies (referred to as “providers”) and promotes consistent regulation in the mortgage market and clarifies how providers can offer nontraditional mortgage products in a way that clearly discloses the risks that borrowers may assume.

In order to maintain regulatory consistency, this guidance substantially mirrors the interagency guidance, except for the deletion of sections not applicable to non-depository institutions.

 

II. BACKGROUND

The Agencies developed their guidance to address risks associated with the growing use of mortgage products that allow borrowers to defer payment of principal and, sometimes, interest. These products, referred to variously as “nontraditional,” “alternative,” or “exotic” mortgage loans (hereinafter referred to as nontraditional mortgage loans), include “interest-only” mortgages and “payment option” adjustable-rate mortgages. These products allow borrowers to exchange lower payments during an initial period for higher payments during a later amortization period.

While similar products have been available for many years, the number of institutions and providers offering them has expanded rapidly. At the same time, these products are offered to a wider spectrum of borrowers who may not otherwise qualify for more traditional mortgages. State and federal regulators are concerned that some borrowers may not fully understand the risks of these products. While many of these risks exist in other adjustable-rate mortgage products, the concern is elevated with nontraditional products because of the lack of principal amortization and potential for negative amortization. In addition, providers are increasingly combining these loans with other features that may compound risk. These features include simultaneous second-lien mortgages and the use of reduced documentation in evaluating an applicant’s creditworthiness.

III. GUIDANCE ON NONTRADITIONAL MORTGAGE PRODUCT RISKS

Residential mortgage lending has traditionally been a conservatively managed business with low delinquencies and losses and reasonably stable underwriting standards. In the past few years consumer demand has been growing, particularly in high priced real estate markets, for closed-end residential mortgage loan products that allow borrowers to defer repayment of principal and, sometimes, interest. These mortgage products, herein referred to as nontraditional mortgage loans, include such products as “interest-only” mortgages where a borrower pays no loan principal for the first few years of the loan and “payment option” adjustable-rate mortgages (ARMs) where a borrower has flexible payment options with the potential for negative amortization.1

While some providers have offered nontraditional mortgages for many years with appropriate risk management, the market for these products and the number of providers offering them has expanded rapidly. Nontraditional mortgage loan products are now offered by more lenders to a wider spectrum of borrowers who may not otherwise qualify for more traditional mortgage loans and may not fully understand the associated risks.

Many of these nontraditional mortgage loans are underwritten with less stringent income and asset verification requirements (“reduced documentation”) and are increasingly combined with simultaneous second-lien loans.2Such risk layering, combined with the broader marketing of nontraditional mortgage loans, exposes providers to increased risk relative to traditional mortgage loans.

Given the potential for heightened risk levels, management should carefully consider and appropriately mitigate exposures created by these loans. To manage the risks associated with nontraditional mortgage loans, management should:

· Ensure that loan terms and underwriting standards are consistent with prudent lending practices, including consideration of a borrower’s repayment capacity; and

· Ensure that consumers have sufficient information to clearly understand loan terms and associated risks prior to making a product choice.

The Vermont Department of Banking, Insurance, Securities and Health Care Administration (the "Department") expects providers to effectively assess and manage the risks associated with nontraditional mortgage loan products.

Providers should use this guidance to ensure that risk management practices adequately address these risks. The Department will carefully scrutinize risk management processes, policies, and procedures in this area. Providers that do not adequately manage these risks will be asked to take remedial action.

The focus of this guidance is on the higher risk elements of certain nontraditional mortgage products, not the product type itself. Providers with sound underwriting and adequate risk management will not be subject to criticism merely for offering such products.

Loan Terms and Underwriting Standards

When a provider offers nontraditional mortgage loan products, underwriting standards should address the effect of a substantial payment increase on the borrower’s capacity to repay when loan amortization begins.

Central to prudent lending is the internal discipline to maintain sound loan terms and underwriting standards despite competitive pressures. Providers are strongly cautioned against ceding underwriting standards to third parties that have different business objectives, risk tolerances, and core competencies. Loan terms should be based on a disciplined analysis of potential exposures and compensating factors to ensure risk levels remain manageable.

Qualifying Borrowers —Payments on nontraditional loans can increase significantly when the loans begin to amortize. Commonly referred to as payment shock, this increase is of particular concern for payment option ARMs where the borrower makes minimum payments that may result in negative amortization. Some providers manage the potential for excessive negative amortization and payment shock by structuring the initial terms to limit the spread between the introductory interest rate and the fully indexed rate. Nevertheless, a provider’s qualifying standards should recognize the potential impact of payment shock, especially for borrowers with high loan-to-value (LTV) ratios, high debt-to-income (DTI) ratios, and low credit scores. Recognizing that a provider’s underwriting criteria are based on multiple factors, a provider should consider these factors jointly in the qualification process and may develop a range of reasonable tolerances for each factor. However, the criteria should be based upon prudent and appropriate underwriting standards, considering both the borrower’s characteristics and the product’s attributes.

For all nontraditional mortgage loan products, a provider’s analysis of a borrower’s repayment capacity should include an evaluation of their ability to repay the debt by final maturity at the fully indexed rate,3 assuming a fully amortizing repayment schedule.4 In addition, for products that permit negative amortization, the repayment analysis should be based upon the initial loan amount plus any balance increase that may accrue from the negative amortization provision.5

Furthermore, the analysis of repayment capacity should avoid over-reliance on credit scores as a substitute for income verification in the underwriting process. The higher a loan’s credit risk, either from loan features or borrower characteristics, the more important it is to verify the borrower’s income, assets, and outstanding liabilities.

Collateral-Dependent Loans —Providers should avoid the use of loan terms and underwriting practices that may heighten the need for a borrower to rely on the sale or refinancing of the property once amortization begins. Loans to individuals who do not demonstrate the capacity to repay, as structured, from sources other than the collateral pledged may be unfair and abusive, may constitute unconscionable conduct, and may constitute conduct that takes advantage of a borrower's lack of bargaining power or lack of understanding of the terms or consequences of the transaction.6 Providers that originate collateral-dependent mortgage loans may be subject to criticism and corrective action.

