6490. Interpretations of Regulation Z

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FEDERAL RESERVE BANK OF NEW YORK I Circular No. 6490* ^February 18, 1970 Interpretations of Regulation Z To All State Member Banks, and Others Concerned, in the Second Federal Reserve District: The following statement was issued January 29 by the Board of Governors of the Federal Reserve System:

The Board of Governors of the Federal Reserve System today issued eight interpreta­ tions of provisions in its Truth in Lending Regulation Z including three changes in interpretations issued previously. Interpretations issued today relate to: Premiums for vendor’s single interest insurance required by creditor (amendment to previous interpretation). Credit for business or commercial purposes — more than 4 family housing units. Renewals of notes (amendment to previous interpretation). Disclosures on multiple advance loans. Premiums for insurance added to an existing balance. Disclosure for demand loans. Mortgages with demand features. Refinancing and increasing — disclosures and effects on the right of rescission (amendment to previous interpretation). Printed below is an excerpt from the Federal Register of February 12, containing the text of the interpretations. Additional copies of this circular will be furnished upon request. Alfred Hayes, President Title 12— BANKS AND BANKING Chapter fl— Federal Reserve System SUBCHAPTER A— BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM [Reg. Z] PART 226—TRUTH IN LENDING Miscellaneous Amendments The following section is added: § 226.302 Credit for business or com ­ mercial purposes— more than 4 fam ­ ily units.

(a) Under 5 226.3(a), extensions of credit for business or commercial p ur­ poses, other than agricultural purposes, are not subject to Regulation Z. The question arises as to w hether an exten­ sion of credit relating to a dwelling (as defined in § 226.2(p)) which contains more th an four-fam ily housing units is an extension of credit for business or commercial purposes.

(b) Credit extended to an owner of a dwelling containing more thaij fourfamily housing units for the purpose of acquiring, financing, refinancing, im ­ proving, or m aintaining th a t dwelling is an extension of credit for business or commercial purposes.

(Interprets and applies 15 U.S.C. 1603) Section 226.404 is amended to read as follows:

§ 226.404 Premiums for vendor’ s single interest insurance required by cred­ itor.

(a) The question arises whether charges or premiums for single interest insurance (Vendor’s Single Interest In ­ surance) w ritten in connection w ith a credit transaction may be excluded from the finance charge under § 226.4(a) (6) if the insurer waives subrogation. (b) If the insurer waives all right of subrogation against the custom er in a single interest policy of insurance against loss of or dam age to property (which Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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may include coverage for skip, conceal­ ment, conversion, and embezzlement) w ritten in connection with a credit transaction, and the creditor complies with the requirem ents of 5 226.4(a)(6), charges or premiums for such insurance may be excluded from the am ount of the finance charge on th at transaction. However, if the insurer does not so waive subrogation in such policy of insurance, the charges or premiums shall be in­ cluded in the finance charge. (Interprets and applies 15 U.S.C. 1605) Section 226.811 is amended to read as follows:

§ 226.811 Renewals of notes.

(a) Any renewal of an extension of credit providing for paym ent of the full principal sum on a specified date shall not be considered a refinancing under § 226.8(j), and no disclosures need be made in connection with such renewal, provided:

(1) All disclosures required under this p art were made in connection with the original extension of credit or a prior renewal thereof;

(2) The am ount of the renewal does not exceed the am ount of the unpaid balance plus any accrued and unpaid finance charge;

(3) The annual percentage rate (or rates) previously disclosed is not in­ creased; and (4) The period for which renewal is made does not exceed by more than 4 days the period of the extension of credit for which disclosures were made. (b) In instances in which disclosures are required to be made and renewal is made by mail, the creditor may not know w hether the customer will reduce his obligation by a paym ent on principal or, if reduced, the am ount of th at reduc­ tion. The question arises as to w hat dis­ closures should be made by mail to the customer in these circumstances. (c) If the creditor knows the am ount of the principal payment, all disclosures should be made on the basis of the re­ sulting new am ount financed. If, how­ ever, the creditor does not know whether the customer will reduce his original obligation, or if so, by how much, he should disclose on the assumption th at there will be no reduction. In such cir­ cumstances, at the creditor’s option, he may make one or more additional dis­ closures based on one or more examples of graduated principal reduction. For example, if a single paym ent note for $1,000 at 7 percent is proposed to be re­ newed for $1,000 at 8 percent for 3 months, in addition to the other required disclosures, the creditor should disclose an am ount financed of $1,000 with a fi­ nance charge of $20, and may, in addi­ tion, disclose th a t with a principal pay­ m ent of $300 the am ount financed would be $700 with a finance charge of $14, and with a principal paym ent of $500 the am ount financed would be $500 with a finance charge of $10. (Interprets and applies 15 U.S.C. 1639) The following sections are added: § 226.813 Disclpsures on multiple ad­ vance loans.

