Issuance of Final Rule, Withdrawal of a Proposed Rule, and Request for Comment on Amendment to Official Staff Commentary, all Pertaining to Regulation Z -- Truth-in-Lending, Circular No. 86-118

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F e d e r a l R e s e r v e B a n k OF DALLAS WILLIAM H. WALLACE FIRST VICE P R E SID E N T December 30, 1986 d a lla s , te x a s 75222 Circular 86-118 TO: The Chief Executive Officer of all member banks and others concerned in the Eleventh Federal Reserve D is tr ic t SUBJECT Issuance of final rule, withdrawal of a proposed rule, and request for comment on amendment to official staff commentary, all pertaining to Regulation Z--Truth in Lending DETAILS The Board of Governors of the Federal Reserve System has issued a final rule th a t would modify the Regulation Z provision granting exemptions to the rig h t to re scission .

As a r e s u lt of the change, the funding of nonfinance charges would not be considered to c o n stitu te the advance of "new money" in the cases of certain refinancings.

The Board of Governors had previously proposed th a t the exemption from the Regulation Z rescission rule applicable to certain refinancings by the same c re d ito r be extended to apply to certain "refinancings" by a d iff e r e n t c re d ito r.

This proposal has been withdrawn.

The Board of Governors also has published for comment a proposed revision to the o ff ic ia l s t a f f commentary regarding the rescission rule. Comments on the proposed amendment should be addressed to Mr. William W. Wiles, Secretary, Board of Governors of the Federal Reserve System, Washington, D.C.

20551.

All correspondence should re fe r to Docket No. R-0577, and must be received on or before January 30, 1987. ATTACHMENTS The material as published in the Federal Register is attached. MORE INFORMATION For fu rth er information, please contact David Dixon of th is Bank's Legal Department a t (214) 651-6228.

Sincerely yours, For additional copies of any circular please contact the Public Affairs Department at (214) 651-6289. Banks and others are encouraged to use the following incoming WATS numbers in contacting this Bank (800) 442-7140 (intrastate) and (800) 527-9200 (interstate).

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library ([email protected])

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FEDERAL RESERVE SYSTEM 12 CFR Part 226 [Regulation Z; Docket No. R-0577] TRUTH IN LENDING Right of Rescission AGENCY:

Board of Governors of the Federal Reserve System. ACTION:

Final rule and withdrawal of proposed rule.

SUMMARY:

The Board is publishing a final rule revising Regulation Z, i t s regulation implementing the Truth in Lending Act. The rule modifies the existing provision that exempts original cred ito rs from providing the right of rescission in certain refinancings secured by the consumer's principal dwelling.

The regulation provides that the right of rescission will not apply i f the original c re d ito r finances nonfinance charges such as atto rn e y 's fees, t i t l e examination fees, and insurance premiums. The Board has decided to withdraw i t s proposal to amend Regulation Z to exclude certain transactions by a cred ito r other than the original c re d ito r from the right of rescissio n .

The proposal would have excluded from the right of rescission extensions of c re d it that replace a transaction secured by the consumer's principal dwelling where (1) no new advances of money are made to the consumer, (2) the annual percentage rate on the new obligation is not subject to increase a f t e r consummation and is the same as or lower than the annual percentage rate on the obligation being replaced, and (3) the new t r a n s ­ action does not have a balloon payment feature. In lig h t of sig n ific a n t concerns expressed by a number of persons commenting on the proposal, including s ig n ific a n t consumer opposition to any expansion of the rescission exemptions, d is s a tis fa c tio n with the limited nature

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- 2 of the proposed exemption, the complexity associated with a rule that might accommodate all i n t e r e s t s , and the s tatu to ry concerns accompanying any attempt to accommodate those i n t e r e s t s , the Board has decided not to create a new rescission exemption for nonoriginal c re d ito rs . EFFECTIVE DATE:

December 16, 1986, but reliance optional until October 1, 1987. FOR FURTHER INFORMATION:

Contact Adrienne Hurt or Leonard Chanin, Staff Attorneys, (202) 452-3867 or (202) 452-3667, Division of Consumer and Community A ffairs, or for the hearing impaired only, Telecommunications Device for the Deaf (TDD) Earnestine Hill or Dorothea Thompson, at (202) 452-3544, Board of Governors of the Federal Reserve System, Washington, D.C. 20551 SUPPLEMENTARY INFORMATION:

(1) Background.