Risk Layering —Providers that originate or purchase mortgage loans that combine nontraditional features, such as interest only loans with reduced documentation or a simultaneous second-lien loan, face increased risk. When features are layered, a provider should demonstrate that mitigating factors support the underwriting decision and the borrower’s repayment capacity. Mitigating factors could include higher credit scores, lower LTV and DTI ratios, significant liquid assets, mortgage insurance or other credit enhancements. While higher pricing is often used to address elevated risk levels, it does not replace the need for sound underwriting.

Reduced Documentation —Providers increasingly rely on reduced documentation, particularly unverified income, to qualify borrowers for nontraditional mortgage loans. Because these practices essentially substitute assumptions and unverified information for analysis of a borrower’s repayment capacity and general creditworthiness, they should be used with caution. As the level of credit risk increases, it is expected that a provider will more diligently verify and document a borrower’s income and debt reduction capacity. Clear policies should govern the use of reduced documentation. For example, stated income should be accepted only if there are mitigating factors that clearly minimize the need for direct verification of repayment capacity. For many borrowers, providers generally should be able to readily document income using recent W-2 statements, pay stubs, or tax returns.

Simultaneous Second-Lien Loans —Simultaneous second-lien loans reduce owner equity and increase credit risk. Historically, as combined loan-to-value ratios rise, so do defaults. A delinquent borrower with minimal or no equity in a property may have little incentive to work with a lender to bring the loan current and avoid foreclosure. In addition, second-lien home equity lines of credit (HELOCs) typically increase borrower exposure to increasing interest rates and monthly payment burdens. Loans with minimal or no owner equity generally should not have a payment structure that allows for delayed or negative amortization without other significant risk mitigating factors.

Introductory Interest Rates —Many providers offer introductory interest rates set well below the fully indexed rate as a marketing tool for payment option ARM products. When developing nontraditional mortgage product terms, a provider should consider the spread between the introductory rate and the fully indexed rate. Since initial and subsequent monthly payments are based on these low introductory rates, a wide initial spread means that borrowers are more likely to experience negative amortization, severe payment shock, and an earlier-than-scheduled recasting of monthly payments. Providers should minimize the likelihood of disruptive early recastings and extraordinary payment shock when setting introductory rates.

Lending to Subprime Borrowers —Providers of mortgage programs that target subprime borrowers through tailored marketing, underwriting standards, and risk selection should ensure that such programs do not feature terms that could become predatory or abusive. They should also recognize that risk-layering features in loans to subprime borrowers may significantly increase risks for both the provider and the borrower.

Non-Owner-Occupied Investor Loans —Borrowers financing non-owner-occupied investment properties should qualify for loans based on their ability to service the debt over the life of the loan. Loan terms should reflect an appropriate combined LTV ratio that considers the potential for negative amortization and maintains sufficient borrower equity over the life of the loan. Further, underwriting standards should require evidence that the borrower has sufficient cash reserves to service the loan, considering the possibility of extended periods of property vacancy and the variability of debt service requirements associated with nontraditional mortgage loan products.

Risk Management Practices

Providers should ensure that risk management practices keep pace with the growth of nontraditional mortgage products and changes in the market. Providers that originate or invest in nontraditional mortgage loans should adopt more robust risk management practices and manage these exposures in a thoughtful, systematic manner. To meet these expectations, providers should:

· Develop written policies that specify acceptable product attributes, production, sales and securitization practices, and risk management expectations; and

· Design enhanced performance measures and management reporting that provide early warning for increasing risk.

Policies —A provider’s policies for nontraditional mortgage lending activity should set acceptable levels of risk through its operating practices and policy exception tolerances. Policies should reflect appropriate limits on risk layering and should include risk management tools for risk mitigation purposes. Further, a provider should set growth and volume limits by loan type, with special attention for products and product combinations in need of heightened attention due to easing terms or rapid growth.

Concentrations —Providers with concentrations in nontraditional mortgage products should have well-developed monitoring systems and risk management practices. Further, providers should consider the effect of employee and third party incentive programs that could produce higher concentrations of nontraditional mortgage loans. Concentrations that are not effectively managed will be subject to elevated supervisory attention and potential examiner criticism to ensure timely remedial action.

Controls —A provider’s quality control, compliance, and audit procedures should focus on mortgage lending activities posing high risk. Controls to monitor compliance with underwriting standards and exceptions to those standards are especially important for nontraditional loan products. The quality control function should regularly review a sample of nontraditional mortgage loans from all origination channels and a representative sample of underwriters to confirm that policies are being followed. When control systems or operating practices are found deficient, business-line managers should be held accountable for correcting deficiencies in a timely manner.

Third-Party Originations —Providers often use third parties, such as mortgage brokers or correspondents, to originate nontraditional mortgage loans. Providers should have strong systems and controls in place for establishing and maintaining relationships with third parties, including procedures for performing due diligence. Oversight of third parties should involve monitoring the quality of originations so that they reflect the provider’s lending standards and compliance with applicable laws and regulations.

Monitoring procedures should track the quality of loans by both origination source and key borrower characteristics. This will help providers identify problems such as early payment defaults, incomplete documentation, and fraud. If appraisal, loan documentation, credit problems, or consumer complaints are discovered, the provider should take immediate action. Remedial action could include more thorough application reviews, more frequent re-underwriting, or even termination of the third-party relationship.

Secondary Market Activity —The sophistication of a provider’s secondary market risk management practices should be commensurate with the nature and volume of activity. Providers with significant secondary market activities should have comprehensive, formal strategies for managing risks. Contingency planning should include how the provider will respond to reduced demand in the secondary market.

While third-party loan sales can transfer a portion of the credit risk, a provider remains exposed to reputation risk when credit losses on sold mortgage loans or securitization transactions exceed expectations. As a result, a provider may determine that it is necessary to repurchase defaulted mortgages to protect its reputation and maintain access to the markets.

Consumer Protection Issues

While nontraditional mortgage loans provide flexibility for consumers, the Department is concerned that consumers may enter into these transactions without fully understanding the product terms. Nontraditional mortgage products have been advertised and promoted based on their affordability in the near term; that is, their lower initial monthly payments compared with traditional types of mortgages. In addition to apprising consumers of the benefits of nontraditional mortgage products, providers should take appropriate steps to alert consumers to the risks of these products, including the likelihood of increased future payment obligations. This information should be provided in a timely manner—before disclosures may be required under the Truth in Lending Act or other laws—to assist the consumer in the product selection process.

Concerns and Objectives —More than traditional ARMs, mortgage products such as payment option ARMs and interest-only mortgages can carry a significant risk of payment shock and negative amortization that may not be fully understood by consumers. For example, consumer payment obligations may increase substantially at the end of an interest-only period or upon the “recast” of a payment option ARM. The magnitude of these payment increases may be affected by factors such as the expiration of promotional interest rates, increases in the interest rate index, and negative amortization. Negative amortization also results in lower levels of home equity as compared to a traditional amortizing mortgage product. When borrowers go to sell or refinance the property, they may find that negative amortization has substantially reduced or eliminated their equity even when the property has appreciated. The concern that consumers may not fully understand these products is exacerbated by marketing and promotional practices that emphasize potential benefits without also providing clear and balanced information about material risks.

In light of these considerations, communications with consumers, including advertisements, oral statements, promotional materials, and monthly statements should provide clear and balanced information about the relative benefits and risks of these products, including the risk of payment shock and the risk of negative amortization. Clear, balanced, and timely communication to consumers of the risks of these products will provide consumers with useful information at crucial decision-making points, such as when they are shopping for loans or deciding which monthly payment amount to make. Such communication should help minimize potential consumer confusion and complaints, foster good customer relations, and reduce legal and other risks to the provider.

Legal Risks —Providers that offer nontraditional mortgage products must ensure that they do so in a manner that complies with all applicable laws and regulations. With respect to the disclosures and other information provided to consumers, applicable laws and regulations include the following:

  • Truth in Lending Act (TILA) and its implementing regulation, Regulation Z.
  • Section 5 of the Federal Trade Commission Act (FTC Act).

TILA and Regulation Z contain rules governing disclosures that providers must provide for closed-end mortgages in advertisements, with an application,7 before loan consummation, and when interest rates change. Section 5 of the FTC Act prohibits unfair or deceptive acts or practices.

Other federal laws, including the fair lending laws and the Real Estate Settlement Procedures Act (RESPA), also apply to these transactions. Moreover, the sale or securitization of a loan may not affect a provider’s potential liability for violations of TILA, RESPA, the FTC Act, or other laws in connection with its origination of the loan. State laws, including laws regarding unfair or deceptive acts or practices, unconscionable conduct, and conduct that takes advantage of a borrower's lack of bargaining power or lack of understanding of the terms or consequences of the transaction, may apply.

Recommended Practices

Recommended practices for addressing the risks raised by nontraditional mortgage products include the following:8

Communications with Consumers —When promoting or describing nontraditional mortgage products, providers should give consumers information that is designed to help them make informed decisions when selecting and using these products. Meeting this objective requires appropriate attention to the timing, content, and clarity of information presented to consumers. Thus, providers should give consumers information at a time that will help consumers select products and choose among payment options. For example, providers should offer clear and balanced product descriptions when a consumer is shopping for a mortgage—such as when the consumer makes an inquiry to the provider about a mortgage product and receives information about nontraditional products, or when marketing relating to nontraditional mortgage products is given by the provider to the consumer—not just upon the submission of an application or at consummation.9 The provision of such information would serve as an important supplement to the disclosures currently required under TILA and Regulation Z or other laws.10

  • Promotional Materials and Product Descriptions

Promotional Materials and other product descriptions should provide information about the costs, terms, features, and risks of nontraditional mortgages that can assist consumers in their product selection decisions, including information about the matters discussed below.

o Payment Shock. Providers should apprise consumers of potential increases in payment obligations for these products, including circumstances in which interest rates or negative amortization reach a contractual limit. For example, product descriptions could state the maximum monthly payment a consumer would be required to pay under a hypothetical loan example once amortizing payments are required and the interest rate and negative amortization caps have been reached.11 Such information also could describe when structural payment changes will occur (e.g., when introductory rates expire, or when amortizing payments are required), and what the new payment amount would be or how it would be calculated. As applicable, these descriptions could indicate that a higher payment may be required at other points in time due to factors such as negative amortization or increases in the interest rate index.

o Negative Amortization. When negative amortization is possible under the terms of a nontraditional mortgage product, consumers should be apprised of the potential for increasing principal balances and decreasing home equity, as well as other potential adverse consequences of negative amortization. For example, product descriptions should disclose the effect of negative amortization on loan balances and home equity, and could describe the potential consequences to the consumer of making minimum payments that cause the loan to negatively amortize. (One possible consequence is that it could be more difficult to refinance the loan or to obtain cash upon a sale of the home.)

o Prepayment Penalties. Providers may not charge a prepayment penalty in Vermont.

o Cost of Reduced Documentation Loans. If a provider offers both reduced and full documentation loan programs and there is a pricing premium attached to the reduced documentation program, consumers should be alerted to this fact.

  • Monthly Statements on Payment Option ARMs

Monthly statements that are provided to consumers on payment option ARMs should provide information that enables consumers to make informed payment choices, including an explanation of each payment option available and the impact of that choice on loan balances. For example, the monthly payment statement should contain an explanation, as applicable, next to the minimum payment amount that making this payment would result in an increase to the consumer’s outstanding loan balance. Payment statements also could provide the consumer’s current loan balance, what portion of the consumer’s previous payment was allocated to principal and to interest, and, if applicable, the amount by which the principal balance increased. Providers should avoid leading payment option ARM borrowers to select a non-amortizing or negatively amortizing payment (for example, through the format or content of monthly statements).

  • Practices to Avoid

Providers also should avoid practices that obscure significant risks to the consumer. For example, if a provider advertises or promotes a nontraditional mortgage by emphasizing the comparatively lower initial payments permitted for these loans, the provider also should give clear and comparably prominent information alerting the consumer to the risks. Such information should explain, as relevant, that these payment amounts will increase, that a balloon payment may be due, and that the loan balance will not decrease and may even increase due to the deferral of interest and/or principal payments. Similarly, providers should avoid promoting payment patterns that are structurally unlikely to occur.12 Such practices could raise legal and other risks for providers.

Providers also should avoid such practices as: giving consumers unwarranted assurances or predictions about the future direction of interest rates (and, consequently, the borrower’s future obligations); making one-sided representations about the cash savings or expanded buying power to be realized from nontraditional mortgage products in comparison with amortizing mortgages; suggesting that initial minimum payments in a payment option ARM will cover accrued interest (or principal and interest) charges; and making misleading claims that interest rates or payment obligations for these products are “fixed.”

Control Systems —Providers should develop and use strong control systems to monitor whether actual practices are consistent with their policies and procedures relating to nontraditional mortgage products. Providers should design control systems to address compliance and consumer information concerns as well as the risk management considerations discussed in this guidance. Lending personnel should be trained so that they are able to convey information to consumers about the product terms and risks in a timely, accurate, and balanced manner. As products evolve and new products are introduced, lending personnel should receive additional training, as necessary, to continue to be able to convey information to consumers in this manner. Lending personnel should be monitored to determine whether they are following these policies and procedures. Providers should review consumer complaints to identify potential compliance, reputation, and other risks. Attention should be paid to appropriate legal review and to using compensation programs that do not improperly encourage lending personnel to direct consumers to particular products.

With respect to nontraditional mortgage loans that a provider makes, purchases, or services using a third party, such as a mortgage broker, correspondent, or other intermediary, the provider should take appropriate steps to mitigate risks relating to compliance and consumer information concerns discussed in this guidance. These steps would ordinarily include, among other things, (1) conducting due diligence and establishing other criteria for entering into and maintaining relationships with such third parties, (2) establishing criteria for third-party compensation designed to avoid providing incentives for originations inconsistent with this guidance, (3) setting requirements for agreements with such third parties, (4) establishing procedures and systems to monitor compliance with applicable agreements, policies, and laws, and (5) implementing appropriate corrective actions in the event that the third party fails to comply with applicable agreements, policies, or laws.

Appendix

Interest-Only Mortgage Loan —A nontraditional mortgage on which, for a specified number of years (e.g., three or five years), the borrower is required to pay only the interest due on the loan during which time the rate may fluctuate or may be fixed. After the interest-only period, the rate may be fixed or fluctuate based on the prescribed index and payments include both principal and interest.

Payment Option ARM —A nontraditional mortgage that allows the borrower to choose from a number of different payment options. For example, each month, the borrower may choose a minimum payment option based on a “start” or introductory interest rate, an interest-only payment option based on the fully indexed interest rate, or a fully amortizing principal and interest payment option based on a 15-year or 30-year loan term, plus any required escrow payments. The minimum payment option can be less than the interest accruing on the loan, resulting in negative amortization. The interest-only option avoids negative amortization but does not provide for principal amortization. After a specified number of years, or if the loan reaches a certain negative amortization cap, the required monthly payment amount is recast to require payments that will fully amortize the outstanding balance over the remaining loan term.

Reduced Documentation —A loan feature that is commonly referred to as “low doc/no doc,” “no income/no asset,” “stated income” or “stated assets.” For mortgage loans with this feature, a provider sets reduced or minimal documentation standards to substantiate the borrower’s income and assets.

Simultaneous Second-Lien Loan —A lending arrangement where either a closed-end second-lien or a home equity line of credit (HELOC) is originated simultaneously with the first lien mortgage loan, typically in lieu of a higher down payment.



1 Interest-only and payment option ARMs are variations of conventional ARMs, hybrid ARMs, and fixed rate products. Refer to the Appendix for additional information on interest-only and payment option ARM loans. This guidance does not apply to reverse mortgages; home equity lines of credit (“HELOCs”), other than as discussed in the Simultaneous Second-Lien Loans section; or fully amortizing residential mortgage loan products.

2Refer to the Appendix for additional information on reduced documentation and simultaneous second-lien loans.

3 The fully indexed rate equals the index rate prevailing at origination plus the margin that will apply after the expiration of an introductory interest rate. The index rate is a published interest rate to which the interest rate on an ARM is tied. Some commonly used indices include the 1-Year Constant Maturity Treasury Rate (CMT), the 6-Month London Interbank Offered Rate (LIBOR), the 11th District Cost of Funds (COFI), and the Moving Treasury Average (MTA), a 12-month moving average of the monthly average yields of U.S. Treasury securities adjusted to a constant maturity of one year. The margin is the number of percentage points a lender adds to the index value to calculate the ARM interest rate at each adjustment period. In different interest rate scenarios, the fully indexed rate for an ARM loan based on a lagging index (e.g., MTA rate) may be significantly different from the rate on a comparable 30-year fixed-rate product. In these cases, a credible market rate should be used to qualify the borrower and determine repayment capacity.

4 The fully amortizing payment schedule should be based on the term of the loan. For example, the amortizing payment for a loan with a 5-year interest only period and a 30-year term would be calculated based on a 30-year amortization schedule. For balloon mortgages that contain a borrower option for an extended amortization period, the fully amortizing payment schedule can be based on the full term the borrower may choose.

5 The balance that may accrue from the negative amortization provision does not necessarily equate to the full negative amortization cap for a particular loan. The spread between the introductory or “teaser” rate and the accrual rate will determine whether or not a loan balance has the potential to reach the negative amortization cap before the end of the initial payment option period (usually five years). For example, a loan with a 115 percent negative amortization cap but a small spread between the introductory rate and the accrual rate may only reach a 109 percent maximum loan balance before the end of the initial payment option period, even if only minimum payments are made. The borrower could be qualified based on this lower maximum loan balance.

6 A loan will not be determined to be “collateral-dependent” solely through the use of reduced documentation.

7 These program disclosures apply to ARM products and must be provided at the time an application is provided or before the consumer pays a nonrefundable fee, whichever is earlier.

8 Providers also should review the recommendations relating to mortgage lending practices set forth in other supervisory guidance from their respective primary regulators, as applicable, including guidance on abusive lending practices.

9 Providers also should strive to: (1) focus on information important to consumer decision making; (2) highlight key information so that it will be noticed; (3) employ a user-friendly and readily navigable format for presenting the information; and (4) use plain language, with concrete and realistic examples. Comparative tables and information describing key features of available loan products, including reduced documentation programs, also may be useful for consumers considering the nontraditional mortgage products and other loan features described in this guidance.

10 Providers may not be able to incorporate all of the practices recommended in this guidance when advertising nontraditional mortgages through certain forms of media, such as radio, television, or billboards. Nevertheless, providers should provide clear and balanced information about the risks of these products in all forms of advertising.

11 Consumers also should be apprised of other material changes in payment obligations, such as balloon payments.

12 For example, marketing materials for payment option ARMs may promote low predictable payments until the recast date. Such marketing should be avoided in circumstances in which the minimum payments are so low that negative amortization caps would be reached and higher payment obligations would be triggered before the scheduled recast, even if interest rates remain constant.

Vermont Disclosure Relating To Amount To Be Financed In A Motor Vehicle Retail Installment Contract As Required By 9 V.S.A. Section 2355(f)(1)(J) And Relating to Department of Motor Vehicles Dealer's Vehicle Record Log Sheet

Bulletin
Sunday, June 25, 2006
Banking Bulletin #28
File attachments: 
http://www.dfr.vermont.gov/sites/default/files/Bulletin%20%2328%20Issued%20June%2026%202006_Corrected_05262015.pdf
http://www.dfr.vermont.gov/sites/default/files/BUL-B-28-2.pdf

BANKING BULLETIN #28

June 26, 2006

Vermont Disclosure Relating To Amount To Be Financed In A Motor Vehicle Retail Installment Contract As Required By 9 V.S.A. Section 2355(f)(1)(J)

And Relating To Department of Motor Vehicles Dealer’s Vehicle Record Log Sheet

This Bulletin is promulgated pursuant to Title 9 V.S.A. §2355(f)(1)(J), to specify the form of the Vermont Disclosure Relating To Amount To Be Financed In A Motor Vehicle Retail Installment Contract disclosure required by Section 2355(f)(1)(J) (“Disclosure Form”) and to respond to certain inquires regarding the calculation of “Cash Price” for purposes of the Disclosure Form and for purposes of the Department of Motor Vehicles (“DMV”) Dealer’s Vehicle Record log sheet.

Disclosure Form . The purpose of the Disclosure Form is to inform consumers, among other things, of the impact of adding negative equity to a motor vehicle retail installment contract. However, this Disclosure Form is required in connection with every motor vehicle retail installment contract regardless of whether or not the transaction involves negative equity.

Section 2355(f)(1)(J) requires a motor vehicle dealer to provide to the buyer(s) an unexecuted copy of the Disclosure Form prior to consummation of the transaction and requires that the Disclosure Form must be signed by the buyer(s) at the time the buyer(s) signs the motor vehicle retail installment contract. The disclosure must be on a form prescribed by the Commissioner on or before July 1, 2006 and as thereafter amended by the Commissioner of Banking, Insurance, Securities and Health Care Administration by rule.

The required form of disclosure is attached.

The Disclosure Form must be provided to buyers beginning July 1, 2006.

The Disclosure Form shall be printed on a single sheet of paper that is easily distinguished from all other disclosures, applications, or other documents presented to the buyer of the motor vehicle. A copy of the completed form must be given to the buyer(s). The form shall be printed in a size equal to at least 12 point type.

The Disclosure Form shall be attached to and shall become a part of the motor vehicle retail installment contract and must be assigned, sold, or transferred together with any assignment, sale, or transfer of the motor vehicle retail installment contract to which it was originally related.

Violations will be subject to remedies prescribed by law.

Calculation of Cash Price for Purposes of the Disclosure Form and the DMV Dealer’s Vehicle Record Log Sheet . The Department has received multiple inquiries about how to calculate the “cash price” for purposes of the Disclosure Form and for purposes of recording on the Department of Motor Vehicles “Dealer’s Vehicle Record” log sheet (TA-VD-125). In preparing this Bulletin the Department has learned that there are multiple forms of motor vehicle installment sales contracts in use in Vermont. Furthermore, based upon the particular form of motor vehicle installment sales contract used by the dealer, and depending upon the practices and procedures used by any particular dealer, the Department has become aware that the components of the “cash price” vary from dealer to dealer and from installment sales contract to installment sales contract.

In order to make the Disclosure Form meaningful to consumers and consistent with the intent of the legislature, the components of the “cash price” as it appears on the Disclosure Form and on the DMV Dealer’s Vehicle Record log sheet must be consistent regardless of the form of installment sales contract used by a dealer and regardless of any particular dealer practices and procedures in preparing the installment sales contract.

The “cash price” on the Disclosure Form and the DMV Dealer’s Vehicle Record log sheet is the minimum price of the vehicle including any accessories that have been attached to the vehicle and reductions for rebates (i.e., rebates, if any, are deducted in determining the cash price). The “cash price” does not include any service contracts, insurance, warranty contracts, debt cancellation agreements, or similar agreements or contracts, and as discussed below, does not include the purchase and use tax.

Purchase and Use Tax . The Department has received inquiries about whether or not the purchase and use tax due on the motor vehicle should be included as part of the “cash price” of the motor vehicle for purposes of Title 9, Vermont Statutes Annotated, Chapter 59, Motor Vehicle Retail Installment Sales Financing Act, for purposes of calculating the “cash price” for purposes of the Disclosure Form, and for purposes of calculating the “cash price” for the DMV Dealer’s Vehicle Record log sheet.

The purchase and use tax is not part of the “cash price” of a motor vehicle. The Department views the purchase and use tax as one of the “official fees” prescribed by law that must be paid in order for the seller to obtain a lien on the motor vehicle. See 9 V.S.A. §2351(7).

VERMONT DISCLOSURE

RELATING TO AMOUNT TO BE FINANCED I N A MOTOR VEHICLE RETAIL INSTALLMENT CONTRACT

Name of Buyer(s)

Date

Trade-in or Cancellation of Lease

Dealership allowance for trade-in: $ Amount owed on trade-in or lease

as of (date): $

EQUITY POSITIVE NEGATIVE**

** If the EQUITY is NEGATIVE, the amount the Dealer is offering you in trade for your vehicle is less than what is currently owed on your vehicle. You MAY be financing an amount in this transaction that exceeds the CASH PRICE of your new vehicle.

$

VERMONT DISCLOSURE

RELATING TO AMOUNT TO BE FINANCED

I N A MOTOR VEHICLE RETAIL INSTALLMENT CONTRACT

Name of Buyer(s)

Date

Trade-in or Cancellation of Lease

Dealership allowance for trade-in: $ Amount owed on trade-in or lease

as of (date): $

EQUITY POSITIVE NEGATIVE**

** If the EQUITY is NEGATIVE, the amount the Dealer is offering you in trade for your vehicle is less than what is currently owed on your vehicle. You MAY be financing an amount in this transaction that exceeds the CASH PRICE of your new vehicle.

$

 

 

 

TO: Motor Vehicle Dealerships and purchasers or assignees of Motor Vehicle Retail Installment Contracts

FROM: Department of Banking, Insurance, Securities and Health Care Administration (the “Department”)

DATE: June 26, 2006

RE: Implementation of Department Banking Bulletin #28 (“Bulletin #28”)

The Department is issuing Bulletin #28 which prescribes the form of disclosure required by Act 143 and by 9 V.S.A. §2355(f)(1)(J) (the “Disclosure Form”). Bulletin #28 also responds to inquiries received by the Department regarding calculation of the cash price on the new Disclosure Form and on the Department of Motor Vehicles (“DMV”) Dealer’s Vehicle Record log sheet.

Bulletin #28 also clarifies that the purchase and use tax due on a motor vehicle is an “official fee” and is not part of the “cash price” under Title 9 V.S.A. Chapter 59.

Purchase and Use Tax . The Department is aware that many dealerships utilize platform automation software that automatically completes the documentation based upon the form of motor vehicle retail installment contract used and the purchaser or assignee of the motor vehicle retail installment contract. The Department is also aware that in some instances the platform automation software includes the purchase and use tax in the “cash price” of the motor vehicle rather than in the “official fees.” The Department recognizes that some dealerships may not be able to modify their platform automation software to remove the purchase and use tax from the “cash price” and include it in “official fees” on the motor vehicle retail installment contract by July 1, 2006, consistent with Bulletin #28. The Department expects that by November 1, 2006 dealerships will implement the changes necessary to bring their platform automation system into compliance with Bulletin #28 and properly account for the purchase and use tax on the motor vehicle retail installment contract.

Disclosure Form and DMV Dealer’s Vehicle Record Log Sheet . Regardless of the platform automation software used by the dealership, however, the Department expects that the cash price that appears on the Disclosure Form and on DMV’s Dealer’s Vehicle Record log sheet will comply with Bulletin #28 beginning July 1, 2006.

Mortgage Broker Issues

Bulletin
Thursday, October 30, 2003
Banking Bulletin #26
File attachments: 
http://www.dfr.vermont.gov/sites/default/files/BUL-B-26.pdf

BANKING BULLETIN # 26

October 30, 2003

MORTGAGE BROKER ISSUES

This Bulletin is provided to clarify some issues that have surfaced recently as the Mortgage Broker business adjusts to the changes in the national lending market.

  1. Prior to taking any fee or collecting any charges, a Mortgage Broker licensed in Vermont must provide a prospective borrower with a Mortgage Broker Agreement. The Commissioner must approve the form and content of the Mortgage Broker Agreement in writing before the Mortgage Broker uses such Mortgage Broker Agreement. A Mortgage Broker may not use any form of Mortgage Broker Agreement other than the form of Mortgage Broker Agreement that has been approved by the Commissioner for use by that specific Mortgage Broker. Notwithstanding the foregoing, a Vermont licensed Mortgage Broker may use the pre-approved form of Mortgage Broker Agreement attached to Regulation B-96-1 without the Commissioner’s prior approval. 8 V.S.A. § 2219; Reg. B-96-1.
  1. The Mortgage Broker Agreement must be signed and dated by both the Mortgage Broker and prospective borrower and must disclose to the prospective borrower the amount of money that will be paid to the Mortgage Broker by the prospective borrower and by the lender (usually called a yield-spread-premium) for securing financing for a residential mortgage loan. Any amount collected by the Mortgage Broker from the prospective borrower or from the lender in excess of the amount disclosed in the Mortgage Broker Agreement is reimbursable to the borrower. 8 V.S.A. § 2219.
  1. A Mortgage Broker licensed in Vermont must place loans only with lenders licensed by the State of Vermont or with lenders specifically exempt from Vermont’s licensed lender statute, such as nationally or state chartered banks or federally or state chartered credit unions. Vermont law does not contemplate the exemption of subsidiaries of nationally or state chartered banks from the licensing requirements of Title 8, Chapter 73, Vermont Statutes Annotated (V.S.A.). Consequently, unlicensed subsidiaries of nationally or state chartered banks do not fit within any of the categories of lenders with which a Mortgage Broker may place a loan. A Mortgage Broker that places a loan with a lender that is not within the permitted categories of lenders is in violation of Title 8, Chapter 73 V.S.A. Additionally, ramifications are significant for any lender that should be licensed and knowingly and willfully lends in Vermont without a license. 8 V.S.A. §2217 (c).
  1. A Mortgage Broker licensed in Vermont may not provide a client with a rate lock, extend a rate lock, or accept discount points or any other funds from a prospective borrower for the purpose of buying down a rate of interest on a residential mortgage loan. Only a lender can offer a rate lock, accept discount points, or accept funds to reduce an interest rate (known as a buy-down). 8 V.S.A. § 2200 (8) and 8 V.S.A. §2217 (a).
  1. A Mortgage Broker licensed in Vermont may not accept and keep escrow waiver fees or any other fees that are associated with the terms and conditions of a loan and typically are charged by the lender on a residential mortgage loan. 8 V.S.A. § 2200 (8) and 8 V.S.A. §2217 (a).
  1. A Mortgage Broker who desires to authorize individuals to act on behalf of the Mortgage Broker must notify the Commissioner of the individuals who will be authorized to act on behalf of the Mortgage Broker and must receive the Commissioner’s approval before the individual may act under the Mortgage Broker’s license. It is a violation of Title 8, Chapter 73 V.S.A. and Regulation B-96-1 to engage in Mortgage Broker activities, either individually or as an authorized agent of a Mortgage Broker, without first obtaining the prior approval of the Commissioner. 8 V.S.A. § 2201; Regulation B-96-1 §2 (b).

Documentation Fees

Bulletin
Monday, October 21, 2002
Banking Bulletin #25
File attachments: 
http://www.dfr.vermont.gov/sites/default/files/BUL-B-25.pdf

BANKING BULLETIN NO. 25

October 21, 2002

DOCUMENTATION FEES

It has come to the Department’s attention that there is confusion about whether so-called “documentation fees” may be charged by automobile dealers.1 The Motor Vehicle Retail Installment Sales Financing Chapter (Title 9, Chapter 59) permits “documentation fees” only when the dealer complies with the conditions described in this bulletin. It should be carefully noted that, although dealers are permitted to charge documentation fees in compliance with this bulletin, dealers are not required to charge a documentation fee for goods and services related to the preparation of documents. Furthermore, this bulletin does not regulate the amount of any documentation fees the dealer may charge to the buyer.

1. Documentation fees. A motor vehicle dealer may charge for services related to the preparation and handling of documents only if the dealer charges all customers for these services and includes the amount of the documentation fee in the “cash price” of the motor vehicle.2 “Cash price” is defined in 9 V.S.A. § 2351 (6) and the required disclosure related to “cash price” is contained in 9 V.S.A. § 2355 (f)(1). When these fees are part of the “cash price,” they must be included in the computation of the motor vehicle purchase and use tax. Official fees, such as for registration and any required inspection of the vehicle, must be itemized as provided in 9 V.S.A. § 2355 (f)(5). Fees for the preparation of loan documents related to the financing of the motor vehicle cannot be included in the “cash price.” (See ¶ 2 below for discussion of charging borrowers for the cost of preparation of loan documents.)

The goods and services for which documentation fees may be charged under this bulletin are as follows:

  • the preparation of vehicle documents, including but not limited to, title and replacement title forms, odometer forms, registration forms, registration transfer forms, tax forms, lien release forms, Buyer’s Guides for used cars, As-Is and limited warranty forms, and warranty registration forms;
  • related assembly, copying, filing, mailing, courier and telephone services;
  • clerical services, such as verification and notarization;
  • related computer, software and programming fees;
  • performance of State inspection and related documentation;
  • purchase of forms, in-transit and 30 day temporary plates;
  • record keeping for the customer and the manufacturer with respect to warranties and maintenance of the vehicle and mailing of maintenance reminders to the customer

2. Fees for preparation of loan documents . A dealer that extends credit on the sale of the automobile may include the cost of preparation of loan documents in the finance charge (a finance charge is the cost of credit, including interest, to the borrower). Any amount included in this manner is subject to all applicable usury laws including truth-in- lending laws. See 9 V.S.A. § 41a. (Note: The term “documentation fees” does not include fees for the preparation of loan documents.)

Elizabeth R. Costle

Commissioner of Banking, Insurance, Securities and Health Care Administration

1 Documentation fees as used in paragraph # 1 of this bulletin do not include the cost of preparation of loan documents. Rather, the handling of the cost of preparation of loan documents is discussed in paragraph # 2.

2 In reviewing this issue, we have also considered the Attorney General’s Automobile Advertising Rule, CF 118. Documentation fees should be included and disclosed in any advertising subject to that rule as part of the Sales Price Available to All.

Vermont Civil Union Law

Bulletin
Monday, June 4, 2001
Banking Bulletin #23
File attachments: 
http://www.dfr.vermont.gov/sites/default/files/BUL-B-23.pdf

BANKIN G BULLETIN NO. 23 June 4, 2001

Vermont Civil Union Law – Effective July 1, 2000

Act 91 of the 1999-2000 Vermont Legislature provides parties to a civil union with the same benefits, protections and responsibilities under law as are granted to spouses in marriage. Pursuant to Section 3 of the Act, a party to a civil union shall be included in any definition or use of the terms "spouse," "family," "immediate family," "dependent," "next of kin," and any other terms that denote the spousal relationship, as those terms are used throughout the law. The term "law" is broadly defined to include any statute, administrative or court rule, policy, common law or any other source of civil law. Consequently, whenever any terms denoting a marital relationship appear in Vermont statutes or the Department’s banking regulations, they shall be construed to include the parties to a civil union. For example, parties to a civil union are entitled to hold property as tenants-by-the-entirety, and 27 V.S.A. §105, Surviving Spouse’s Interest in Homestead, is automatically amended to include the surviving party of a civil union.

Sample forms for Individual Retirement Accounts ("IRAs") and residential mortgage loan applications, designed through a cooperative effort by representatives of the industry and this Department, are attached hereto in order to provide guidance to the industry. However, the attachment of such forms should in no way be interpreted to mean such forms are required. Providers of IRAs and mortgage lenders should review their current applications, disclosures and procedures to evaluate any element of risk that may be mitigated through the use of such forms.

This bulletin is intended to provide general information and alert interested parties to changes that may be necessary in their operations. A copy of Act 91 may be obtained from: Legislative Council, 115 State Street, Drawer 33, Montpelier, Vermont 05633- 5301; (802) 828-2231. An unofficial version may be obtained from the Vermont Legislative Home Page web site.

Elizabeth R. Costle

Commissioner of Banking, Insurance, Securities and Health Care Administration

 

SAMPLE VERMONT ADDENDUM TO INDIVIDUAL RETIREMENT ACCOUNT DISCLOSURES

Individual Retirement Accounts are regulated under federal law. Federal law generally defines a "spouse" as a person of the opposite sex who is a husband or a wife. 1 U.S.C.A.

§7. Certain federal IRA benefits available to a spouse may not be available to a party to a civil union. You should consult an attorney or financial advisor for specific legal or financial advice regarding the rights and benefits available to you under an Individual Retirement Account.

SAMPLE VERMONT ADDENDUM TO RESIDENTIAL MORTGAGE LOAN APPLICATION

Can anyone, other than you, claim a homestead interest* in the property that will secure repayment of the loan?

! NO ! YES

If yes, who may be able to claim a homestead interest?

 


Name

 

Dated this ___ day of _____, 20__.

 


Borrower

 

 


Co-Borrower

 

 

*Vermont law recognizes a homestead right in the spouse or civil union partner of the legal owner of real estate, which is used or kept as their primary home, even if the spouse or civil union partner is not a co-owner of that home. This homestead interest prevents creditors from attaching the entire homestead property without the written consent of both spouses or partners. Therefore, the lender will require that both spouses or civil union partners sign the mortgage deed, or otherwise waive their homestead interest in the property, in order to insure that it is fully enforceable.

This Addendum has been prepared in response to Act 91 of the 2000 Legislative Session, effective July 1, 2000, which provides that parties to a civil union shall have all the same benefits, protections, and responsibilities afforded under Vermont law to spouses in a marriage.

You should consult an attorney for specific legal advice regarding homestead rights and for specific legal advice regarding benefits, protections, and responsibilities under Act 91.

Permitted Charges on Mortgages

Bulletin
Monday, June 23, 1997
Banking Bulletin #19
File attachments: 
http://www.dfr.vermont.gov/sites/default/files/BUL-B-19.pdf

BANKING BULLETIN NO. 19

JUL Y 23, 1997

PERMITTED CHARGES ON MORTGAGES

Bulletin No. 11, attached hereto, was issued by the Department on June 18, 1984 regarding permitted charges on subordinate lien mortgages. In the introductory paragraph of the bulletin, Commissioner Chaffee stated that the Federal “…Depository Institutions Deregulations and Monetary Control Act of 1980 (hereinafter “DIDMCA”) pre-empted provisions of Vermont Law ‘limiting the rate or amount of interest, discount points, finance charges or other charges, on mortgage loans secured by a first lien on residential real property or a residential manufactured home…” This federal pre-emption was effective March 31, 1980.

One of the Vermont statutes pre-empted by DIDMCA was 9 V.S.A. 42 which prohibits the charging of any fee not specifically reference therein. Because 9 V.S.A. 42 originally applied to the making of first mortgages as well as other loans, the statute was only pre- empted when applied to first liens and continued to have application to other loans, including subordinate lien mortgages.

Pursuant to the federal law, a state could, between April 1,1980 and March 31, 1983, adopt a law which regulated the amount of interest, discount points, finance charges, or other charges which may be imposed on a first mortgage. In recognition of the federal pre-emption in this area, the Vermont legislature, on March 9, 1982 amended 9 V.S.A. 41a to add section (b)(8) which provides that the interest on a loan or extension of credit secured by a first lien against real estate would be the rate of interest allowed under DIDMCA. The Vermont legislature took no action to renew the application of 9 V.S.A. 42 to first mortgages.

On April 19, 1983, the legislature enacted 8 V.S.A. 2201(a) to expand mortgage lending by non-bank lenders in the State of Vermont. Prior to the adoption of that statute, licensed lenders were only legally authorized to make subordinate lien mortgages and then only if the individual loan exceeded $3000.00 and was for a term of nor more than 15 years.

The enactment of H.315 on April 18, 1983, which added 8 V.S.A. 2201(a), eliminated a number of the restrictions on mortgage lending by licensed lenders in Vermont. The statement of purpose contained in H.315 provided: “It is the purpose of this bill to remove certain statutory restrictions on mortgage loans made under 8 V.S.A. Chapter 73 by lenders other than Vermont depository institutions…”

The legislative history behind H.315 indicates that the legislature intended, by authorizing licensed lenders to write first and second mortgages under section 2201(a), to increase competition in the Vermont marketplace which would thereby increase and enhance mortgage credit availability. The bill’s sponsor, Representative Michael Kimack testified before the Senate Finance Committee:

“So when we talk about what the bill really does, it basically will permit a little bit more competition in the banking area dealing with people (non-bank lenders) who would have the availability of mortgages at perhaps somewhat lesser rates and perhaps somewhat lesser point structures… So, the bill, form the point of view of its intent is to allow the market to be open, to bring these people under the purview of the banking and insurance agency…” (Senate Finance Committee, March 19, 1983, Transcript at p.25.)

To provide parity within the mortgage lending industry in Vermont, licensed lenders were allowed to charge the same interest rates as banks: the interest rates permitted under DIDMCA for first liens, as provided under 9 V.S.A. 41a(b)(8), and the interest rates allowed under 9 V.S.A. 41a(b)(7) for subordinate liens.

As it had in the 1981 statute related to subordinate liens, H.390, the legislature incorporated 9 V.S.A. 42 by reference into section 2201(a). At the time of the enactment of section 2201(a), 9 V.S.A. 42 had been pre-empted by DIDMCA in its application to first liens but not to subordinate liens.

One of the general rules of statutory construction provides that when a legislature incorporates a statute by reference into another statute, it adopts the referenced statute as it exists at the time of the adoption..73 Am. Jur 2d 29; 82 C.J.S. 70; Sutherland on Statutory Construction, Section 51.08. The Vermont Supreme Court has recognized this general rule of statutory construction. Court of Insolvency v. Meldon, 69 Vt. 510, 513 (1897). By incorporating 9 V.S.A. 42 by reference into 8 V.S.A. 2201(a), the legislature incorporated 9 V.S.A. 42 as it stood at the time the 1983 law was passed. On April 19, 1983, section 42 did not apply to first liens because of pre-emption by DIDMCA.

There is also nothing in either H.315 or the legislative history of the enactment of that bill to indicate that the legislature intended to overcome the federal pre-emption of 9 V.S.A 42 as applied to first liens written by licensed lenders. Although DIDMCA does allow a state, at any time after April 1, 1980, to adopt laws which regulate “discount points or such other charges” on first liens, there is not evidence that the Vermont legislature intended to do so when it simply consolidated existing statute relating to mortgage in

H.315. In fact, the legislative intent was the opposite-to place licensed lenders on a level playing field with banks who are not restricted in their charges on first liens.

The legislative history evinces the intent of the legislature that licensed lenders be restricted under 9 V.S.A. 42 in the making of subordinate liens and not first liens. It is important to note that the first incorporation by reference of 9 V.S.A. 42 into the Licensed Lenders’ statute was the 1981 enactment of H.390 which applied to subordinate liens only. The legislative history of the 1983 law, H.315, further substantiates the legislature’s intent to provide an open marketplace for mortgage lending in Vermont and to that end, provide the same restrictions on all Vermont lenders related to the permitted charges under 9 V.S.A. 42; in other words, to apply section 42 to subordinate liens only.

Consequently, the Department interprets the inclusion of 9 V.S.A. 42 in 8 V.S.A. 2201(a) as a limitation on the charging of fees by licensed lenders on subordinate liens and not first liens. This interpretation is consistent with Bulletin No. 11 which states the Department’s position that, after DIDMCA, subordinate liens continue to be regulated by Vermont law.

 

Elizabeth R. Costle

Commissioner of Banking, Insurance, Securities & Health Care Administration

Banking Division

Molly Dillon
Molly Dillon
Deputy Commissioner of Banking

The Vermont Banking Division regulates and examines a variety of entities that include banks, credit unions, lenders, mortgage brokers, sales finance companies, debt adjusters, and money servicers. The Division also provides consumer assistance, education, and outreach to protect consumers from financial fraud.

Contact us at 1.888.568.4547 or DFR.BNKConsumer@vermont.gov

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