(a) In connection with construction and other multiple advance loans under § 226.8(i), which are payable in a single sum or permanently financed by the same creditor at m aturity of the con­ struction phase with interest only pay­ able up to such m aturity, and in which either the am ount or date of an advance is not determinable, the question arises whether a method m ight be utilized to estimate the inform ation to be disclosed under § 226.8 (b) (2) and (3) and (d) (3). (b) In such cases, at the creditor’s option, required inform ation may be estimated and disclosed as follows: (1) The following m athem atical equa­ tions based upon assumed continuous (2) If the equations under subdivision (ii) of subparagraph (1) of this para­ graph are utilized, the amounts of any required interest payments during the construction phase may be omitted in making the disclosures required under § 226.8(b) (3); however, if the equations under subdivision (iii) of subparagraph (1) of this paragraph are utilized, then the am ount of each scheduled interest paym ent shall be disclosed as required under § 226.8(b) (3).

(3) In the case of a combination con­ struction loan and perm anent financ­ ing provided by the same creditor: (i) The am ount of interest finance charge to be paid prior to the due date of the first amortization paym ent shall be estimated as prescribed under sub­ division (ii) or (iii) of subparagraph (1) of this paragraph as the case may be and shall be treated as prepaid finance charge for computational purposes; and (ii) Estim ation of the annual per­ centage rate shall be made without re­ advances may be utilized in estimating the am ount of the interest component of the finance charge and the annual per­ centage rate by substituting the ap­ propriate numerical amounts for the following symbols in the equations: (i) Symbols:

L = Amount of loan commitment. r=Stated annual Interest rate expressed as a decimal figure.

n=Number of Interest payments to be made to maturity.

m = Number of Interest periods (unitperiods) In 1 year.

P = Total amount of any prepaid finance charge under 1 226.8(e). B = Amount of any required deposit bal­ ance under § 226.8(e).

(ii) If Interest is computed from the date of each advance on only the amounts advanced:

gard to the number of interest only pay­ ments to be made, assuming the first paym ent period to be th at Interval be­ tween the date the finance charge begins to accrue and the date the first am ortiza­ tion paym ent is due.

(4) Disclosures made in accordance with this interpretation, when made along with the other disclosures required under § 226.8 (b) and (d), shall con­ stitute “all other m aterial disclosures required under this p art” referred to un­ der § 226.9(a):

E x a m p l e I A $20,000 construction loan commitment on which the precise dates or amounts of advances are not determinable. The obliga­ tion bears a stated 6 percent interest rate and interest Is to be paid monthly on the amounts advanced, and the total of the amounts advanced under the commitment plus any unpaid Interest is due and payable at the end of 9 months from the date the finance charge begins to accrue. There is a loan fee of 1 percent ($200), but there is no required deposit balance. Substituting these terms for the symbols, the equations become: (9 X 0.06 X 20,000) + (2X 12X200) — n aaft4 or 8.84% or 8% % estimated annual percentage rate. 9X [(20,000-(2 X 200) ] 9 X 0.06 X 20.000 _ 4^0 or $450 estimated interest finance charge component of the finance 2 X 12 charge.

If the terms stated in the example were changed so that interest would be computed on the full amount of the commitment from the date the finance charge begins to accrue without regard for the dates of disbursements or actual amounts of funds disbursed, the equations under (ill) above become: (2X9X 0.06X20,000)+ (2 X 12X200) - 0 14&7 or 14.97% or 15% estimated annual percentage 9X [(20,000 — 2 X 200) ] rate_ ^ 9 X 0.06 X 20,000 _ 9qq or $900 estimated Interest finance charge component of the finance charge. This Interest would be payable In 9 monthly payments of $100 each.