Section 125 of the Truth in Lending Act (TILA) provides that consumers have the right to rescind certain credit transactions in which a security in te r e s t is taken in the consumer’s principal dwelling.

The right of rescission was established to provide consumers an opportunity to reexamine th e ir credit contracts and cost disclosures in order to reconsider t h e i r decision to place an important asset -- the home - - at risk by offering i t as security for the c re d it extension. The rescission period runs for three business days ending on midnight of the th ird business day following consummation, delivery of material Truth in Lending d isclosures, or delivery to the consumer of the notice of the right to rescind, whichever occurs l a s t .

Under section 226.23 of Regulation Z, which implements the a c t 's rescission provision, a cre d ito r is prohibited from performing services or disbursing funds, other than in escrow, during the rescission period. A consumer may waive the right to rescind where the consumer has a bona fide personal financial emergency.

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Currently, both the act and Regulation Z provide th a t refinancings^/ by the same c re d ito r of credit already secured by the consumer's principal dwelling are exempt from the right of rescission where no "new money" is advanced to the consumer.

The regulation t r e a t s as new money the difference between the new "amount financed" and the unpaid principal balance plus any earned unpaid finance charges on the obligation being refinanced. Under th is rule, nonfinance charges, such as a ttorn e y 's fees, t i t l e examination fees and insurance premiums, i f financed by the c re d ito r, are added to the old debt to arrive at the new amount financed.

The provisions in existin g section 226.23 (f)(2) provide that the transaction is rescindable to the extent of these charges.

In lig h t of the substantial increase in consumer applications to refinance residential mortgage loans, the Board received a number of inquiries and complaints about the a p p lic a b ility of the rescission rules to refinancings. As a result of consumer and cred ito r concerns, the Board published for public comment on August 6, 1986 (51 FR 28245) a proposal to create a new exemption from the right of rescission for transactions involving the nonoriginal c re d ito r, and to revise the d efin itio n of new money for purposes of the current exemption for original c re d ito rs . The Board received approximately 165 comments on the proposed amendments.

The Board has decided not to create - 3 - \ [ Although the term "refinancing" in § 226.23 of Regulation Z refers only to new transactions by the same c re d ito r th a t had made the original extension of c re d it, the term in th is discussion is used in a generic sense to refer to a tran saction by any cred ito r th at s a t i s f i e s and replaces an existing obligation.

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- 4 a new exemption for nonoriginal c re d ito rs , but has decided to revise i t s d e f i n i ­ tion of new money for purposes of the existing exemption from the rescission right for original c re d ito rs .

(2) Proposal to exempt "refinancings'* by the nonoriginal c r e d i t o r . Section 125(e) of the TILA exempts from rescission only refinancings by the original c re d ito r where no new advances of money are made.

The proposed amendment to Regulation Z would have expanded the class of transactions exempt from the rescission provisions to include certain types of refinancings by creditors other than the original c r e d ito r. The expansion of the rescission exemption to exempt certain additional types of refinancings was based on the idea that i t would benefit both consumers (in allowing for immediate access to credit) and cre d ito rs (in relieving some compliance costs) and, i f limited, would be consistent with congressional intent in creating the right of r e s c i s ­ sion.

In an e f f o r t to ensure th a t transactions remain subject to the right of rescission where the consumer arguably needs the rig h t, and in view of the existing statu to ry exemption applicable to the original c re d ito r only, the proposal would have limited the types of refinancings offered by a new c re d ito r that could be exempt from the right of rescissio n . Under the proposal, a refinancing by a new c re d ito r would have q u alified for the exemption only i f : (1) no new advances of money were obtained by the consumer, (2) the annual percentage rate (APR) on the new transaction was not subject to increase a f t e r consummation and was the same as or lower than the APR on the obligation being refinanced, and (3) the new transaction did not have a balloon payment feature. After careful consideration of the comment l e t t e r s and fu rth er evaluation of the proposal, the Board has decided not to amend Regulation Z

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- 5 to create a new exemption from the right of rescission for refinancings by a new c re d ito r.

The Board's decision is based on several considerations. F i r s t , there was a strong b e lie f among persons opposed to expanding the rescission exemptions -- p a rtic u la rly those representing the consumer in te r e s t -- th a t the Board's proposed amendment would eliminate an important consumer rig h t . These commenters f e l t that the purpose of the right of rescission - - to allow consu­ mers time to reconsider the risks in encumbering t h e i r homes for an extension of c re d it - - is c ru c ial, p a rtic u la rly at a time when so many consumers are refinancing loans.

The opponents believed th a t the proposal, even with i t s lim itatio n s aimed at exempting only loans th at would pose no greater risk than the original loans, was not s u ffic ie n t to ensure that consumers will have the right of rescission in all transactions when i t would be de sirab le. In addition to the concerns about the loss of a substantive consumer protection, those opposing the proposed amendment often cited t h e i r b e lie f that the Board would be exceeding i t s rulemaking authority under the TILA i f i t were to exempt transactions by a c re d ito r other than the original c re d ito r because the current s ta t u te expressly exempts only refinancings by the same c re d ito r. While most commenters generally favored expansion of the category of refinancings that would be exempt from the rescission provisions, many commenters did not favor the Board's sp ec ific proposal.

A number of c re d ito rs , for example, urged the Board to adopt sim ilar exemption rules for original and nonoriginal cred ito rs by deleting the various q u a lific a tio n s from the proposed amendment. They argued th a t where a consumer refinances a loan, regardless of who the c re d ito r i s , the right to rescind is an unnecessary protection because there is adequate time between application and closing for reconsideration of a cre d it decision.

They also claimed there is l i t t l e support for the idea that a consumer

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- 6 undertakes less risk when refinancing a loan with the same c r e d ito r, or th at the consumer needs the additional rescission protections only when dealing with a d iffe re n t c re d ito r.

While the Congress' rationale for r e s tr ic tin g the exception to the original cred ito r may be unclear, the s ta t u te unambiguously exempts refinancings only with the original c re d ito r.

It is the Board's view that adopting a broad exemption th at would t r e a t new creditors the same as original cred ito rs would be inconsistent with the s tatu to ry intent of the rescission provisions. Any exemption would have to be ta ilo re d to ensure that the rescission provisions apply to transactions where the right of rescission is arguably a needed pro­ t e c tio n .

With regard to the exemption as proposed, many commenters urged th a t various modifications be made in the proposal to exempt additional transactions th a t they believed would impose no increased risk to consumers. For instance several commenters suggested th a t:

-- The refinancing of a variable rate loan with no caps to a variable rate loan with caps should be exempt from the right of rescissio n .

-- The refinancing of a fixed rate loan to a variable rate loan with a rate cap that is equal to or less than the APR (or in te re s t rate) on the existing loan should be exempt from the right of rescission. - - Only where a balloon payment feature is added or where a balloon payment on the refinancing is higher than the balloon payment on an e xisting loan should the transaction remain subject to the right of rescission.

The Board believes that modifying the proposal to expand the rescission exemption to include more transactions in which additional risk is not an apparent concern would lik ely resu lt in a very technical and complex rule. Several commenters, in response to the Board's s o l i c i t a t i o n for comment as to whether additional lim itatio n s should be contained in the proposal,

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- 7 f e l t th at additional conditions should be imposed before a transaction is exempt from the right of rescissio n .

Most of those addressing the question stated that refinancings with a demand feature should be subject to the right of rescission on the ground th at a demand loan is j u s t as risky, i f not more so, than a loan with a balloon payment fe a tu re . Others stated th at scheduled payments on the refinancing should be lower than scheduled payments on the e xisting loan before the right of rescission is eliminated. Other commenters suggested additional conditions.

The Board believes th a t d rafting a rule accommodating these concerns would create a very technical regulation, and would s ig n ific a n tly lim it the number of transactions th at would be covered by the amendment.

In lig h t of the strong opposition to any expansion of the rescission exemptions from a number of commenters, the desire of many commenters to have the rescission exemption expanded beyond th at which was proposed by the Board, the complexity associated with a rule to accommodate all i n t e r e s t s , and the statu to ry c o n stra in ts, the Board has decided not to adopt the proposed amendment to create a new rescission exemption regarding refinancings by a cred ito r other than the original c re d ito r.

(3) New money proposal.

In addition to proposing to amend Regulation Z to exempt certain refinancings by a nonoriginal c re d ito r, the Board proposed to redefine what co n stitu tes a new advance of money obtained by a consumer for purposes of the e xisting exemption for refinancings. The Board has decided to adopt the proposed amendment to Regulation Z th a t would redefine a new advance of money.

Section 226.23(f)(2) currently provides th a t a consumer shall receive the right of rescission in a refinancing by the original c re d ito r i f the consumer receives "new money."

Under th is rule, new money has been tre a te d as the difference between the new amount financed and the outstanding balance plus any

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earned unpaid finance charges.

Because of th is d e fin itio n , the right of r e s c is ­ sion often would be triggered i f the consumer merely finances costs th at are not finance charges, such as a tto rn e y 's fees, t i t l e examination fees, and insurance premiums, even where a consumer does not get additional money for other purposes. The Board proposed for comment a revision to th is rule to provide th a t i f the new money re su lts solely from a decision by the consumer to finance nonfinance charges such as a tto rn e y 's fee s, t i t l e examination fe e s, and insurance premiums, these costs would not tr ig g e r the rig h t of re scissio n . (Under the existing ru le , points and other finance charges, even i f financed by the c re d ito r, would not tr ig g e r the rig h t of rescission since they are not part of the "amount fi nanced.") Over two-thirds of the commenters supported the Board's proposal to revise the d e fin itio n of new money.

The majority of commenters stated th a t most consumers ask to finance these costs when refinancing t h e i r mortgage, thus trig g erin g the right of rescission in a large number of refinancings. While commenters varied in the estimates of these c o sts, i t appears th a t these costs are generally below $1,000 or 3% or less of the principal loan amount. Most commenters stated th a t these costs were not s ig n ific a n t enough to j u s t i f y the consumer receiving the right of rescission solely for these charges. Several commenters opposed to revising the d e fin itio n of new money stated th a t costs such as a tto rn e y 's fees, t i t l e examination fees, and insurance premiums can be s ig n if ic a n t, and th a t consumers need an opportunity to reconsider a tran sactio n when these costs are financed by a c r e d ito r . A few commenters f e l t the Board should not take any action th a t may reduce consumer protections in the rescission area.

After careful consideration of all comments received and furth er examination of the proposal, the Board has decided to adopt the new money - 8 -

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- 9 proposal.

The Board believes th at consumers do not need the right of rescission when refinancing with an original c re d ito r i f the only reason for receiving the right is due to a decision to finance nonfinance charge closing co sts. Such amounts do not appear to be s ig n if ic a n t, in lig h t of the principal loan amount being refinanced, and thus do not put the consumer's principal dwelling at any s ig n ific a n tly greater ris k .

The Board also believes that the requirement in section 226.4(c)(7) that common closing costs must be bona fide and reasonable to be excluded from the finance charge should allay concerns expressed by some commenters that cred ito rs may use th is revision to add unreasonable charges to the new t r a n s ­ action.

Furthermore, i t should be noted th a t i f the consumer rescinds a transaction involving new money, section 226.23(d) provides th a t the consumer is not lia b le to pay any amount, including the cost of the refinancing. Minor e d ito ria l revisions have been made to the proposal so that the provision will be phrased in terms of what transactions are subject to the right of rescission rather than what transactions are covered by the exemption. These revisions were made to more clearly s t a t e the rule th a t , where a transaction involves new money, only the new money is rescindable. In addition to i t s final rule, the Board is also publishing for public comment in th is issue of the Federal Register a proposal to amend the o f f ic i a l s t a f f commentary to address issues that may a ris e as a resu lt of the new rule. (4) Regulatory impact.

The revision to the rescission provision in Regulation Z would reduce the number of transactions for which creditors would need to provide consumers with a notice of t h e i r rescission rights and an opportunity to rescind.

Therefore, i t appears that c re d ito rs , including small e n t i t i e s , would not incur any additional costs as a resu lt of the proposed changes.

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- 10 - List of Subjects in 12 CFR 226 Advertising; Ranks; Ranking; Consumer protection; Credit; Federal Reserve System; Finance; Penalties; Truth in lending. Pursuant to authority granted in § 105(a) of the Truth in Lending Act, 15 U.S.C. § 1604(a), the Board is amending Regulation Z (12 CFR Part 226) as follows:

(1) The authority c i ta t io n for Part 226 continues to read: AUTHORITY: Sec. 105, Truth in Lending Act, as amended by Sec. 605, Pub. L. 96-221, 945 S tat. 170 (15 II.S.C. § 1604 et s e q .).

(2) 12 CFR Part 226 is amended by revising § 226.23(f)(2) to read as fol 1 ows:

SECTION 226.23 — Right of Rescission * * * * * (f) Exempt tra n s a c tio n s .

The right to rescind does not apply to the following: * * * (2) A refinancing or consolidation by the same cre d ito r of an extension of cred it already secured by the consumer's principal dwelling. The right of rescission shall apply, however, to the extent the new amount financed exceeds the unpaid principal balance, any earned unpaid finance charge on the existing debt, and amounts a ttrib u ted solely to the costs of the refinancing or consoli­ dation.

* * * * * Ry order of the Board of Governors of the Federal Reserve System, December 11, 1986.

(signed) William W. Wiles Wil1iam W. Wiles Secretary of the Board

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FEDERAL RESERVE SYSTEM 12 CFR Part 226 [Reg. Z; R-0577] TRUTH IN LENDING Proposed Update to Official Staff Commentary AGENCY:

Board of Governors of the Federal Reserve System. ACTION:

Proposed o ff ic ia l s t a f f in te rp re ta tio n . SUMMARY:

The Board is publishing for comment a proposed revision to the o f f ic i a l s t a f f commentary to Regulation Z (Truth in Lending) regarding the right of rescission in the refinancing of a closed-end credit tra n sac tio n . The revision relates to an amendment to Regulation Z recently adopted by the Board that redefines what con stitu te s a new advance of money in a refinancing th at is exempt from the rescission provisions. (The regulatory amendment is contained elsewhere in th is issue.) The proposed commentary provision would revise existing comment 23(f )-4 which explains what c o nstitutes a new advance of money in a refinancing by the original c re d ito r th at would require the c re d ito r to give a consumer the opportunity to rescind an extension of additional c re d it. DATE:

Comments must be received on or before January 30, 1987. ADDRESS:

Comments should be mailed to William W. Wiles, Secretary, Board of Governors of the Federal Reserve System, Washington, D.C. 20551, or delivered to the 20th Street mail services courtyard entrance, 20th Street between C Street and Constitution Avenue, N.W., Washington, D.C., between 8:45 a.m. and 5:15 p.m. weekdays. Comments should include a reference to R-0577.

Comments may be inspected in Room B-1122 between 8:45 a.m. and 5:15 p.m. weekdays.

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- 2 - FOR FURTHER INFORMATION:

Contact Adrienne Hurt or Leonard Chanin, Staff Attorneys, Division of Consumer and Community A ffairs, at (202) 452-3867 or (202) 452-3667; for the hearing impaired only, Telecommunications Device for the Deaf (TDD) Earnestine Hill or Dorothea Thompson, at (202) 452-3544, Board of Governors of the Federal Reserve System, Washington, D.C. 20551.

SUPPLEMENTARY INFORMATION: (1) General .

The Truth in Lending Act (TILA) provides th a t , in a consumer cred it transaction in which the consumer's principal dwelling secures an extension of c r e d it, the consumer has three business days, generally from the date of consummation of the cred it tra n sac tio n , in which to rescind the tran sac tio n . This right of rescission was created to allow consumers time to reexamine th e ir cred it contracts and cost disclosures and to reconsider whether they want to place an important asset - - the home - - at risk by offering i t as security for the c r e d i t.

Not all c re d it transactions secured by a consumer's principal dwelling are subject to the right of re s c is s io n . Under section 125(e) of the TILA a refinancing by the same cred ito r (the original creditor) is not subject to the right of rescission i f no new advances of money are made to the consumer.

The Board has recently adopted an amendment to Regulation Z to redefine what co n stitu tes a new advance of money obtained by a consumer for purposes of the rescission exemption for refinancings. The regulatory amendment is contained elsewhere in th is issu e. The amendment redefines a new advance of money as only amounts above the costs a ttrib u ta b le to the refinancing that are in the amount financed. Comment 2 3 (f )-4 would be revised to incorporate the revised d efin itio n of a new advance of money in a refinancing and to fu rth er explain

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- 3 what amounts are included in determining what c onstitutes a new advance. In addition, a minor e d ito ria l change would be made in the f i r s t sentence of comment 2 3 (f )-4 to c la r if y that a consolidation is a type of refinancing. No substantive change is intended.

It is expected th a t revisions to comment 2 3 ( f ) -4 will be adopted in final form in March 1987 (along with the final version of the sixth general update to the commentary to Regulation Z, a proposal of which was published at 51 FR 43,37 2 on December 2, 1986). Compliance would be optional until the uniform e ffe c tiv e date of October 1, 1987, for mandatory compliance.

Certain conventions have been used to highlight the proposed revision.

New language is shown inside bold-faced arrows, and underlined, while language that would be deleted is set off with brackets. Pursuant to authority granted in section 105 of the Truth in Lending Act (15 U.S.C. 1604 as amended), the Board proposes to amend the o ff ic ia l s t a f f commentary to Regulation Z (12 CFR Part 226 Supp. I) as follows: List of Subjects in 12 CFR Part 226 Advertising; Banks, Banking; Consumer protection; Credit; Federal Reserve System; Finance; Penalties; Truth in lending. For the reasons set forth above, the Board proposes to amend 12 CFR Part 226 as follows:

(1) The authority c i ta tio n for Part 226 continues to read as follows: AUTHORITY: Sec. 105, Truth in Lending Act, as amended by sec. 605, Pub. L. 96-221, 94 S ta t. 170 (15 U.S.C. 1604 et s e q .) . (2) Text of re v is io n s .

The proposed revisions to the Official Staff Commentary (12 CFR Part 226, Supp. I) read as follows: SUPPLEMENT I - Official Staff In terp retatio n s

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- 4 - Section 226.23 - - Right of Rescission * * * * * 23(f) Exempt Transactions ★ * ★ * * 4. New advances.

The exemption in section 226.23(f)(2) applies only to refinancings [or consolidations] >(including con solid atio n s)< by the original c re d ito r.

[ I f the transaction involves the advance of new money, then only the amount of the new money is rescindable. For example, if the sum of the outstanding principal balance plus the earned finance charge is $1,000 and the new amount financed is $1,000, then the refinancing would be exempt.

On the other hand, i f the new amount financed exceeds $1,000, then the amount in excess of that $1,000 would be rescindable.] >If the refinancing involves a new advance of money, the amount of the new advance is rescindable.

For purposes of the right of rescissio n , a new advance does not include amounts a ttrib u te d to the costs of the refinancing.

These amounts would include section 226.4(c)(7) charges (such as attorneys fees and t i t l e examination and insurance fees, i f bona fide and reasonable in amount), as well as insurance premiums and other charges th a t are not finance charges.

(Finance charges on the new transaction -- points, for example — would not be considered in determining whether -------------- 1---------------------------- — - X - , - - .

.

------- - - _____ ____________ - ■ — — ■ ■ there is a new advance of money in a refinancing since finance charges are always excluded from the amount financed.) To i l l u s t r a t e , i f the sum of the outstanding principal balance plus the earned unpaid finance charge is $50,000 and the new amount financed is $51,000, then the refinancing would be exempt i f the extra $1,000 is a ttrib u te d solely to costs financed in connection with the refinancing th a t are not finance charges.

Of course, i f new advances of money are made (fo r example, to

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- 5 pay for home improvements) and the consumer exercises the right of re scissio n , the consumer must be placed in the same position as he or she was prior to entering into the new c re d it tra n s a c tio n . Thus, i f applicable, all amounts of money (which would include all the costs of the refinancing) already paid by the consumer to the c re d ito r or to a th ird party as part of the refinancing would have to be refunded to the consumer. (See the commentary to 226.23(d)(2) for discussion of refunds to consumers.)< A model rescission notice applicable to transactions involving new advances appears in appendix H.

Board of Governors of the Federal Reserve System, December 11, 1986. (signed) William W. Wiles William W. Wiles Secretary of the Board