Estimated annual percentage rate= n( L- 2P- 2B) Estimated interest finance charge = ^-r- 2m (iii) If interest is computed on the full am ount of the commitment without regard for the dates of disbursements or actual amounts disbursed: Estimated annual percentage rate = Estimated interest finance ch arge= 5^ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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E x a m p le I I A $20,000 construction, loan followed by permanent financing in same amount. Six percent Interest. One point loan fee. Nine months to maturity of construction phase. Nine monthly payments of interest only during construction phase. Twenty-year ma­ turity on permanent financing to be amor­ tized in 240 equal monthly payments Includ­ ing Interest and principal. From mortgage amortization tables: Amortization of a $20,000, 6 percent, 20year loan in 240 equal monthly payments including interest and principal requires each monthly payment to be $143.29. Total of 240 payments (240X $143.29)_____________________ $34,389.60 Subtract amount of loan princi­ pal _________________________ 20, 000. 00 Interest finance charge on per­ manent financing_____________ 14, 389. 60 Add: Estimated interest finance charge on construction phase (pursuant to subdivision (ii)) _ 450. 00 Add: Loan fee 1 point__________ 200. 00 Estimated finance charge- 15, 039. 60 (If the interest on the construction phase is computed on the full amount of the com­ mitment for the full time to maturity with­ out regard for the dates of disbursements or actual amounts disbursed pursuant to sub­ division (ill), the estimated interest finance charge for the construction phase would be $900 which would result in a total estimated finance charge of $15,489.60.) Loan fee 1 point prepaid finance charge _________________________ $200. 00 For computational purposes con­ sider Interest to be paid on con­ struction phase as prepaid (not to be disclosed as prepaid)________ 450. 00 Total amount treated as pre­ paid finance charge for computational purposes__ 650. 00 Computa­ tional Disclosure purposes purposes Amount of loan_________$20, 000 $20, 000 Deduct total of estimated finance charge treated as prepaid____________ Deduct actual amount of prepaid finance charge_____ _ _ Estimated a m o u n t fi­ nanced for computa­ tional purposes_______ 19, 350 Amount financed to be disclosed______________ 19, 800 Adjust first payment period (period of con­ struction loan pliis period from maturity date of construction loan to due date of first amortization payment) by dividing the period of the construction loan by 2 and add­ ing the period of time between the maturity date of the construction loan and the date the first amortization payment is due. 9 months divided by 2 = 4% months plus 1 m onth= 5 y2 months Prom Appendix A (page A2) of Volume I of the Board’s Annual Percentage Rate Tables, read across to 5 months and on the line below opposite 15 days ( y2 month) read + 9 0. This adjustment should be added to the number of regular amortization pay­ ments to determine the number of payments in utilizing the Annual Percentage Rate Tables:

240 monthly payments+adjustment 8.0=249 Following the directions on page 1 of Volume I:

Estimated finance charge $15,039.60 X 100 = $1,503,960 which should be divided by the estimated amount financed for computational purposes:

$1,503,96019,350 = $77.72 estimated fi­ nance charge per $100 of estimated amount financed for computational purposes. Refer to page 309M of Volume I, read down number of payments column to 249; read across to 78.71 (which is nearest to $77.72 computed above), and read up to 6.25 per­ cent which is the estimated annual percent­ age rate to be disclosed. In the example where the interest on the construction phase is computed on the full amount of the commitment without regard for the dates of advances or actual amounts advanced, the estimated finance charge per $100 of amount financed is $81.96. On page 309M of Volume I, read down to the 249th payment line and across to $82.39 which is the nearest amount to $81.96, and read up to 6.50 percent which Is the estimated annual percentage rate to be disclosed. (Interprets and applies 15 U.S.C. 1638 and 15 U.S.C. 1639) § 226.814 Premiums for insurance added to an existing balance.

(a) Subsequent to the consummation of a consumer credit transaction the cus­ tomer may wish to purchase optional in­ surance in connection with the obligation. Typically, mortgage life and disability insurance may be offered to the customer at some date after consum­ mation under a plan in which the lender will advance the amount of the premium due and add th at amount to the existing unpaid balance of the obligation. Gen­ erally, each instalm ent on the original obligation paid during the period before the next premium is due will be increased proportionately to liquidate the amount of the additional advance plus any fi­ nance charge. Additional advances are made automatically for renewal pre­ miums as they become due unless the borrower requests discontinuance of the coverage. The question arises as to the required disclosures.

(b) In such cases the insurance agree­ ment may be considered a single sepa­ rate transaction, and the disclosures required under § 226.8, at the creditor’s option, need be made only prior to time the agreement is executed and only with respect to the amount of the initial ad­ vance. For example, a mortgage life and disability insurance plan in which the annual premium advanced was $145 re­ payable in 12 monthly instalm ents of $12.61 added to the regular monthly mortgage payments would be disclosed as an “amount financed” of $145, a “fi­ nance charge” of $6.32, and a “total of payments” of $151.32. Additional dis­ closures as applicable under § 226.8 would, of course, be made. If, as in some cases, only a portion of the advance is liquidated during the premium period with the remainder payable at the end of the mortgage contract, the creditor would likewise calculate the amount of finance charge which would accrue on the advance until paid in full. (c) In some cases the advance is se­ cured by a security interest in real prop­ erty which is used or expected to be used as the principal residence of the customer. In those cases the premium advance agreement is rescindable under § 226.9, and notice of the right of rescis­ sion provided in § 226.9(b) need only be given at the time the agreement is exe­ cuted. Subsequent advances for renewal premiums are not subject to the right of rescission.

(Interprets and applies 15 U.S.C. 1638 and 15 U.S.C. 1639) § 226.815 Disclosure for demand loans. (a) Section 226.8(b)(3) requires a creditor to disclose the number, amount and due dates or periods of payments scheduled to repay an extension of credit other than open end and, in appropriate cases, the total of payments. The ques­ tion ari^fes as to how these requirements should be met in the case of demand loans.

(b) Section 226.4(g) provides th a t for the purpose of calculating the finance charge and annual percentage rate, de­ mand loans are considered to have a one-half year m aturity unless the obli­ gation is alternatively payable upon a stated m aturity, in which case the stated m aturity shall be used.

(c) In order to comply with the re­ quirements of § 226.8(b) (3), if no alter­ native m aturity date is specified, the creditor need disclose only the due dates or periods of payments of all scheduled interest payments for the first one-half year. In such cases, the creditor need not disclose the number, amounts or total of payments or identify any balloon pay­ ment. Effective May 1, 1970, creditors shall disclose the fact th at the obligation is payable on demand.

(d) If an alternative m aturity date is specified, all disclosures required under § 226.8(b) (3) shall be made, using th at date.

(Interprets and applies 15 U.S.C. 1639) § 226.816 Mortgages with demand fea­ tures.

(a) In some cases real estate m ort­ gages are w ritten for a stated period, for example 1 year, with the provision th a t they shall be payable on demand after expiration of th at period, provided th at until such demand is made the principal and interest shall be paid in scheduled periodic installments until paid in full. The obligation is thus payable according to a specified amortization schedule sub­ ject to the holder’s right to demand pay­ m ent after the stated period. (b) The question arises whether the creditor may make disclosures based on the specified amortization schedule or whether disclosures m ust be made on the basis of the m aturity established by the expiration of the stated period. (c) In such cases the creditor may make disclosures based on the specified amortization schedule, provided he dis­ closes clearly and conspicuously th a t the obligation is payable on demand after the stated period together with the fact th a t disclosures are made on the basis of the specified amortization schedule.

Otherwise, disclosures shall be based Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

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upon the earliest date demand for pay­ m ent in full may be made under the term s of the mortgage showing the un­ paid balance due at th at time as a “bal­ loon paym ent.”

(d) The disclosure requirements of this interpretation shall become effective May 1,1970.

(Interprets and applies 15 U.S.C. 1639) Section 226.903 is amended to read as follows:

§ 226.903 Refinancing and increasing— disclosures and effects on the right of rescission.

(a) In some cases the creditor of an obligation will refinance th at obligation at the request of a customer by perm it­ ting the customer to execute a new note, contract, or other document evidencing the transaction under the terms of which one or more of the original credit terms, including the m aturity date of the obliga­ tion, are changed. Except as provided in § 226.811, such refinancing constitutes a new transaction, and all disclosures re­ quired under § 226.8 must be made. The question arises as to whether that trans­ action is subject to the right of rescission under § 226.9 where the obligation is already secured by a security interest in real property which is used or expected to be used as the principal residence of th a t customer.

(b) If the am ount of such new trans­ action does not exceed the am ount of the unpaid balance plus any accrued and un­ paid finance charge on the existing obli­ gation, § 226.9 does not apply to the transaction.

(c) If, however, such new transaction is for an increased amount, th at is, for an am ount in excess of the am ount of the unpaid balance plus any accrued and unpaid finance charge on the existing ob­ ligation, § 226.9 applies to the transac­ tion. However, such right of rescission applies only to such excess and does not affect the existing obligation (or related security interest) for the unpaid balance plus accrued unpaid finance charge. (d) If a transaction is refinanced by a creditor other than the creditor of the existing obligation, the entire transaction is subject to § 226.9.

(Interprets and applies 15 U.S.C. 1639) By order of the Board of Governors, January 28, 1970.

[seal] K enneth A. K enyon, Deputy Secretary.

fF.R. Doc. 70-1735; Filed, Feb. 11, 1970; 8:45 a.m.] Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis