What Are Loan Fees In Residential Mortgage

When obtaining a loan, a borrower will incur a number of charges and costs. Many of these may be financed, such as paid out of loan proceeds which reduces the amount of cash in a refinance or applied to the purchase in a purchase loan. If paid for by the mortgage broker in exchange for a higher interest rate (YSP) they are financed. Others are paid up front or in cash at closing by the borrower.

A loan fee established as a percentage of the loan amount or principal balance may be referred to as “points.” One point is the same as one percent of the loan amount (not one percent of interest rate).

Fees that may be expressed as points include a loan origination fee, a mortgage broker’s fee, discount points and yield spread premiums, which are all percentages of the loan amount, or loan balance.

A loan origination fee covers the lender’s cost and profit for preparing documents and providing other services in processing the loan in-house.

The mortgage broker’s fee pays for a mortgage broker to originate the loan.

A prepayment penalty may be charged on a nongovernment-backed loan that is paid off early. It may be a percentage of the loan amount or be the amount of interest the lender would have earned for a specified period (e.g., interest for the following six months).

The par rate is the interest rate that would be charged without any yield spread premiums to increase it or discount points to decrease it.

Discount points are fees charged to a borrower for a loan at a reduced interest rate. As discussed earlier, one point of discount does not equal one point of interest.

Yield spread premiums (YSPs) are points credited for an interest rate above its par rate. “No closing cost” loans result from applying the YSP to pay the borrower’s closing costs so that they need not be paid up front. Some states prohibit the use of terms such as “No Cost” or similar claims in mortgage loan advertising as they are misleading and deceptive.

Rate sheets provide options that may be offered to borrowers in terms of interest rates and points charged. The more points paid by the borrower up front, the lower the interest rate charged over the duration of the loan. As the interest rate increases, fewer points will be paid. For a loan above the par rate, points may become a negative number on the rate sheet. Negative points mean the lender will credit the borrower with a YSP to reduce his closing costs.

For Example
Based on the rate sheet below for borrower-paid loan originator compensation, there are no points needed to obtain a loan at 6.25%. To buy his interest rate down, a borrower could pay 1 point and get a 0.25% interest rate reduction. To get extra cash at closing, equal to 1% of the loan amount, he could agree to pay 6.5%.


Interest Rate

















The formula for any loan fees that are expressed as points or percentages is:

Loan Amount x Percentage of Fees = Amount of Loan Fees

The phrases “3 points,” or “3 discount points,” and “3 percent loan fee” or “3 percent loan origination fee” all relate to a 3 percent fee. Loan Fees (or Points) = 0.03 x Loan Amount.

If the fee percentage needs to be calculated, this can be done by dividing the loan fees by the loan amount.

For Example
A borrower paid $300,000 for a home. He got an 80% loan, paying 1 point for a loan origination fee and 2 discount points.

  • The points amounted to 3% of the loan amount.
  • The loan was $240,000 (80% of the $300,000 price).
  • The points were $7,200 (3% of the $240,000 loan = 0.03 x 240,000).


What Are Prorations

Recurring expenses (e.g., property taxes, interest, insurance or homeowners’ association assessments) will generally be prorated at the time of closing. Prorating involves proportionately allocating an expense based upon the relative time for which a party is responsible for the expense. These costs must be included in the disclosures provided to the borrower prior to consummation of his loan. For example, if a sale closed three months into the tax year, proration would allocate the seller’s responsibility for the annual property tax to be one-quarter and the buyer’s responsibility to be three-quarters.

Proration is used to:

  • split the cost of monthly interest on an assumed loan, the cost of annual taxes or the cost of homeowners’ association fees between the buyer and seller.
  • determine how much the seller may be entitled to receive as a refund of a prepaid hazard insurance premium, if he cancels the policy before it expires.
  • determine how much of a full month’s interest a buyer or seller may owe a lender for use of its money for less than a full month.

Prorating may be performed using a 365-day year or a 360-day year:

  • In a 365-day-year prorate, the annual cost is divided by 365 to get the daily cost, and each month is considered to have the number of days it actually does have.
  • In a 360-day-year prorate, the annual cost is divided by 360 to get the daily cost, and each month is considered to have 30 days, regardless of the number of days it actually has.

In a leap year, 366 days would be substituted for 365.

Prepaid interest, or per diem interest, is the dollar amount cost of the interest that the buyer will be charged at closing for the use of the loan proceeds from the date the loan closes to the date the loan payment schedule begins, typically the first day of the following month.

In addition, the seller may have to pay interest on his existing loan at closing, since his last payment prior to closing covered the interest accrued in the month before the payment. Because interest is paid in arrears, a loan payment for April would include interest for the month of March. If the sale closed in April, the seller would owe interest for the use of the funds in April up to or through the closing date, either to the lender (if the loan were paid off) or to the buyer (if the buyer were to assume the loan).

The prorated interest amounts can be calculated using the following steps:

  1. Annual Interest = Loan Amount x Annual Percent Interest
  2. Daily Interest = Annual Interest ÷ Days in the Year (365 or 360)
  3. Prepaid Interest on New Loan = Daily Interest x Days from Closing to the Next Month (using the exact days in the month for a 365-day prorate, or 30 days for a 360-day prorate)
  4. Interest on Seller’s Existing Loan = Daily Interest x Days from Last Payment to Closing
For Example
For Example
A $100,000 loan with a 5.5% interest rate closes on August 17. This means the buyer will pay for interest that is charged starting on August 17. The loan payment schedule will “start” on September 1, with the first payment (covering the interest for September) due October 1.Using a 365-day year, the lender is owed interest for 15 days in August (31 days – 16 days after the release of funds on August 17).Annual Interest = $100,000 x 5.5% = $5,500
Daily Interest = $5,500 ÷ 365 = $15.07
Prepaid Interest = $15.07 x 15 = $226.05Using a 360-day year, the lender is owed interest for 14 days in August (30 days – 16 days prior to release of funds on August 17).Annual Interest = $100,000 x 5.5% = $5,500
Daily Interest = $5,500 ÷ 360 = $15.28
Prepaid Interest = $15.28 x 14 = $213.92


In some cases, when the loan closes very early in the month, the lender will start the loan term earlier and rebate the interest to the borrower. For example, if the loan above were to close on August 4 instead of August 17, the loan payment schedule would start on August 1; the first payment would be due on September, 1 rather than October 1; and the lender would credit four days of interest back to the borrower.

Mortgage Lock-ins

Any quoted interest rate is binding only if the loan were to be settled within the time period specified in the Loan Estimate provided by the loan originator, which may be one day or several days. If a borrower chooses to float the interest rate, the rate will not be set until closing, unless the borrower obtains a lock-in (also called a rate lock or rate commitment). This is a lender’s promise to hold a certain interest rate and a certain number of points for the borrower for a specified period of time while his loan application is processed. In order for the lock-in agreement to be enforced by the borrower, it must be in writing and be acknowledged by the lender. If the loan is not settled within the lock-in period, the locked-in rate and points may be lost.

Most lenders will not charge a lock-in fee to lock an interest rate or a number of points for a limited period, such as 10 days or 60 days, but they may charge a fee for a longer lock-in period. The fee is usually expressed as points (e.g., 1/4 point for a 90-day lock), but it might be a flat fee or even a fraction of a percent added to the locked-in rate. It may be charged at settlement or up front.

If a rate lock expires, the prevailing rate at the time becomes the new rate of the loan and the loan rate floats until a new rate lock is created. Among the factors affecting the fee is the length of the lock-in period (e.g., the longer the period, the greater the risk to the lender that interest rates will have risen) and the lock-in option selected.


Some of the lock-in options that might be available to a borrower include:

  • locked-in interest rate and locked-in points. This is a “true lock-in,” as it freezes the rate and points.
  • locked-in interest rate and floating points. This freezes the rate but allows points to fluctuate with market conditions. Therefore, if market interest rates drop, the points may drop; if rates rise, the points may increase. However, the points may be locked in at some time before settlement at the then-current level.
  • floating interest rate and floating points. Often called a “float-to-lock,” this freezes the interest rate and the points at some time after the application but before settlement.
  • float-down rate lock. This caps the interest rate and the number of points but allows the borrower to get the loan at a lower rate if rates float down.

Upon loan approval, the lender will provide a loan commitment promising to grant a loan at specific terms, including the loan amount, the length of time the commitment is valid, and any conditions for making the loan, such as receipt of a satisfactory title insurance policy protecting the lender. These conditions are called closing stipulations and may be pre- or post-closing. A loan will not be funded by the lender until all post-closing stipulations are met.

Mortgage Lock-ins

A borrower’s monthly mortgage payment will repay money borrowed plus interest. It may also include a reserve payment (also known as an escrow or impound payment) that represents approximately 1/12 of the estimated annual hazard and flood insurance premiums and property taxes. Some escrow accounts will include assessments of special improvements, homeowners’ association fees and other recurring charges.

The escrow account is required for:

  • all FHA and VA loans.
  • conforming conventional loans for greater than 80 percent of the appraised property value.
  • higher-priced mortgage loans secured by a first lien on the borrower’s principal dwelling.

When there is need of an account, the borrower may be required to make an initial deposit into the reserve account at settlement to ensure that the regular monthly deposits will accumulate enough to pay the property taxes, insurance premiums or other charges when they are due.

Tax Escrow and Insurance Reserves

A borrower’s monthly mortgage payment will repay money borrowed plus interest. It may also include a reserve payment (also known as an escrow or impound payment) that represents approximately 1/12 of the estimated annual hazard and flood insurance premiums and property taxes. Some escrow accounts will include assessments for special improvements, homeowners’ association fees and other recurring charges.

The escrow account is required for:

  • all FHA and VA loans.
  • conforming conventional loans for greater than 80 percent of the appraised property value.
  • higher-priced mortgage loans secured by a first lien on the borrower’s principal dwelling.

When there is need of an account, the borrower may be required to make an initial deposit into the reserve account at settlement to ensure that the regular monthly deposits will accumulate enough to pay the property taxes, insurance premiums or other charges when they are due.


The maximum amount a lender can collect for this deposit cannot exceed the sum of:

  • an amount sufficient to pay taxes, insurance premiums or other charges up to the due date of the new loan’s first full monthly mortgage installment payment; plus
  • an additional amount sufficient to pay future estimated taxes, insurance premiums and other charges, not in excess of two months’ worth, which is 1/6 of the estimated charges for the following 12 months.
For Example
The settlement date is May 31, the due date of the borrower’s first mortgage loan payment is July 1, and annual taxes are $2,160.

  • The monthly tax accrual: $2,160 ÷ 12 months = $180

The due date for taxes is November 15 for the tax year. The reserve amount represents the amount of taxes accruing between November 15 of last year and June 30.

  • The reserve amount: $180 x 8 months = $1,440

Additional reserve amounts can be required of up to two months’ advance payment.

  • Two months’ estimated charges: $180 x 2 months = $360

The maximum total reserve deposit for taxes at settlement is: $1,440 + $360 = $1,800

If the due date for taxes were April 30, the reserve amount would be due for only May and June.

  • The reserve amount: $180 x 2 months = $360
  • Two months’ estimated charges: $180 x 2 months = $360
  • Maximum total reserve deposit: $360 + $360 = $720, equal to four months of taxes


The same procedure is used to determine the maximum amounts that can be collected by the lender for insurance premiums or other charges.

Once monthly mortgage payments begin, the borrower cannot be required to pay more than 1/12 of the annual taxes and other charges each month, unless a larger payment is necessary to make up for a deficit in his account (caused by increased taxes or insurance premiums) or to maintain the two-month cushion, which is 1/6 of annual charges.

A clause in the mortgage or trust deed will generally require the borrower to maintain property insurance (i.e., hazard insurance) and provide that, if the policy lapses because of nonpayment of the premium, the lender can declare the buyer in default and force place the insurance (i.e., pay for the coverage and require that the borrower reimburse the lender in order to avoid foreclosure). A mortgagee clause in the insurance policy will include the lender as an additional loss payee so that, in the event of a covered loss, the lender will have some say over how the insurance claim proceeds are used (e.g., to repair the damage or, if the borrower and lender agree, to apply them to the balance of the debt instead of repairing the damage).


Fannie Mae requires that for any first-lien mortgage (excluding a reverse mortgage), the minimum hazard insurance coverage required is the lesser of:

  • 100 percent of the insurable value of the improvements, as established by the property insurer; or
  • the unpaid principal balance of the mortgage, as long as it equals the minimum amount (80 percent of the insurable value of the improvements) required to compensate for damage or loss on a replacement cost basis. If it does not, then the coverage that does provide the minimum required amount must be obtained.
For Example
A buyer obtains a $160,000 loan to purchase a property with a sales price of $200,000. The insurer determines the insurable value of the improvements is $150,000. Therefore, the purchaser need obtain only $150,000 of hazard insurance.The insurable value does not include the value of the land.


With regard to one- to four-family investment property in which the owner will not live, Fannie Mae and Freddie Mac require six months of principal, interest, and property taxes and insurance (PITI) in reserve. This reduces the lender’s risk in the event the owner experiences a period of vacancies.


Flood Insurance Legislation

Dwelling and homeowners insurance cover losses to improvements (not to land) caused by fire, windstorms and other natural causes. However, these policies do not cover a property owner against catastrophic losses from such causes as earthquakes and floods. To get such coverage, he can purchase earthquake coverage and/or flood insurance as endorsements or separate policies.

The National Flood Insurance Act of 1968 and the Flood Disaster Protection Act of 1973 prohibited any lender from making, increasing, extending or renewing a loan that will be benefited by any federal program (e.g., an FHA loan) and that is secured by improved real estate or a mobile home located in an area designated by the Federal Emergency Management Agency (FEMA) as a Special Flood Hazard Area (SFHA), unless the building or mobile home and any personal property securing the loan are covered by flood insurance:

  • for the entire loan term.
  • with a limit of at least the lesser of:
    • the outstanding principal loan balance; or
    • the maximum limit of coverage made available under the Flood Disaster Protection Act for the particular type of property. Coverage is limited to the overall value of the property less the value of the land.


Flood Zone Determination

In his appraisal, an appraiser will review a FEMA Flood Insurance Rate Map and show the FEMA flood zone designation, map panel number, map number and map date in the report. However, the final responsibility for determining whether a property is located in an SFHA rests with the originating lender. Therefore, the mortgagee will often obtain a flood zone certification, independent of any assessment made by the appraiser.

Flood insurance is required for property improvements located in an SFHA Zone A (an area subject to inundation by a 1%-annual-chance flood event) or a Zone V (an area along the coast subject to inundation by a 1%-annual-chance flood event with additional hazards associated with storm-induced waves).

Fannie Mae, Freddie Mac and Ginnie Mae are required to have procedures reasonably designed to ensure that required flood insurance is in place throughout the term of any mortgage loan they purchase or guarantee. Therefore, they require lenders and servicers to monitor, on an ongoing basis, the flood zone status of any loans sold to or serviced for them. In order to comply with these requirements, mortgage lenders must obtain an initial flood zone determination before originating a mortgage loan and take steps to monitor the flood zone status of any improvements securing the loan throughout the loan term.


A borrower may be charged:

  • a fee for flood zone determinations and life-of-the-loan tracking, not to exceed the actual charge of any third party used to make the determination.
  • an initial insurance premium at closing and an ongoing annual premium for any required flood insurance. If an escrow account is required for taxes and hazard insurance premiums, escrow must also be used for required flood insurance premiums.

If, at any time during the life of a loan, the lender determines that the property is in an SFHA and is not covered by flood insurance, it will instruct the borrower to obtain flood insurance. If the borrower does not promptly purchase the required insurance, the lender will force place (i.e., purchase) the insurance on the borrower’s behalf.

The Biggert-Waters Flood Insurance Reform Act of 2012 contains many reforms and changes, including clarifying that private flood insurance may satisfy flood insurance requirements if it meets certain standards. Fannie Mae, Freddie Mac and Ginnie Mae are required to accept flood insurance from private providers as an alternative to National Flood Insurance Program (NFIP) policies. The Act also amended RESPA to require an explanation of flood insurance and the availability under the NFIP or from a private insurance company.


Refinancing Considerations

Reasons a person might consider refinancing a home mortgage include:

  • lowering monthly payments.
  • withdrawing equity (cash-out mortgage refinance) to repay the previous mortgage and meet other financial expenses.
  • converting an adjustable-rate mortgage to a fixed-rate mortgage.
  • stopping the payment of private mortgage insurance.

Just as financing a new loan has a cost, so does refinancing. These costs may include, but are not limited to:

  • application, loan origination and appraisal fees.
  • escrow and title insurance costs.
  • per-diem interest.
  • tax and insurance reserves.
  • prepayment penalties on the existing loan.

Lenders have the responsibility to prove there is tangible net benefit to the borrower before proceeding with a refinance application. For example, a lender cannot charge $10,000 in fees just to get a one-quarter point reduction to the borrower’s interest rate. The benefit to the borrower would not justify the monetary cost.

A tangible net benefit to the borrower may be:

  • refinancing an adjustable-rate mortgage to a fixed-rate mortgage.
  • depending on the type of ARM being refinanced:
    • a reduction of at least five percent in the principal and interest payment; or
    • a new interest rate that is at least two percentage points below the current rate.


Prepayment Penalties

Loans may be made with or without a prepayment penalty provision. The presence of a prepayment penalty can affect the interest rate the lender will offer and create an additional cost when refinancing the loan.

A prepayment penalty is a charge imposed by the lender if the borrower repays the loan within a specified period of time, generally within five or fewer years from the date of consummation of the loan. A loan with a prepayment penalty will generally have a lower interest rate than one without, because it discourages the borrower from refinancing immediately if market interest rates drop.

All prepayment penalties will apply to repayment due to refinancing, because refinancing would occur when the borrower could obtain lower rates elsewhere and the lender would probably not be able to loan the money out again at the rate being charged the borrower. A penalty that applies only to refinancing is called a soft prepay penalty; one that applies to any prepayment, including from the sale of the property, is called a hard prepay penalty.


A penalty is most often expressed as a percentage of the outstanding loan balance at the time of prepayment or as a specified number of months of interest.

For Example

A $100,000 loan at 6% interest has a 2% penalty for prepayment within two years. If, at the time of prepayment, the loan balance were $98,750, the penalty would be 2% of $98,750.

A $100,000 loan at 6.5% interest has a penalty equal to six months’ interest if the loan were repaid within three years. If, at the time of prepayment, the loan balance were $98,750, the penalty would be 3.25% of $98,750.

A prepayment penalty may also be imposed for partial prepayments above a certain percentage of the loan balance within a certain period of time. Typically, a borrower may not prepay more than 20 percent of the loan balance in a single calendar year without penalty.


Refinancing Cost Recapture

A borrower intending to keep the refinanced loan for a number of years typically saves money by paying his loan costs up front, because his interest rate or loan amount will be lower and he will pay the lower rate year after year. Of course, if he does not keep the loan for the anticipated period, his costs may be more than if he had financed them in the new loan. For example, if he saves $40 a month in mortgage payments, his savings is $480 per year. If he paid loan and closing costs totaling $2,000, it would take more than four years to recapture his refinancing costs ($2,000 ÷ 480 = 4.16 years, or 4 years and 2 months).

Refinancing makes sense when a no-cost mortgage (no out-of-pocket costs) includes points and closing costs:

  • in the new interest rate, which is lower than his current rate; or
  • in the new loan amount, when the new monthly payment is still lower with the same or shorter loan term.

However, the borrower’s interest rate or mortgage payments will be higher than if he had paid his costs up front.




Waiting Period To Finance The Purchase Of Another Home

Fannie Mae 2

► Foreclosure: 7 years from the completion date
► Short sale/deed-in-lieu: 4 years
► Chapter 7 bankruptcy: 4 years from discharge or dismissal date
► Chapter 13 bankruptcy: 2 years from discharge, 4 years from dismissal


Freddie Mac 3

► Foreclosure: 7 years from the completion date
► Short sale/deed-in-lieu: 4 years
► Chapter 7 bankruptcy: 4 years from discharge or dismissal date
► Chapter 13 bankruptcy: 2 years from discharge date, 4 years from dismissal



► Foreclosure: 3 years from the completion date
► Short sale/deed-in-lieu: 1 year with conditions
► Chapter 7 bankruptcy: 2 years from discharge date
► Chapter 13 bankruptcy: with a full 1 year of payout*

*With satisfactory payment history, borrowers can ask permission from the courts to enter into a new mortgage.

4 https://www.fha.com/fha_requirements_credit

VA 5

► Foreclosure: 2 years from the discharge date
► Short sale/deed-in-lieu: No specific waiting period
► Chapter 7 bankruptcy: 2 years from discharge date
► Chapter 13 bankruptcy: with a full 1 year of payout*

*With satisfactory payment history, borrowers can ask permission from the courts to enter into a new mortgage.

5 https://www.blogs.va.gov/VAntage/19931/va-busts-four-home-loan-myths-that-hurt-veteran-homebuyers/

USDA/Rural 6

► Foreclosure: 3 years from completion date
► Short sale/deed-in-lieu: 3 years from completion date
► Chapter 7 bankruptcy: 3 years from discharge date
► Chapter 13 bankruptcy: with a full 1 year of payout*

*With satisfactory payment history, borrowers can ask permission from the courts to enter into a new mortgage.

6 http://usdaloan.org/how-to-get-a-usda-mortgage-after-bankruptcy/

What is ARM in Mortgage

The initial interest rate for an ARM may be:

  • the fully indexed rate (the margin plus the index rate); or
  • a lower rate, which may be called a “discounted index rate,” a “start rate,” a “teaser rate,” or the note rate (as it was the rate expressed in the mortgage note). This rate is lower than the fully indexed rate and lower than that for an FRM, making the ARM payments more affordable than those for an FRM for the same loan amount.

The initial rate and payment amount on an ARM remain in effect for a limited period of time, ranging from just one month to five years or more. When that initial rate period has expired, the rate will be adjusted based on the index rate at that time and any caps.

For Example
The lender’s fully indexed one-year ARM rate (index rate plus margin) is currently 6%. At that rate, the monthly payment for the first year of a particular loan would be $1,199.10. But the lender is offering an ARM with a discounted initial fixed rate of 4% for the first year. At the 4% rate, the monthly payment for the first year would be just $954.83. The adjustable-rate that goes into effect starting in year 2 of the loan will vary, and most likely rise, based the index rate that will fluctuate during the loan’s term.


When the initial rate is discounted, it and the loan payments can vary greatly from the rates and payments later in the loan term, even if interest rates are stable. When a loan’s APR is significantly higher than its initial rate, it is likely that the rate and payments will be much higher when the loan adjusts, even if current interest rates remain the same.

A lower initial ARM rate provides an incentive for a borrower to assume some of the interest risk (i.e., the risk of rising interest rates during the loan period) that the lender has with a fixed-rate loan. A lender making a 5 percent fixed-rate loan would receive 5 percent interest whether current interest rates were 4 percent or 10 percent. If the current rates were 10 percent, he could be paying a higher rate of interest for the money he is borrowing than he is receiving from his existing fixed-rate borrowers. An ARM interest rate, however, will increase when current rates increase, so the lender is able to pass on some or all of the interest risk to the borrower. This means ARM loan payments generally rise when interest rates rise and fall when interest rates fall.


A loan applicant should be advised to seriously consider whether he will be able to afford the higher payments required when the loan rate is adjusted:

  • if interest rates are rising rapidly at the time of the application.
  • if his initial rate is discounted. Because use of a deeply discounted initial rate exposes the borrower to the risk of payment shock and negative amortization, many lenders now require, and for some types of loans, the law now requires, that the borrower is qualified based on the fully indexed rate.

For Example
A 30-year $150,000 loan has a one-year ARM rate (index rate plus margin) at 6%. However, the lender is offering a 4% rate for the first year. With the 4% rate, the monthly payment for this loan is $716.12 during the first year.

In the second year, the index rate stays the same. The monthly payment amount still increases, based on the 6% ARM rate, to $899.33.

For Example
If the index rate then increases 2 percentage points in one year, the ARM rate will rise to a level of 8%. The monthly payment will increase to $1,100.65, assuming the loan has no rate adjustment cap, as discussed later in the course.
ARM Interest Rate            Monthly Payment
1st Year, at 4%                       $716.12
2nd Year, at 6%                      $899.33
3rd Year, at 8%                    $1,100.65
If the borrower were qualified for the loan based on the Ability to Repay Rule (ATR Rule), the annual increase in the monthly payment amount should present no problem. Under the rule, a creditor must determine that a loan applicant is able to repay the loan according to its terms. One of the factors in determining the ability to repay is whether the applicant can make monthly payments in an amount based on the loan’s fully indexed rate and substantially equal monthly payments that fully amortize the loan.

The Adjustment Period
For a loan with an adjustable interest rate, the interest rate and loan payment are subject to change.

The terms of the loan will specify the frequency of monthly payment changes. It may specify that the interest rate and monthly payment are subject to change every month, quarter, year, three years, five years, or some other term. The period between rate changes is called the adjustment period.

For Example
A loan with an adjustment period of one year is called a one-year ARM, and the interest rate and payment can change once every year.

A loan with an initial three-year interest rate and then an annual adjustment period is typically called a 3/1 ARM, which means that the first adjustment occurs three years into the loan and then will adjust every year for the remaining term of the loan.

ARMs may have limits on the amount of any one adjustment and/or the amount of the total adjustment from the note rate over the entire term of the loan. These limits are referred to as caps. They may limit the percentage by which the interest or the payment can increase at each adjustment.


Interest Rate Caps
One such limit is an interest rate cap, which limits the amount by which the loan’s interest rate may change.

One version of this cap is the periodic adjustment cap. This cap limits the amount of the increase, and often the decrease, in the interest rate at the time of any adjustment. With a 1 percent cap, if the current interest rate being charged on the loan is 6 percent, the lender cannot raise the interest rate above 7 percent at the time of the next adjustment, whether the adjustment period is one year or five years. When the adjustment period is one year, the lender may refer to the interest rate cap as an “annual cap.”

A new rate that is subject to an interest cap at the time of an adjustment is equal to the lower of:

  • the index rate plus margin; or
  • the current rate plus the cap.


For Example
An ARM had an initial rate of 6%. It has a 2% annual cap and a margin of 2.5%. If its index rate, the Treasury bill rate, has increased 3 percentage points to 6.5%, the new ARM rate when it is adjusted would be the lower of the two calculations:
6.5% (Index Rate)                            6.0% (Current Rate)
+ 2.5% (Margin)                              + 2.0% (Cap)
9.0% ARM (Without Cap)                   8.0% ARM (With Cap)
ARM Interest Rate                                Monthly Payment
1st Year, at 6%                                          $899.33
2nd Year, at 9% (without cap)                    $1,206.93
2nd Year, at 8% (with cap)                        $1,100.65
In this case, the difference in the second year between the monthly payment with the cap and the payment without the cap would be $106.28.

A lifetime (overall) cap limits the interest rate increase, and perhaps the total rate decrease, over the entire term of the loan. Most ARMs have a lifetime cap.

An ARM with a 1/6 cap has a 1 percent cap per year and a 6 percent lifetime cap.

For Example
A loan was written at 6% interest with a 1/5 cap. The interest rate on the loan could never be increased by more than 1 percentage point in a year or by more than 5 percentage points (to a maximum of 11%) over the life of the loan. If the same annual cap applies to decreases, the rate would never be reduced by more than 1 percentage point per year.

Assume the index rate increases 1 percentage point in each of the first 10 years:

ARM Interest Rate Monthly Payment
1st Year, at 6% $899.33
10th Year, at 15% (without cap) $1,896.67
10th Year, at 11% (with 5% cap) $1,428.49

With a 5% overall cap, the payment would never exceed $1,428.49, no matter how much rates continue to rise.


Interest Rate Caps

Some ARMs have three interest rate caps:

  1. An initial cap
  2. A periodic cap (usually annual)
  3. A lifetime cap



For Example

A seven-year ARM has interest rate caps of 5/2/5.

  • The initial cap is 5 percent. When the first change takes effect at the start of the eighth year of the loan, it cannot result in a rate higher than 5 percentage points above the start rate.
  • The periodic cap is 2 percent (and applies to any change during the remainder of the loan term). If the changes are annual, the rate cannot increase by more than 2 percentage points in any year.
  • The lifetime cap is 5 percent. Therefore, the interest rate can never be higher than 5 percentage points above the start rate.

Remember that an initial cap of 5 percent does not mean the rate will necessarily go up by 5 percentage points when it adjusts, only that it can adjust by as much as 5 percentage points. The 2 percent periodic cap means the rate can change by any amount (based on the index rate changes) up to 2 percentage points at any time of adjustment, as long as the new rate is not above the lifetime cap.

If the initial adjustment cap and annual caps are the same (e.g., 1 percent) and the lifetime cap is 6 percent, the ARM may be described as either a 1/1/6 or just as a 1/6 caps.

Some ARMs allow a larger rate change at the first adjustment and then apply a periodic rate adjustment cap to all future adjustments. An ARM may have an initial fixed rate period of three years, after which the first adjustment can increase the rate by up to 2 percentage points, with any further increase limited to 1 percentage point, and with no lifetime cap. This may be advertised as a 3/2/1 ARM.

A drop in interest rates does not always lead to a drop in a borrower’s monthly payments. With an ARM that has an interest rate cap, the cap may hold the rate and payment below what it would have been if the change in the index rate had been fully applied. The increase in the interest that was not imposed because of the rate cap might carry over to future rate adjustments. This is called carryover. So at the next adjustment date, the payment might increase even though the index rate has stayed the same or declined.

For Example

Jerry Attric has a $150,000, 30-year ARM loan with a 6% interest rate. The index on his ARM increased 3 percentage points during the first year. However, because his ARM limits rate increases to 2 percentage points at any one time, the rate is adjusted by only 2 percentage points, to 8%, for the second year. The remaining 1 percentage point increase in the index carries over to the next periodic adjustment. So even though there is no change in the index during the second year, when the lender adjusts Jerry’s interest rate for the third year, the rate increases by 1 percentage point, to 9%, and his payment increases by $106.28.
ARM Interest Rate                                                                     Monthly Payment
1st Year, at 6%                                                                       $899.33
If index rises 3% 2nd Year, at 8% (with 2% rate cap)                 $1,100.65
If index stays same for 3rd Year, at 9%                                    $1,206.93

In general, a loan’s rate can increase at the time of any scheduled adjustment when the lender’s fully indexed ARM rate (the index plus the margin) is higher than the rate the borrower is paying before that adjustment.

Payment Caps

In addition to interest caps, an ARM may have a payment cap. A payment cap limits the percentage increase of the required minimum periodic payment from the previous periodic payment, regardless of the change in the index or the interest rate, which if paid in that amount will cause the deferring of some of the interest.

The payment cap limits only the amount the required minimum scheduled payment can increase. It does not limit interest rate increases. Therefore, payments limited by such caps may not cover all the interest charged on the loan. If that is the case, the unpaid interest is automatically added to the debt and interest is then charged on that amount. Because any unpaid interest is added to the mortgage principal, the borrower owes more than the amount originally borrowed. When a payment cap limits the increase to a borrower’s required minimum monthly payments and the deferred interest is added to the amount owed on the loan, this is called negative amortization.

Some ARMs with payment caps do not have periodic interest rate caps.

For Example
For Example
Mel Lowe has a 30-year $150,000 ARM loan with no interest cap but with a payment cap of 7.5%. This means his monthly payment will not increase more than 7.5% over his previous payment, even if interest rate changes would indicate a higher payment is needed to pay all of the interest being charged. Mel’s monthly payment in the first year was $899.33, based on a 6% interest rate. This year, his rate has increased to 8%, which without any cap would result in a payment of $1,100.65. However, because of the payment cap it can go up to only $966.78 in Year 2 (7.5% of $899.33 is an additional $67.45).Unfortunately for Mel, he is still being charged the 8% interest on the $133.87 ($1,100.65 – $966.78), so the unpaid interest is added to his loan balance, resulting in negative amortization.
ARM Interest Rate                                                        Monthly Payment
1st Year, at 6%                                                              $899.33
2nd Year, at 8% (without payment cap)                           $1,100.65
2nd Year, at 8% (with 7.5% payment cap)                          $966.78

Negative Amortization

Negative amortization occurs when the amount owed increases, even when the borrower makes all required payments on time, because his monthly mortgage payments are not large enough to pay all of the interest charged.

Eventually, the borrower will have to repay the higher remaining loan balance at the interest rate then in effect. When this happens, a substantial increase in the monthly payment may result.

A mortgage may have a cap on negative amortization, typically limiting the total amount owed to 110 percent to 125 percent of the original loan amount. At that point, the lender will reset the monthly payment amounts to fully repay the loan over the remaining term. Any payment cap will not apply, and payments could be substantially higher. A borrower can limit negative amortization by voluntarily increasing his monthly payment.


Payment Shock
Payment shock occurs when a borrower’s mortgage payment rises sharply (perhaps doubling or tripling) at a rate adjustment. Often the borrower is less creditworthy and less financially able to make the increased payments that are due following the shock. Depending on the terms and conditions of a mortgage and changes in interest rates, ARM payments can change quite a bit over the life of the loan. So although a borrower could save money in the first few years of an ARM, that same borrower may find himself “shocked” when forced to face much higher payments in the future.

For Example
In the second year of an ARM with an initial 4% discounted rate, the interest rate rises to the 6% fully indexed rate, even though the index rate had not changed, and the monthly payment increases from $954.83 to $1,192.63. If the index rate had increased 1 percentage point in that year, the ARM rate would have risen to 7%, and monthly payments would have risen to $1,320.59. That is an increase of $365.76 in the monthly payment. This is payment shock!


Prepayment Penalties (12 CFR 1026.32(b)(6))
An ARM may require the borrower to pay special fees or penalties upon refinance or early payoff if a loan is paid off within the first three years of its term. The amount of that penalty is limited based on when the payoff occurs. Prepayment penalties include:

  • hard prepayment penalties, where an extra fee or penalty is imposed if the loan is paid off during the penalty period for any reason (e.g., because of refinance or sale of the home).
  • soft prepayment penalties, where an extra fee or penalty is owed if the loan is refinanced, but not if the home is sold.
  • prepayment penalties even if a borrower makes only a partial prepayment. However, most mortgages do allow a borrower to make additional principal payments with any monthly payment. They do not consider this to be a prepayment and do not charge a penalty for the extra amounts.

(12 CFR 1026.43(g)(2))
Prepayment penalties can be several thousand dollars. When permitted, a prepayment penalty may not exceed:

  • two percent of the amount prepaid if prepayment occurs within the first two years after consummation of the loan; and
  • one percent of the amount prepaid if prepayment occurs within the third year after consummation of the loan.
For Example
Grace Period has an ARM with an initial annual rate of 6% that will last for three years. At the end of the second year, she decides to refinance and pay off her original loan. At the time of refinancing, her balance is $194,936. Because her loan has a prepayment penalty on the remaining balance (i.e., the amount prepaid), she would owe about $3,898.72 (2% x $194,936 = $3,898.72).

Often, there is a trade-off between a prepayment penalty and lower origination fees or lower interest rates. Because the lender would prefer that the loan not be repaid within a short period, he may be willing to charge lower loan fees or a lower interest rate if the borrower will accept a loan with a prepayment penalty.

Conversion Fees
A loan agreement may include a clause that allows the borrower to convert an ARM to a fixed-rate mortgage at designated times. Upon conversion, the new rate is generally set using a formula provided in the loan documents. In order to obtain this conversion right, the borrower may be charged a somewhat higher interest rate or up-front fees as well as a fee at the time the conversion right is exercised.

When Consumers Might Want an ARM
A consumer might prefer an ARM to a fixed-rate mortgage loan when:

  • he anticipates selling or refinancing his home before the initial rate adjusts.
  • he anticipates a significant increase in wages before the initial rate adjusts.
  • interest rates are too high to accept for the entire loan term.
  • he anticipates interest rates will fall and can accept the risk if they do not.

Hybrid ARMs

hybrid ARM is a mix (hybrid) of a fixed-rate loan and an adjustable-rate loan. It has an initial period during which the rate is fixed, after which, for the remainder of the loan term, the rate is adjustable. An ARM with a two-year fixed period may be advertised as:

  • a 2/28 ARM, meaning it has an interest rate that is fixed for the first two years, followed by a 28-year period during which the rate will be adjustable. The adjustment period may be a number of years, annual, six months or shorter.
  • a 2/1 ARM, to show a fixed rate for two years and an annual adjustment period after that, or as a 2/6 ARM to show a fixed rate for two years and a six-month adjustment period after that.
  • a two-year ARM, meaning the rate is fixed for two years and implying that it has annual adjustments and a 30-year term.
Most ARM loans are simply referred to as “ARMs” and do not refer to the term “hybrid”. Additionally, federal regulations prohibit the use of the term “fixed” when advertising an ARM.


The Federal Housing Administration (FHA) offers a standard one-year ARM and four hybrid ARM products, with initial interest rates constant for the first three, five, seven or 10 years. After the initial period, the interest rate adjusts annually. Therefore, an FHA 10/1 ARM has a fixed rate for the first 10 years and adjusts annually starting in Year 11. The one-year ARM and three-year hybrid ARM have annual interest rate caps of 1 percent and lifetime interest rate caps of 5 percent. The five-, seven- and 10-year hybrid ARMs have annual interest rate caps of 2 percent and lifetime interest rate caps of 6 percent.

For Example
An FHA 5/1 ARM has caps of 2/6. This means it is fixed for five years, with annual adjustments. These adjustments are capped at 2 percentage points each year and 6 percentage points over the term of the loan.


While a fixed-rate mortgage may be offered on an interest-only (I-O) payment plan, most mortgages that offer an I-O payment plan have adjustable interest rates. An interest-only ARM payment plan allows a borrower to pay only the interest for a specified number of years, typically between three and 10 years. This allows the borrower to have smaller monthly payments for a period of time. After that, the monthly payment will increase, even if interest rates stay the same, because the borrower must start paying back the principal as well as the interest each month. Therefore, with an interest-only ARM, payment shock will often occur when the I-O period ends. The longer the I-O period, the higher the monthly payments will be after the I-O period ends, because the remaining period within which all of the principal must be repaid will be correspondingly shorter.

For Example
Jess Trite has a 30-year mortgage loan with a five-year I-O payment period. As a result, he will pay only interest for five years and then must pay both the principal and interest over the next 25 years. Because the principal is now included in his payments after the fifth year, those payments will be much higher than they had been, even if the rate stays the same.

For some I-O loans, the interest rate adjusts during the I-O period as well.


Risks of I-O ARMs

I-O mortgage payment ARMs present the borrower with substantial risks, including:

  1. Rising monthly payments and payment shock: Initially, I-O ARM payments are lower than traditional mortgage payments. However, when the I-O payment period ends, the payments will change considerably, as the entire principal amount will have to be repaid over a shorter period than 30 years.The greatest risk occurs when the borrower focuses only on his ability to make the I-O payments, because eventually he will have to pay all of the interest and some of the principal each month. When that happens, the increase in his payment could lead to payment shock and an inability to make the required payment.Before taking an I-O mortgage he must consider not only how he will make the initial payments but also whether he can make the payments in the years ahead.
  2. Refinancing: A borrower may plan on avoiding payment shock and higher monthly payments by refinancing his mortgage, if necessary. However, this would be feasible only if interest rates decrease. Because no one knows what interest rates will be in three, five or 10 years, it is as realistic a plan as placing all of one’s savings on red (or black) at a roulette table.
  3. Prepayment penalties. If the I-O mortgage has a prepayment penalty, a borrower who refinances the loan during the prepayment penalty period could owe additional fees (the penalty). Most mortgages will allow the borrower to pay additional amounts each month, without penalty, that will apply to principal. However, some loans will apply the repayment penalty when too much of the principal is prepaid in one year. A loan may limit the amount that may be prepaid without penalty to:
    • a percentage (e.g., 10 percent) of the principal amount (either the original amount or the current balance), payable in a lump sum or in installments, at any time or at one or more specified times during the year; or
    • a percentage of any scheduled payment (e.g., 50 percent).
  4. Falling housing prices. A borrower may have a home worth less than he owes on the mortgage if he starts with minimal equity and housing prices fall, or if housing prices neither rise nor fall and he has experienced negative amortization. In either case, it would be difficult to refinance or sell the home. If he were to sell, he would have to pay money at closing unless the lender agrees to a short sale and allows the property to be released from the lien even though it is sold for less than the loan balance. However, the borrower will have ruined credit and may still be held liable for repayment of the lender’s shortage after the sale.

Despite their risks, the I-O ARM might be suitable for a borrower if one of the following apply:

  • His current income is modest, but he is reasonably certain that his income will increase in the near future (e.g., he is finishing a degree or training program).
  • He will have sizable equity in the home and will use the money that would normally go toward principal payments for other investments.
  • He will have irregular income (e.g., commissions or seasonal earnings) and wants the flexibility of making I-O minimum payments during low-income periods and larger payments during higher-income periods.


Pros and Cons of I-O ARMs


  • This type of loan allows the borrower to make lower monthly payments during the first few years of the loan.
  • It is flexible in that it allows the borrower to repay some of the principal at any time to help keep future payments lower.


  • Eventually, the principal borrowed must be repaid.
  • Lower monthly payments last only during the I-O-payment period. Payments will be larger later, and the borrower could lose his home and credit standing if he no longer has the income to cover those larger payments.
  • I-O monthly payments can increase, even during I-O-payment period.
  • In making I-O payments, the borrower does not build any equity through repayment of loan principal, even though he is making monthly payments. Although equity buildup through principal repayment is generally not significant during the first five years of a loan, the lack of any such buildup during this period would make it difficult for the borrower to sell his home within that period if there were no increase in the market value of his home or if any increase were not sufficient to cover the number of his selling expenses.

Interest-Only Loans under Dodd-Frank (15 USC 1639c(a)(6)(A), (B), (D))
The Dodd-Frank Act discouraged the origination of nonstandard loans, including interest-only ARMs. The resulting amendments to the TILA (the ATR Rule) require a creditor to:

  • use a fully amortizing repayment schedule when determining a consumer’s ability to repay variable-rate loans that defer the payment of principal or interest.
  • when making an interest-only loan, assess repayment ability using the payment amount required to amortize the loan by the end of its term.

In calculating the monthly payment amount for nonstandard residential mortgages to determine repayment ability, a creditor must:

  • base repayment on substantially equal monthly payments that will fully repay the loan by the end of its term, with no balloon payment;
  • use a fixed interest rate over the entire term of the loan that is equal to the fully indexed rate at the time the loan closes and that does not take into account any introductory rate.
  • assume full disbursement of the loan proceeds at the time the loan is consummated.


For Example

Loan Comparisons

Each loan is for $180,000 with a 30-year term:

Type of loan                 Rate                       Payment                        Equity buildup (5 yrs)
Fixed-rate                  6.7%                    $1,161                            $11,118
I-O Fixed-rate             6.9%                    $1,035 I-O/$1,261             $0
5/1 ARM                    6.4%                     $1,126                            $11,702
5/1 I-O ARM               6.4%                     $960                               $0

(Rate increases 2 percentage points per year up to 12.4%. 7.5% annual payment cap. Loan reaches 125% balance limit in month 49 and is recast as an amortizing loan at the beginning of Year 5.)

Money Laundering In Real Estate and Mortgage

Money Laundering

Money laundering is the process by which a criminal seeks to conceal the illegal origin of certain funds so that he may enjoy his ill-gotten gains. In effect, he is filtering the illegal gains, or “dirty” money, through a series of financial transactions in an effort to “clean” the funds so that they appear to be proceeds from legal activities. This may be done by:

  • hiding the origin and ownership of the criminal funds;
  • maintaining control of the criminal proceeds during the laundering process;
  • disguising and/or altering the form of the criminal funds (e.g., converting cash to loan disbursements); and
  • “cleaning” the criminal funds so that they can be used for legitimate purposes or used in other criminal activities.

While difficult to estimate, most sources put the amount of money laundered around the world each year at a staggering $2.5 trillion dollars, or about 5 percent of the world’s gross domestic product.

Terrorist Financing

Terrorist financing is a crime in which the threat of violence is used to intimidate a particular population to do, or to abstain from doing, a specific act. Financial infrastructure is essential to terrorist operations. Because terrorist groups must be able to access their funds easily and keep those funds fluid to obtain necessary materials and manage logistics, money laundering is critical to their operations.

Terrorists use both unlawful and legitimate sources to finance their operations. Unlawful activities include kidnapping, narcotics trafficking, smuggling, fraud, robbery and identity theft. Legitimate sources include charities, foreign government sponsors, business ownership and group members’ employment.

“Money laundering and terrorist financing are financial crimes with potentially devastating social and financial effects. From the profits of the narcotics trafficker to the assets looted from government coffers by dishonest foreign officials, criminal proceeds have the power to corrupt and ultimately destabilize communities or entire economies. Terrorist networks are able to facilitate their activities if they have financial means and access to the financial system. In both money laundering and terrorist financing, criminals can exploit loopholes and other weaknesses in the legitimate financial system to launder criminal proceeds, finance terrorism or conduct other illegal activities and, ultimately, hide the actual purpose of their activity.”

(Federal Financial Institutions Examination Council. Bank Secrecy Act, Anti-Money Laundering Examination Manual. http://www.ffiec.gov/bsa_aml_infobase/pages_manual/OLM_002.htm)


To disguise illegal activities and gains, money launderers may use techniques such as:

  • placement, the process of introducing unlawful proceeds into the financial system (e.g., loan balances quickly reduced by multiple cash payments under reporting thresholds).
  • layering, the process of separating the criminal proceeds from their criminal origins using financial transactions in one or more accounts (e.g., negotiable instruments used to purchase other negotiable instruments; the deposit of cash followed by a transfer of funds in almost the same amount to other accounts).
  • integration, the process of combining criminal proceeds with legal funds to provide legitimate ownership.
For Example
Sammy Hotfingers, head honcho for a local theft ring, deposited a large amount of cash into his bank account. The money was the proceeds made from selling the stolen goods on Craigslist. Sammy then used those funds, along with a mortgage, to purchase his dream home. Some months later, Sammy took out a home improvement loan using the house as collateral, telling the lender he wanted to begin making some upgrades. Sammy made large cash payments on the second mortgage, again using proceeds from his illegal activity. Sammy’s activities are a form of money laundering known as integration.


Red Flags
Red flags are suspicious activities that indicate possible illegal or unscrupulous activity. They include:

  • a customer who provides insufficient or suspicious information.
  • efforts to avoid reporting or recordkeeping requirements.
  • funds transfers:
    • in large or odd amounts; or
    • to or from a financial secrecy haven or a high-risk geographic location.
  • repetitive, unexplained or unusual transfer activities.
  • activity inconsistent with the customer’s business.
  • unusual or unexplained lending activity, such as:
    • a loan secured by pledged assets held by a third party unrelated to the borrower;
    • a loan made for, or paid on behalf of, a third party with no reasonable explanation; or
    • use of a certificate of deposit, purchased using an unknown source of funds, to secure a loan.
  • an employee who:
    • exhibits a lavish lifestyle not supported by his salary;
    • fails to follow established policies and procedures; or
    • is reluctant to take a vacation.
  • unusual or suspicious customer activity.

Red flags for identifying possible terrorist financing activity include:

  • activity inconsistent with a customer’s business (e.g., a customer’s stated occupation is not commensurate with the type or level of business activity).
  • funds transfer activities such as:
    • transfers that are ordered in amounts designed to avoid triggering identification or reporting requirements;
    • transfers that do not identify the originator or person on whose behalf the transaction is occurring; or
    • the use of personal, business or nonprofit accounts to funnel money to a small number of foreign beneficiaries.
  • unusual or suspicious transactions such as:
    • transactions involving foreign currency exchanges followed by funds transfers to higher-risk locations;
    • transactions involving the movement of funds to or from higher-risk locations where there appears to be no logical business reason for the person to be dealing with those locations; or
    • banks from higher-risk locations opening accounts.

A complete list of money laundering and terrorist financing red flags is included in the Anti-Money Laundering Examination Manual, which can be found at the following websites:


Bank Secrecy Act

The Bank Secrecy Act (the BSA), formally referred to as the Currency and Foreign Transactions Reporting Act of 1970, was designed to prevent financial institutions in the United States from being used to launder money. In requiring such institutions to work with government agencies to prevent and detect money laundering, provisions of the BSA require recordkeeping and the reporting of specific transactions that have a higher risk of being used to launder money, evade taxes and aid in other criminal activities. Required reports include:

  • the Currency Transaction Report (CTR, IRS form 4789).
  • the Report of International Transportation of Currency or Monetary Instruments (MIR, IRS form 4790).
  • the Report of Foreign Bank and Financial Accounts (FBAR, IRS form TD F 90-22.1).

These reports assist in forming the paper trail needed by law enforcement to track untaxed dollars and the millions of dollars being laundered through financial institutions.

The BSA was amended by the passage of the USA PATRIOT Act of 2001. It is enforced by the Financial Crimes Enforcement Network (FinCEN), a section of the U.S. Treasury Department.

Bank Secrecy Act

Purpose and Applicability
The goals of the BSA include:

  • preventing and detecting money laundering and the financing of criminal activity.
  • documenting large currency transactions.
  • improving reporting and aiding in the investigation of financial crimes.

The BSA applies to financial institutions. A financial institution is each agent, agency, branch or office within the United States of any person doing business, whether or not on a regular basis or as an organized business concern, as:

  • a bank.
  • a broker or dealer in securities.
  • a money services business.
  • a telegraph company.
  • a casino.
  • a card club.
  • a person under the supervision of any state or federal bank supervisory authority.
  • a futures commission merchant.
  • an introducing broker in commodities.
  • a mutual fund.
  • nondepository financial institutions, including mortgage bank, broker, lender and originators employed by mortgage licensees.

BSA Requirements (12 CFR §326.8 (c))
Under the BSA, financial institutions are required to establish and maintain procedures designed to ensure their compliance with the law. Federal regulations outline such requirements. Each institution must develop a written anti-money laundering compliance program, which must be approved by the institution’s board of directors. Minimum requirements for the program include:

  • internal controls and metrics to ensure compliance.
  • independent auditing of compliance.
  • the designation of individuals responsible for managing compliance.
  • staff training for compliance.

BSA Requirements – (continued)

Provisions of the BSA also require a financial institution to:

  • report to FinCEN on a CTR any large currency transaction that exceeds $10,000. Such a transaction may be a single transaction or a structured currency transaction (i.e., multiple transactions made by or on behalf of the same person designed to evade reporting requirements).
  • record specific, large negotiable instrument purchases. Financial institutions must record single or structured cash purchases of negotiable instruments between $3,000 and $10,000. (Purchases that exceed $10,000 would require a CTR.) These records must be provided to FinCEN upon request.
  • report suspicious activity and transactions to FinCEN using a Suspicious Activity Report (SAR).
  • record large wire transfers that exceed $3,000, regardless of whether it is the initiating, intermediary or receiving institution. When requested, institutions must provide these records to FinCEN.
  • monitor foreign account activities. Financial institutions are prohibited from establishing, maintaining, administering or managing a correspondent account in the United States for, or on behalf of, a foreign shell bank (i.e., a foreign bank without a physical presence in any country). Covered institutions must also ensure that the accounts they maintain for foreign banks are not being used by that foreign bank to indirectly serve any foreign shell bank.

Provisions of the BSA also require a financial institution to (continued):

When a financial institution maintains a correspondent account for a foreign bank, the institution must record and report “the name and street address of a person who resides in the United States and is authorized, and has agreed to be an agent to accept service of legal process for records regarding each such account” when the owner’s or agent’s shares of the foreign bank are not publicly traded. (31 CFR §1010.630(a)(2))

The required information must be maintained and certified and/or updated at least every three years. If, at any point, the covered financial institution determines that the information provided by the foreign bank is not accurate, it must request accurate certification or close all correspondent accounts with the foreign bank.

The only exemption is if the foreign bank annually files with the Federal Reserve a form FR YR-7. The FR YR-7 is an annual report by a foreign banking organization (FBO) with a U.S. presence that includes financial statements, organizational structure information, shares and shareholder information, as well as eligibility data required for qualification as an FBO under Regulation K. (Federal Reserve, 2011)


Provisions of the BSA also require a financial institution to (continued):

  • cooperate with money laundering or suspicious activity investigations and any FinCEN requests for information related to such investigations.
  • implement a customer identification program (CIP) that includes procedures for:
    • verifying customer identities;
    • maintaining verification records;
    • cross-checking customer identities with government lists for known or suspected terrorists or terrorist organizations;
    • distributing CIP notices to customers; and
    • working with third-party financial institutions to meet CIP requirements.

Penalties (31 USC §5322)
Violations of the BSA may result in penalties for individuals, financial institutions and employees of financial institutions. These include the following:

  • Individuals: An individual may be sentenced to as much as 10 years in prison and ordered to pay up to $500,000 in fines. Personal property, loan collateral, bank accounts or any other assets or involved property may be seized.
  • Covered financial institutions: A financial institution may:
    • lose its institution charter;
    • be fined up to $1 million; and/or
    • be the subject of a cease-and-desist order covering all of its operations.
  • Covered financial institution employees: An individual employee in violation of the BSA (including those who willfully “look the other way”) may:
    • face employment termination;
    • be barred from the financial services industry; and/or
    • be subject to up to 10 years in prison and/or fines in an amount up to $500,000.

Additional consequences may be imposed by other government organizations as a result of noncompliance, as these types of crimes typically involve violations of numerous laws, including the BSA.


USA Patriot Act

The USA PATRIOT Act of 2001 (“Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism”) amended the BSA following the events of September 11, 2001.

The purpose of the USA PATRIOT Act, as it relates to covered financial institutions, is to:

  • better prevent, detect and prosecute money laundering and terrorist financing.
  • enhance:
    • law enforcement investigatory tools; and
    • the requirements for, and impose special scrutiny on, high-risk customers, products and geographic locations that may be susceptible to criminal abuse.
  • impose requirements on all members of the financial services industry to report suspected money laundering.
  • strengthen measures to prevent the use of the U.S. financial system for personal gain by corrupt foreign officials and facilitate repatriation of stolen assets to the citizens of countries to whom such assets belong.


Relevant Sections
The scope of the USA PATRIOT Act is significant and wide ranging. The sections that affect financial institutions include the following:

  • Section 311 – Special Measures for Jurisdictions, Financial Institutions or International Transactions of Primary Money Laundering Concern: Section 311 enhances requirements for correspondent accounts. This includes requiring verification and information collection similar to that for domestic customers, as well as establishing guidelines for the opening or maintenance of U.S. correspondent or payable-through accounts (also known as “pass-through” or “pass-by” accounts) for foreign banking institutions.
 A correspondent account, as defined by the USA PATRIOT Act, is an account established to:

  • receive deposits from, or make payments on behalf of, a foreign financial institution; or
  • handle other financial transactions related to such an institution.

A payable-through account is a checking account, generally marketed to foreign banks, that allows such banks to offer their customers access to the U.S. banking system.

  • Section 312 – Special Due Diligence for Correspondent Accounts and Private Banking Accounts: Section 312 amends the BSA by requiring enhanced due diligence by U.S. financial institutions that maintain correspondent accounts for foreign financial institutions or private banking accounts of non-U.S. persons.

USA Patriot Act

The scope of the USA PATRIOT Act is significant and wide ranging. The sections that affect financial institutions include the following (continued):

  • Section 313 – Prohibition on U.S. Correspondent Accounts with Foreign Shell Banks: To prevent foreign shell banks from having access to the U.S. financial system, Section 313:
    • prohibits banks and broker-dealers from maintaining correspondent accounts for any foreign bank that does not have a physical presence in any country; and
    • requires financial institutions to ensure their correspondent accounts are not indirectly used to provide correspondent services to such banks.
  • Section 314 – Cooperative Efforts to Deter Money Laundering: Section 314 requires information sharing from financial institutions and regulators to law enforcement when formally requested through FinCEN and establishes requirements for institutions that participate in voluntary sharing.
  • Section 319(b)– Bank Records Related to Anti-Money Laundering Programs: Section 319(b):
    • authorizes the Attorney General or the Secretary of the Treasury to issue a summons or subpoena to any foreign bank that maintains a correspondent account in the United States for records related to such accounts; and
    • requires the maintenance of records identifying a legal agent for correspondent accounts.

The scope of the USA PATRIOT Act is significant and wide ranging. The sections that affect financial institutions include the following (continued):

  • Section 325– Concentration Accounts at Financial Institutions: Section 325 permits the Secretary of the Treasury to issue regulations regarding concentration accounts. This includes ensuring that such accounts are not used to disguise the identity of the customer who is the owner of the funds moved through the account.
A concentration account (also known as a “special-use,” “suspense” or “collection” account) is an internal account established to facilitate the processing and settlement of multiple or individual customer transactions within the bank, usually on the same day.
  • Section 326 – Verification of Identification: Section 326 establishes requirements for verifying customer identities at the time an account is opened.
  • Section 351 – Amendments Relating to Reporting of Suspicious Activities: This section expands:
    • immunity from liability for reporting suspicious activities; and
    • the prohibition against notifying an individual who is the subject of an SAR of its filing.
  • Section 352– Anti-Money Laundering Programs: Section 352 requires financial institutions to establish anti-money laundering programs.


Government Agencies
Several U.S. government agencies work together to prevent and detect money laundering and enforce anti-money laundering laws and regulations.

U.S. Treasury
The BSA grants authority to the U.S. Treasury to require covered financial institutions (e.g., banks, savings associations and credit unions) and nonbank financial institutions (e.g., money services businesses, mortgage lenders, brokers/dealers in securities and insurance companies) to establish anti-money laundering programs, file reports and retain records.

A bureau within the U.S. Treasury Department, FinCEN is the delegated administrator of the BSA. As such, it is charged with:

  • issuing guidance and regulations;
  • enforcing the BSA; and
  • coordinating communication and investigations with law enforcement agencies and financial institutions.


The Federal Banking Agencies
The federal banking agencies are responsible for helping to ensure compliance with the BSA by banks and other institutions, which the agencies monitor and regulate through supervision and audits.

The Office of Foreign Assets and Control (OFAC) is an office under the U.S. Treasury Department responsible for administering and enforcing economic sanctions.


Required Reporting
Currency Transaction Report
Under the BSA, a financial institution must report to FinCEN single or structured currency transactions that exceed $10,000 using a Currency Transaction Report (CTR). Currency transactions include “any deposit, withdrawal, exchange or other payment or transfer” that involves currency (Federal Financial Institutions Examination Council, 2010).

A CTR must be filed within 15 days following the day on which the reportable transaction occurred (25 days if filed electronically), and a copy must be retained by the institution for at least five years. Certain types of customers may be exempted from currency transaction reporting, however, including:

  • Phase I exemptions, such as:
    • domestic banks;
    • federal, state or local government agencies;
    • United States governmental authorities; and
    • entities, other than banks, whose common stocks are listed on the New York Stock Exchange or American Stock Exchange or have been designated as NASDAQ National Market Securities listed on the NASDAQ Stock Market.
  • Phase II exemptions, such as:
    • certain nonlisted businesses; and
    • payroll customers (i.e., customers that have maintained transaction accounts at the exempting institution for at least two months and that frequently withdraw more than $10,000 cash to pay their employees).


nonlisted business is a commercial enterprise with domestic operations that:

  • has maintained a transaction account at the exempting institution for at least two months;
  • frequently engages in currency transactions with the exempting institution in excess of $10,000; and
  • is incorporated or organized under the laws of the United States or a state.

Among those businesses not eligible for a Phase II exemption from the filing requirements are:

  • automobile or equipment dealerships;
  • lawyers, accountants and doctors;
  • investment services;
  • real estate brokers; and
  • title insurance and real estate closing agencies.


Suspicious Activity Report

Under the BSA, a financial institution must file a Suspicious Activity Report (SAR) upon the detection of:

  • criminal violations that:
    • involve insider abuse in any amount;
    • total $5,000 or more when a suspect can be identified; or
    • total $25,000 or more regardless of a potential suspect.
  • transactions conducted or attempted that total $5,000 or more, when the bank knows, suspects or has reason to suspect that the transaction:
    • may involve money laundering or other criminal activity;
    • is designed to evade the provisions of the BSA;
    • has no business purpose or apparent lawful purpose; or
    • is not typical for the customer.

A SAR must be filed with FinCEN no later than 30 days after the date of initial detection, and a copy, as well as any supporting documentation, must be maintained for at least five years.

Information entered on an SAR must be as accurate as possible and should include:

  • information about the reporting financial institution.
  • information about the suspect.
  • information about the suspicious activity, including, among other things:
    • the date(s) of the suspicious activity;
    • the total dollar amount of the suspicious activity;
    • a characterization of the suspicious activity;
    • the amount of recovered money, if any; and
    • any law enforcement agency notified, including a contact name and telephone number.
  • information about a contact person for the SAR.
  • an SAR narrative.
 An SAR narrative should be organized into an introduction, body and conclusion; may not include any supporting documentation, tables or graphics; and should answer the following questions:

  • Who is conducting the suspicious activity?
  • What instruments or mechanisms are being used to facilitate the suspect transaction(s)?
  • When did the suspicious activity take place?
  • Where did the suspicious activity take place?
  • Why does the filer think the activity is suspicious?
  • How did the suspicious activity occur?



Suspicious Activity Report – (continued)

The BSA and other privacy laws require that SARs be kept confidential and shared only with other law enforcement agencies. Also, federal law provides civil liability protection to persons filing SARs, regardless of whether such reports are filed pursuant to SAR instructions or are filed voluntarily. This means that financial institutions and their employees involved in SAR reporting are protected from civil lawsuits.

Suspicious Activity Monitoring
To ensure that suspicious activity is identified, an effective monitoring and reporting system must be in place. Components of such a system include:

  • the identification of unusual activity.
  • the ability of employees to be aware of and to identify unusual or suspicious activity.
  • the use of law enforcement requests to alert the financial institution to suspicious activity (e.g., subpoenas; National Security Letters, which are written investigative demands).
  • transaction monitoring through the review of transaction reports, patterns and suspicious activity.
  • automated account monitoring software.
  • the reporting of suspicious activity, even if it is not identified with an underlying crime.


Money Laundering Schemes
Knowledge of common schemes identified by financial institutions during their SAR investigations helps other institutions identify potential suspicious activity and money laundering schemes.

Findings in FinCEN’s 2008 report “Suspected Money Laundering in the Residential Real Estate Industry” showed that a sampling of 151 SAR narratives fell into six categories:

1. Structuring (e.g., making cash deposits or withdrawals at dollar values of $10,000 or less, making them at multiple teller windows on a single banking day, or making them at multiple branch locations or by multiple individuals into a single account on a single day)

2. Money laundering

For Example
A bank reported that during a three-month period, a customer received nearly $800,000 in large wire transfers to his account from an escrow company. The customer then purchased three large cashier’s checks payable to the same escrow company. It has been FinCEN’s experience that such activity may be part of a layering scheme.



Findings in FinCEN’s 2008 report “Suspected Money Laundering in the Residential Real Estate Industry” showed that a sampling of 151 SAR narratives fell into six categories (continued):

3. Tax evasion

For Example
A bank reported a series of transactions occurring within a one-month period in which the same property was bought and sold among related individuals. As a result of this flipping of the property, the bank granted a loan refinance of more than $600,000 to an individual who did not hold title to the property at the time the loan closed. The bank indicated in the SAR narrative that it was not able to definitively determine the motive for these transactions but surmised that they may have been conducted to promote money laundering or tax evasion.

4. Fraud

For Example
A mortgage lender reported that one of its customers was named in media reports. The customer had pled guilty to wire fraud and money laundering. He admitted that he obtained $6.4 million in mortgage loans using false appraisals.


Findings in FinCEN’s 2008 report “Suspected Money Laundering in the Residential Real Estate Industry” showed that a sampling of 151 SAR narratives fell into six categories (continued):

5. Identity theft

For Example
A mortgage lender reported that it received a change of address on a home equity line of credit account and later determined that the actual account holder’s identity had been assumed by another individual. Nearly $260,000 was paid out against the home equity line before the fraud was discovered. The funds were paid by check to several individuals.

6. Other reported or suspected illicit activities

For Example
A bank reported that within a four-month period a customer made structured cash deposits to her account. She also deposited large checks written by individuals residing in two different states. Additionally, the customer had received five wire transfers to her account totaling $150,000. All of these monies served to fund a wire transfer of more than $450,000 to an escrow companyIt was noted that another of the deposited large checks bore a memo line notation apparently referencing real estate in a city in a Middle Eastern country under Office of Foreign Assets Control sanctions. The customer also sent a wire transfer from the account to an individual located in another country in the same region.


Customer Identification Program (31 CFR §1020.220)
Under the BSA, all covered financial institutions must implement a Customer Identification Program (CIP) to help prevent and detect suspicious activity.

With such a program, a covered financial institution:

  • must verify customer identities and maintain verification records. (All verification documentation and information must be maintained for five years after the record was made.)
  • must cross-check customer identities with government lists for known or suspected terrorists or terrorist organizations.
  • must distribute CIP notices to customers.
  • may rely on verifications made by third-party financial institutions that meet CIP requirements.

Customer Identification Program – (continued)

Documentary Verification
Acceptable verification documents include:

  • for an individual customer, unexpired government-issued identification that establishes the nationality or residence of the individual (e.g., a driver’s license or passport).
  • for an entity:
    • certified Articles of Incorporation;
    • a government-issued business license;
    • a partnership agreement; or
    • a trust instrument.

Customer Identification Program – (continued)

Nondocumentary Verification
When acceptable documents are not available, the CIP must instruct institution employees on how to verify customer identities through:

  • customer contact.
  • third-party reporting agencies or public databases.
  • financial institution references.
  • financial statements.

Other CIP Requirements
In addition to identity verification, a financial institution must have procedures in place to:

  • cross-check customer identities with government lists for known or suspected terrorists or terrorist organizations.
  • notify customers of information requests to verify their identities.
  • obtain financial institution references.


Customer Due Diligence

Effective customer due diligence (CDD) sets forth policies and procedures that may be used to evaluate the risk of certain customer relationships. These policies and procedures increase the ability of a financial institution to:

  • protect itself against high-risk transactions; and
  • prevent and detect money laundering and terrorist financing.

BSA requires that covered financial institutions have in place the following CDD policies and procedures:

  • Adequate high-risk procedures based on the institution’s risk profile
  • CDD expectations and responsibilities
  • Adequate CIP and suspicious activity monitoring systems
  • Procedures for evaluating insufficient information
  • Accuracy and maintenance procedures

In May 2016, FinCEN issued final rules under the BSA to clarify and strengthen customer due diligence (CDD) requirements. The key requirements for financial institutions under the new rule include:

  • identifying and verifying the identity of customers.
  • identifying and verifying the identity of beneficial owners with 25% or more equity interest of the institution’s legal entity customers.
  • understanding the nature and purpose of customer relationships in order to develop a customer risk profile.
  • conducting ongoing monitoring to maintain and update customer information as well as identify and report suspicious transactions.


Customer Due Diligence – (continued)

Covered financial institutions not only must continually monitor and evaluate all customers, but also must obtain additional information for customers designated as high risk. Additional information that may be required may relate to:

  • the purpose of the account.
  • the source of the customer’s wealth.
  • the account’s beneficiaries.
  • the customer’s occupation and/or type of business.
  • financial statements.
  • financial institution references.
  • the proximity of the customer’s street address, employer or business location to the institution.
  • the frequency of international transactions.
  • forecasted activity volume.
  • explanations for account activity changes.


Information Sharing
The BSA and the USA PATRIOT Act require that covered financial institutions share information with federal law enforcement agencies as well as other financial institutions. This is coordinated through FinCEN.

When a federal law enforcement agency seeks specific information from a particular financial institution, the request is submitted through FinCEN, which then submits the request to the named financial institution. The request details the information needed. Within 14 days after receiving an information request, a covered institution must conduct a one-time search of its records to identify any current or past accounts or transactions for the specified individual or entity.

Covered financial institutions may voluntarily share information with other institutions to aid in identifying and reporting suspected terrorist or money laundering activities. Participating institutions must notify FinCEN of their voluntary sharing.


Mortgage Loan Fraud

In recent years federal and state regulatory and law enforcement agencies have exerted considerable efforts in preventing, investigating and prosecuting mortgage loan fraud.

Most data on mortgage fraud is compiled by the FBI from:

  • complaints from the mortgage industry at large.
  • the Housing and Urban Development Office of Inspector General (HUD-OIG) reports.
  • SARs filed with FinCEN.

Freddie Mac and Fannie Mae are required to report suspicious mortgage fraud activity on a Mortgage Fraud Incident Notice (MFIN) to an examiner-in-charge.

Lenders, insurers and regulatory agencies voluntarily contribute to a database compiled by the Mortgage Asset Research Institute, Inc. (MARI). The database, called the Mortgage Industry Data Exchange (MIDEX), consists of information about persons who participated in mortgage fraud.

Mortgage fraud may be investigated by the FBI, the HUD-OIG, the Internal Revenue Service (IRS), Postal Inspection Service, and state or local agencies.

Title 18 of the United States Code specifies jail terms and fines for the following crimes associated with mortgage loan fraud:

  • For fraud/false statements, up to five years in jail and/or a $100,000 fine
  • For a false mortgage loan application, conspiracy to commit fraud, fraud/swindles or bank fraud, up to 30 years in jail and/or a $1 million fine

The FBI and Mortgage Brokers Association have developed a Mortgage Fraud Warning Notice for voluntary use by mortgage loan originators. The notice points out the penalties for mortgage fraud.


Mortgage loan fraud can be fraud for property and/or fraud for profit.

Fraud for Property

Fraud for property involves a borrower lying about income or assets in order to qualify for a loan to buy a home in which he plans to live, but which he might resell at a profit if his income does not increase to enable him to keep making his payments. The most common activities involving fraud for property include the following:

  • Asset fraud:
    • Failing to disclose the use of a credit card (an unsecured loan) advance as the source of a down payment
    • Overstating assets for a down payment or collateral for the loan
    • Claiming a loan for the down payment as a gift, with use of a fraudulent gift letter
    • Claiming payment of an earnest money deposit that does not exist

Fraud for Property – (continued)

The most common activities involving fraud for property include the following (continued):

  • Income and employment fraud:
    • Overstating income and/or place or length of employment
    • Reporting fictitious employment and/or other sources of income with verification provided by co-conspirators
    • Lumping part-time income, bonuses and sporadic income in with salaried income
For Example

False Tax Letters

A Gainesville, Virginia, tax preparer was sentenced in June 2012 for his role in a mortgage fraud scheme.

According to court records, the defendant ran a tax preparation business, and beginning in 2004 he worked with real estate agents to help buyers obtain mortgage loans for which they were unqualified. The defendant did this by creating fraudulent tax letters that stated the borrowers had self-employment income and owned their own businesses when, in fact, they did not and usually had only low-paying jobs and could not afford to purchase the homes. The defendant also produced fraudulent tax returns to support the false income claims.

As a result of the false letters, Virginia mortgage lenders made more than $3.9 million in fraudulent loans to unqualified buyers and suffered losses of almost $2.4 million.

For his role in the scheme, the defendant was sentenced to 24 months in prison, followed by three years of supervised release. (“Tax Preparer Sentenced for Mortgage Fraud,” June 8, 2012, mortgagefraudblog.com)

Home Ownership and Equity Protection Act

The Home Ownership and Equity Protection Act of 1994 (the HOEPA) amended TILA by adding disclosure requirements for high-rate, high-fee loans.


High-Cost Loan

The loans covered under HOEPA are high-cost loans. They may also be called Section 32 loans because that is the section of Regulation Z in which they are defined. A high-cost loan is defined as any consumer credit transaction that is secured by the borrower’s principal dwelling in which:

  • the APR exceeds the APOR by more than:
    • 6.5 percentage points for a first-lien loan;
    • 8.5 percentage points for a first-lien transaction if the dwelling is personal property (e.g., a manufactured home) and the loan amount is less than $50,000; or
    • 8.5 percentage points for a subordinate lien loan; or
  • the total points and fees payable exceed:
    • for a transaction with a loan amount of $20,579 or more, five percent of the total loan amount; or
    • for a transaction with a loan amount of less than $20,579, the lesser of eight percent of the total loan amount or $1,029; or

High-Cost Loan – (continued)

high-cost loan is defined as any consumer credit transaction that is secured by the borrower’s principal dwelling in which (continued):

  • the creditor may charge:
    • a prepayment penalty more than 36 months after consummation or account opening; or
    • total prepayment penalties exceeding more than two percent of the amount prepaid.
The points and fees trigger ($1,029) and the total loan amount threshold ($20,579) figures must be adjusted annually on January 1 based on the annual percentage change in the Consumer Price Index reported on the preceding June 1.


For Example

For a $30,000 second-mortgage loan to be a high-cost mortgage, the APR must exceed the APOR by more than 8.5 percentage points or have points and fees charged that exceed 5% of the loan amount.

A $16,500 first mortgage is a high-cost mortgage if the APR exceeds the APOR by more than 6.5 percentage points or has points and fees that exceed the lesser of 8% of the loan amount or $1,029. In this case, the lender charges 6% in fees ($990), which is less than both the 8% and the $1,029thresholds. However, it is still considered to be a high-cost mortgage because it meets the 6.5 percentage points threshold required under the HOEPA.




High-Cost Loan – (continued)

Exemptions (12 CFR 1026.32(a)(2))
The rules related to high-cost mortgages do not apply to:

  • a reverse mortgage transaction;
  • a transaction to finance the initial construction of a dwelling;
  • a transaction originated by a housing finance agency that is also the creditor for the transaction; or
  • a transaction originated under the U.S. Department of Agriculture’s Rural Development Direct Loan Program.



In addition to other disclosures required under TILA, a creditor making a high-cost loan must provide a borrower certain disclosures at least three business days prior to consummation. They include:

  • the following statement:
You are not required to complete this agreement merely because you have received these disclosures or have signed a loan application. If you obtain this loan, the lender will have a mortgage on your home. You could lose your home, and any money you have put into it, if you do not meet your obligations under the loan.
  • the annual percentage rate.
  • the amount of the regular monthly or other periodic payment and the amount of any balloon payment.
  • for a variable-rate transaction, a statement that the interest rate and monthly payment may increase and a disclosure of the amount of the single maximum monthly payment based on the loan’s maximum interest rate.
  • for a closed-end transaction:
    • the total amount the consumer will borrow, as reflected by the face amount of the note; and
    • when the amount borrowed includes finance charges allowed in the calculation of points and fees in a high-cost mortgage, that fact must be stated, together with the disclosure of the amount borrowed.
The disclosure of the amount borrowed is considered accurate if it is not more than $100 above or below the amount required to be disclosed.

Prohibited Terms

A high-cost loan may not provide for:

  • a payment schedule with regular periodic payments that result in a balloon payment, unless:
    • the payment schedule is adjusted for the irregular or seasonal income of the borrower;
    • the loan is a bridge loan with a term of 12 months or less, taken in connection with the acquisition or construction of a dwelling that will be the borrower’s principal residence; or
    • the loan satisfies the requirements of a balloon-payment qualified mortgage.
  • negative amortization.
  • a payment schedule that consolidates more than two periodic payments and pays them in advance from the proceeds.
  • an increase in the interest rate after default.
  • a refund calculated by a method less favorable than the actuarial method for rebates of interest arising from a loan acceleration due to default.

The actuarial method is a method of calculating prepaid interest refunds that approximates the interest actually earned on a day-by-day basis; for a one-year loan, the interest is 1/365 per day.


A high-cost loan may not provide for (continued):

  • a prepayment penalty for longer than 36 months after consummation.
  • a demand feature that allows the lender to terminate the loan in advance of the original maturity date and demand repayment of the entire outstanding balance. However, repayment may be accelerated if the consumer:
    • committed fraud or material misrepresentation in connection with the loan;
    • fails to meet the repayment terms for any outstanding balance; or
    • acts in a manner that adversely affects the lender’s security for the loan or any right of the lender in the security.


A lender extending mortgage credit subject to HOEPA may not:

  • pay a contractor under a home improvement contract from the loan proceeds other than:
    • by an instrument payable to the consumer;
    • jointly to the consumer and the contractor; or
    • at the election of the consumer, through a third-party escrow agent in accordance with terms established in a written agreement signed by the consumer, the lender and the contractor prior to the disbursement. (12 CFR 1026.34(a)(1))
  • sell or assign the mortgage to another person without furnishing the following statement to the purchaser or assignee:
Notice: This is a mortgage subject to special rules under the federal Truth in Lending Act. Purchasers or assignees of this mortgage could be liable for all claims and defenses with respect to the mortgage that the borrower could assert against the lender. (12 CFR 1026.34(a)(2))


A lender extending mortgage credit subject to HOEPA may not (continued):

  • within one year of making a high-cost loan, refinance the same borrower into another such loan unless the refinancing is in the borrower’s interest. (12 CFR 1026.34(a)(3))
An assignee holding or servicing the loan is subject to the same prohibition for the remainder of the one-year period. A lender or assignee may not try to evade this provision by arranging for refinancing of its own loans by affiliated or unaffiliated lenders or by modifying a loan agreement and charging a fee.
  • recommend or encourage default on an existing loan or other debt prior to and in connection with the consummation of a high-cost mortgage that refinances all or any portion of the existing loan or debt. (12 CFR 1026.34(a)(3))
  • finance fees and charges that are required to be included in the calculation of points and fees. (12 CFR 1026.34(a)(10))
  • structure a transaction that is a high-cost mortgage in a form with the intent of evading the requirements of a high-cost mortgage, including dividing the loan transaction into separate parts. (12 CFR 1026.34(b))
  • in an open-end, high-cost mortgage, extend credit based on the value of the consumer’s collateral without regard to his repayment ability as of the date of consummation, including consideration of his current and reasonably expected income, employment, assets other than the collateral, current obligations and mortgage-related obligations (i.e., expected property taxes, premiums for mortgage-related insurance required by the lender and similar expenses). This prohibition does not apply to temporary (bridge) loans that have terms of 12 months or less. (12 CFR 1026.34(a)(4))


Verification of Repayment Ability for an Open-End High-Cost Mortgage (12 CFR 1026.34(a)(4))
A lender must verify the consumer’s repayment ability in an open-end, high-cost mortgage by:

  • verifying the amounts of income or assets it relies upon to determine repayment ability. Expected income or assets may be verified by the consumer’s W-2 forms, tax returns, payroll receipts, financial institution records or other third-party documents that provide reasonably reliable evidence of the consumer’s income or assets.
  • verifying the consumer’s current obligations, including any mortgage-related obligations associated with another credit obligation undertaken prior to or at account opening and secured by the same dwelling.

Verification of Repayment Ability for an Open-End High-Cost Mortgage – (continued)

A lender is presumed to be in compliance with the requirement to verify repayment ability if it:

  • verifies the consumer’s repayment ability;
  • determines the consumer’s repayment ability, taking into account current obligations and mortgage-related obligations, using the largest required minimum periodic payment based upon the following assumptions:
    • The consumer borrows the full credit line approved at account opening with no additional extensions of credit;
    • The consumer makes only required minimum periodic payments during the draw period and any repayment period; and
    • If the APR may increase on the open-end credit, the maximum APR included in the contract applies at account opening and during the draw period and any repayment period; and
  • assesses the consumer’s repayment ability taking into account at least one of the following:
    • the ratio of total debt obligations to income (i.e., debt-to-income ratio); and/or
    • the income the consumer will have after paying debt obligations.

There is no presumption of compliance available for a transaction for which the regular periodic payments would cause the principal balance to increase.


Certificate of Counseling (12 CFR 1026.34(a)(5))
A creditor may not extend a high-cost mortgage to a consumer unless the creditor receives written certification that the borrower has obtained counseling from a HUD- or state housing finance authority-approved counselor as to the advisability of the mortgage. The counseling must occur after the consumer receives:

  • the Loan Estimate;
  • disclosures required under a home equity loan; or
  • disclosures required for a high-cost mortgage.

A consumer may not be steered or directed to choose a particular counselor or counseling organization.


Late Fees (12 CFR 1026.34(a)(8))
To be lawfully charged, a late payment fee must be specifically permitted by the terms of the loan contract or open-end credit agreement. However, if permitted, it may not:

  • exceed four percent of the payment past due;
  • be imposed more than once for any single late payment;
  • be imposed before the end of the 15-day grace period (i.e., the 16th day following the date the payment is due);
  • be imposed because a late payment fee previously assessed was deducted from a timely made full payment.

Payoff Statement (12 CFR 1026.34(a)(9))
A lender or servicer must provide, upon the request of a consumer or his agent, a statement of the amount due to pay off a high-cost mortgage. The statement must be provided for free up to four times during any one calendar year, but the lender may charge a reasonable fee for any additional requests. All payoff statements must be provided within five business days after receipt of the request.


Minimum Standards for Transactions


In addressing the Ability to Repay and Qualified Mortgage rules, Regulation Z (as amended by the revisions to TILA) establishes minimum standards for any consumer credit transaction that is secured by a dwelling, including any real property attached to a dwelling (i.e., covered transaction). These provisions do not, however, cover home equity lines of credit, bridge loans or reverse mortgages.

The revisions to TILA resulting from the passage of the Dodd-Frank Act in 2010 were Congress’ response to the housing crisis of the 2000s and were put in place to protect the mortgage marketplace and homeowners from the effects of past lax underwriting standards (e.g., the making of low-doc and no-doc loans, equity-based lending). By requiring that loan issue be based on the proper analysis of a borrower’s ability to repay the loan, the likelihood of fraud in loan origination is reduced and consumers may be protected from predatory lending activities. The new rules also address the improper use of multiple loans (i.e. piggyback lending) by requiring that, if a creditor knows that more than one loan is being secured by the same property and the same borrower, the creditor make a good faith determination that the borrower is able to repay the combined payments of all loans secured by the same property.


Ability to Repay Rule

Under the Ability to Repay (ATR) Rule, a creditor may not make a covered loan unless it makes a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms.



Covered Transaction (12 CFR 1026.43(b)(1))
The ATR Rule is broad in its context. As such, a covered transaction is a consumer credit transaction secured by a dwelling, including any real property attached to the dwelling.

dwelling is a residential structure of up to four units that is used as a residence and includes a condominium; a cooperative unit; a mobile home, boat or trailer, if used as a residence; and a second home.

Fully Indexed Rate (78 Fed.Reg., No. 20, Official Interpretations 43(b)(3), 6602)
The fully indexed rate is the interest rate that is calculated using the subject loan’s index or formula that will apply after recast and the maximum margin that may apply at any time during the term of the loan. A loan product’s low introductory rate may not be included in the calculation of the fully indexed rate.


Definitions – (continued)

Recast (12 CFR 1026.43(b)(11))
Recast is the time within a loan’s term at which payments that will fully amortize the loan over its remaining term are required. In other words, recast occurs at the end of the period during which:

  • payments on an adjustable-rate mortgage are based on a low introductory rate.
  • interest-only payments may be made on an interest-only loan.
  • negatively amortizing payments may be made on a negative amortization loan.

Fully Amortizing Payment (12 CFR 1026.43(b)(2))
Fully amortizing payments are periodic payments of principal and interest that, when paid according to the repayment schedule, will fully repay the loan over its term.


Definitions – (continued)

Simultaneous Loan (12 CFR 1026.43(b)(12))
simultaneous loan is an additional covered transaction or an open-end home equity line of credit that will be secured by the same dwelling and is:

  • made to the same consumer at the same time or before the closing on the covered transaction; or
  • if made after the closing, made to cover the closing costs of the first transaction.

Mortgage-Related Obligations (12 CFR 1026.43(b)(8))
Mortgage-related obligations include:

  • property taxes;
  • taxes, assessments and surcharges imposed by a government entity;
  • fees and special assessments imposed by a condominium, cooperative or homeowners’ association;
  • ground rent and leasehold payments; and
  • premiums for insurance products required by the creditor, such as homeowners insurance, credit insurance and charges for debt cancellation or suspension coverage.

Repayment Assessment

In assessing a consumer’s ability to repay, a creditor must consider the consumer’s:

  • current or reasonably expected income or assets other than the value of the property securing the loan.
  • current employment status, if income from his employment is used in determining repayment ability.
  • monthly payment on:
    • the covered transaction; and
    • any simultaneous loan that the creditor knows, or has reason to know, will be made.
  • monthly payment for mortgage-related obligations.
  • current debt obligations, including alimony and child support.
  • monthly debt-to-income ratio or residual income.
  • credit history.

Repayment Assessment – (continued)

The information relied upon in determining a consumer’s repayment ability must be verified using reasonably reliable third-party records. As such, income and/or assets may be verified with:

  • copies of federal and/or state tax returns.
  • W-2 forms or similar IRS forms used for reporting wages and/or tax withholding.
  • payroll statements, including Leave and Earnings Statements from the military.
  • financial institution records.
  • records from the consumer’s employer or a third party that obtained information from the employer.
  • if applicable, records from a federal, state or local government agency stating the consumer’s income from benefits or entitlements.
  • receipts from the consumer’s use of:
    • check cashing services; and/or
    • a funds transfer service.

Repayment Assessment – (continued)

In addition, a creditor may rely on a credit report to verify a consumer’s current debt obligation. However, if the consumer’s application includes a current debt that is not shown on the consumer’s credit report, the debt need not be independently verified.

One of the most important considerations in determining repayment ability is the consumer’s ability to make prescribed monthly payments. In general, the periodic payment amount upon which that determination is made is calculated using the greater of the fully indexed rate of the loan or any introductory rate and substantially equal monthly payments that fully amortize the loan.

Special rules apply to simultaneous loans, loans with a balloon payment or interest-only payments, and those that provide for negative amortization. While there may be circumstances under which a consumer would want such a nontraditional loan, under the ATR Rule, the applicant must still qualify for such a loan based on his ability to make amortizing payments at the fully indexed rate.



Payment Shock Refinancings

The amended TILA includes provisions that encourage creditors to refinance potentially unaffordable mortgages, known as hybrid loans (e.g., ARMs, interest-only loans and negative amortization loans), to standard, more affordable mortgages. The goal of these provisions is to create an opportunity for a consumer to avoid the payment shock that will occur when his initial fixed interest rate expires and becomes an adjustable rate. As such, these refinancing are called payment shock refinancings.


Payment Shock Refinancings – (continued)

Under the ATR Rule, a creditor is exempt from performing a full repayment analysis when originating a payment shock refinancing provided each of the following conditions is met:

  • The refinancing must be provided by the borrower’s current creditor or loan servicer.
  • The monthly payment on a new standard mortgage must be materially lower (i.e., a reduction of 10%) than the monthly payment on the nonstandard mortgage.
  • The creditor must receive the borrower’s application for a refinancing no later than two months after the nonstandard mortgage has recast.
  • On the existing non-standard mortgage, the borrower may not have made:
    • more than one payment that is more than 30 days late during the 12 months immediately preceding the creditor’s receipt of the refinance application; and
    • any payments more than 30 days late during the six months immediately preceding the creditor’s receipt of the refinance application.
  • For a loan consummated after January 10, 2014, the existing loan:
    • must have been subject to an ability-to-repay analysis; or
    • must be a qualified mortgage

Provisions in the Dodd-Frank Act established a presumption of compliance with the ATR requirements for a certain category of mortgages called qualified mortgages, thus giving creditors the incentive to make such mortgages by protecting creditors from liability.
(12 CFR 1026.43(e)(2))

qualified mortgage (QM) is a covered transaction:

  • that provides for substantially equal, regular periodic payments that do not:
    • result in an increase in the principal balance (i.e., negative amortization);
    • allow the borrower to defer the repayment of principal (i.e., interest-only loans); or
    • in general, result in a balloon payment at maturity.
  • for which the lender determines repayment ability based on:
    • the monthly payment for mortgage-related obligations;
    • the consumer’s reasonably expected income and assets; and
    • the consumer’s debt obligations.

Qualified Mortgage Rule

A QM may not:

  • have a term that exceeds 30 years;
  • provide for points and fees that exceed three percent of the total loan amount; and
  • have a monthly debt-to-income ratio that exceeds 43 percent.


Underwriting Standards

In making a QM, required underwriting standards include:

  • calculation of monthly payments using the maximum interest rate that may apply during the loan’s first five years.
  • periodic payments that will repay:
    • the principal balance that is outstanding after the interest rate adjusts to the maximum rate applicable during the loan’s first five years; or
    • the loan amount over the term of the loan.
  • verification of the consumer’s current or reasonably expected income or assets.
  • calculation of the consumer’s:
    • current debt obligations, including alimony and child support; and
    • monthly debt-to-income ratio, which may not exceed 43 percent.


Limitations on Points and Fees (12 CFR 1026.43(e)(3), 78 FR 6531)
A QM of $102,894 or more may not have points and fees that exceed three percent of the total loan amount. For mortgages with smaller loan amounts, the points and fees limitation is based on loan size and is adjusted for inflation on January 1 of each year.

Calculating Monthly Payments(12 CFR 1026.43(b)(3), -(e)(2)(iv)(A), 78 FR 6479)
To be classified as a QM, monthly payments for determining ability to repay are calculated at the maximum rate of interest that will apply during the first five years of the loan term, resulting in periodic payments that will repay:

  • the principal balance that is outstanding after the interest rate adjusts to the maximum rate applicable during the loan’s first five years; or
  • the loan amount over the term of the loan.

This method of calculating monthly payments differs from the method used in calculating monthly payments for nonqualified mortgages, which uses the fully indexed rate as determined at the time of consummation of the loan and fully amortizing monthly payments that are substantially equal.

ATR vs. QM Rules

The two sets of underwriting standards in the rule are derived from guidelines in the Dodd-Frank Act. QM underwriting rules take into account any adjustment in interest rate that can occur during the first five years, including any adjustment due to changes in the index rate, but ignore any adjustment in interest rate that may occur after the first five years (e.g., for an ARM with an initial adjustment period of seven years, the interest rate used for the QM calculation will be the initial interest rate). In contrast, there is no time limitation on adjustments in the nonqualified mortgage.

Another distinction between the underwriting requirements for a nonqualified mortgage and a QM deals with the debt-to-income ratio. There is no limiting ratio for a nonqualified mortgage. However, in order to earn the safe harbor that is extended to QMs, the consumer’s total monthly debt may not exceed 43 percent of his total monthly income.

As such, the ATR Rule, while tightening lending standards, does not require that a creditor base its lending decisions on strict mathematical models. Rather, it gives a creditor the ability to exercise its discretion by refraining from setting out certain specifications, such as:

  • how much income would be needed to support a particular level of debt; or
  • how credit history should be weighed against other factors.

Ultimately, a lending decision is in compliance with the new statutory and regulatory standards when a creditor makes a reasonable and good faith determination that the loan applicant has a reasonable ability to repay the loan according to its terms based on its consideration of the eight assessment factors required under the ATR rule.

Prepayment Penalties

Under the ATR/QM rule, a covered transaction may not include a prepayment penalty unless:

  • the prepayment penalty is permitted by law; and
  • the transaction:
    • has an annual percentage rate that may not increase after consummation;
    • is a qualified mortgage; and
    • is not a higher-priced mortgage.
  • the fee does not exceed:
    • two percent of the outstanding loan balance prepaid if prepaid during the first two years following consummation; or
    • one percent of the outstanding loan balance prepaid if prepaid during the third year following consummation.

Prepayment Penalties

When a creditor offers a consumer a covered transaction that includes a prepayment penalty, it must also offer him a loan product that:

  • does not have a prepayment penalty;
  • has an annual percentage rate that may not increase after consummation; and
  • has the same type of interest rate as the loan that has the prepayment penalty (e.g., a fixed rate or variable rate).

If the subject transaction meets all of these criteria, a creditor is still prohibited from including a prepayment penalty in the loan unless it also offers an alternative mortgage product that does not include a prepayment penalty and that:

  • has the same type of interest rate as the mortgage that includes a prepayment penalty provision (e.g., both loans are fixed-rate mortgages or both loans are step-rate mortgages).
  • has the same loan term as the term for the mortgage that includes a prepayment penalty provision.
  • meets the requirements of a QM in terms of:
    • periodic payments; and
    • points and fees limitations.
  • is offered with a good faith belief that the consumer will be able to qualify for the loan.



If the credit securing a consumer’s dwelling does not meet the definition of open-end credit, a creditor may not structure the loan as an open-end loan in order to evade the requirements for closed-end transactions.

Record Retention

As evidence of compliance, records relating to minimum standards for transactions must be retained for three years after consummation of a transaction.


Homeowners Protection Act (HPA)

The Homeowners Protection Act (HPA), signed in 1998 and amended in 2000, was enacted to assist homeowners in the cancellation and termination of private mortgage insurance (PMI) once the requirement to maintain such coverage has passed. The law applies to most conventional, first-lien residential mortgage loans obtained on or after July 29, 1999; it does not apply to VA- or FHA-backed loans or second mortgages.

Private Mortgage Insurance


To compensate for the increased risk of borrower default when a loan-to-value ratio exceeds 80 percent:

  • a lender may:
    • charge a higher interest rate or more discount points for the loan; or
    • require that the borrower pay a premium for mortgage insurance.
  • if the loan is to be sold to Fannie Mae and Freddie Mac, it must be insured by PMI, issued by a private mortgage insurance company. In addition to protecting the lender, this insurance also benefits a borrower by enabling him to get financing with a smaller down payment.

The insurance premium may be:

  • included in the borrower’s payment; or
  • paid by the lender and repaid by the borrower in the form of a higher interest rate on the loan.

As the down payment decreases, the loan as a percentage of value increases, increasing the risk of default and the amount of the mortgage insurance required.


Cancellation of PMI
As the borrower pays down his loan, the lender’s risk decreases, as does the need for the PMI.

The borrower may submit a written request to the lender seeking cancellation of the PMI if:

  • the mortgage has been paid to the point where it equals 80 percent of the lower of:
    • the home’s purchase price; or
    • the appraised value of the home at the time of purchase;
  • the borrower has not made a payment more than:
    • 30 days late in the past year; or
    • 60 days late in the past two years;
  • there are no subordinate liens against the property; and
  • the property is not worth less than the original purchase price or value.

If the lender does not grant the request, it must provide reasons for the denial.

PMI coverage is automatically canceled:

  • if his loan payments are current, once the borrower pays his mortgage down to 78 percent of the original value; or
  • when a loan that is current reaches the midpoint of its amortization period (e.g., after 180 payments of a 30-year loan).


Required Disclosures
A lender or servicer must notify a consumer of his rights regarding PMI insurance:

  • at loan closing;
  • annually; and
  • upon cancellation or termination of the PMI.

At loan closing, a lender must disclose:

  • when the borrower may request cancellation of the PMI.
  • when the PMI will be automatically terminated.
  • any exemptions to the right to cancellation or automatic termination.
  • for fixed-rate loans only, a written initial amortization schedule.

The cost for PMI insurance is disclosed initially on the Loan Estimate and then again on the Closing Disclosure.


Annually, a mortgage loan servicer must send a written statement that discloses:

  • the right to cancel or terminate the PMI.
  • an address and telephone number to contact the loan servicer to determine when the PMI may be canceled.

After the cancellation or termination of PMI coverage, a servicer must:

  • within 30 days, notify the borrower that:
    • the PMI has been terminated; and
    • no more PMI premiums are due.
  • within 45 days, refund any unearned premiums to the borrower.

The content of these disclosures will vary based upon whether:

  • the loan is designated as a high-risk loan.
  • the loan has a fixed rate or variable rate.
    • For a fixed-rate loan, the notice must indicate the automatic termination date based on the date in the payment schedule where the loan-to-value ratio is projected to reach 78 percent of the original value.
    • For a variable-rate loan, the notice must indicate that the lender must provide notification when:
      • the loan has reached a point where the borrower may request PMI cancellation; and
      • PMI will automatically terminate.
  • the PMI is paid by the borrower or lender. Lender-paid PMI (LPMI) requires disclosure of how it differs from borrower-paid PMI. Because the cost of lender-paid insurance is compensated for in the interest rate, it is tax deductible (although it is not subject to borrower cancellation). Borrower-paid PMI is not tax deductible for a borrower with an income of more than $100,000, but it may be canceled.

Piggyback Financing

One way lenders have helped borrowers avoid the cost of mortgage insurance is through piggyback financing (i.e., simultaneous loans), which combines an 80 percent first loan with either:

  • a 20 percent second loan;
  • a 15 percent second loan and a 5 percent down payment; or
  • a 10 percent second loan and a 10 percent down payment.

However, provisions of the amended TILA and Regulation Z require a lender to ensure that the borrower has the ability to repay any loans secured by the same collateral, according to their terms.

How To Advertise In Residential Mortgage via GOOGLE or Facebook Ads

Trigger Terms
An ad must disclose a number of additional credit terms if it contains a trigger (or triggering) term. A triggering term is any of the following credit terms specifically recited in an ad:

  • The amount or percentage of any down payment (e.g., 5 percent down, 95 percent financing, $6,200 down), except when the amount of the down payment is zero
  • The number of payments or period of repayment (e.g., 360 monthly payments, a 30-year loan)
  • The amount of any payment (e.g., “payments of less than $1,400 per month”)
  • The amount of any finance charge (e.g., “total financing costs of less than $3,000”)

The additional disclosure is required even if a triggering term is not stated explicitly but may be readily determined from the ad.

For Example
An ad that states “80% financing” implies that a 20 percent down payment is required. In such a case, disclosure is required. However, an ad that states “100% financing” requires no further disclosures because no down payment is required.


Trigger Terms – (continued)

The additional disclosures required in an ad containing a triggering term include:

  • the amount or percentage of the down payment.
  • the terms of repayment (i.e., the payment schedule, including the number, timing and amount of the payments, including any final balloon payment required to repay the debt).
  • the annual percentage rate, using that term or the abbreviation “APR.” If the APR may be increased after consummation of the credit transaction, that fact must also be disclosed.
For Example
An ad containing the credit terms could read:

  • Cash price $100,000 with $5,000 down
  • Interest at 9-7/8% (10.5% APR)
  • Mortgage of $94,600 to be paid in 360 equal and consecutive monthly installments of $822.08, plus taxes and insurance


Trigger Terms – (continued)

Disclosures are triggered only when credit terms are specific. When statements about credit terms are general, additional disclosures are not required. General terms that do not trigger the required disclosures would include:

  • “Low down payment.”
  • “No down payment.”
  • “FHA financing available.”
  • “Easy monthly payments.”
  • “Low interest rates.”
  • “Easy credit terms.”

If an ad shows the annual percentage rate without showing any other credit terms (e.g., “6.5% APR” or “1% below our standard APR”), additional disclosures are not required.


An advertiser may include examples of one or more typical extensions of credit that are specific to a particular transaction as a substitute for required disclosures. The ad must contain all of the terms that apply to each example, and the credit terms must actually be available.

If an ad states a rate of finance charge, it must state the rate as an annual percentage rate, using that term or the abbreviation APR. The primary lending rate that may be advertised is the APR. An ad for a loan secured by a dwelling may, in addition, include a simple annual interest rate that applies to the unpaid balance, provided it is not more conspicuous than the APR.

For Example
An ad for mortgage credit may show 7% as the interest rate as long as it also includes “7-1/8% APR” (the APR reflects insurance, discounts, points and other charges as well as interest). If the interest rate can change during the loan term, that fact must also be contained in the ad.


Except for television or radio advertisements, additional requirements apply to any ad for credit secured by a dwelling, including promotional materials accompanying applications.

If the ad states a simple annual rate of interest and more than one simple annual rate of interest will apply over the term of the loan, the ad must clearly and conspicuously (i.e., with equal prominence and in close proximity to any advertised rate) disclose:

  • each applicable simple annual rate of interest. In a variable-rate transaction, a rate determined by adding a reasonably current index and margin must be disclosed.
  • the period of time during which each simple annual rate of interest will apply.
  • the APR for the loan.

If the ad states the amount of any payment, it must also clearly and conspicuously disclose:

  • the amount of each payment that will apply over the term of the loan, including any balloon payment. If the loan is a variable-rate loan, the payment amount must be based on a reasonably current index and margin.
  • the period of time during which each payment will apply.
  • for a first-lien loan secured by a dwelling, the fact that the payments do not include amounts for taxes and insurance premiums, if applicable, and that the actual payment obligation may be greater.
  • the APR for the loan.


A television or radio ad stating any of the terms requiring additional disclosures may either:

  • state each of the additional disclosures or information required; or
  • list a toll-free telephone number, or one that allows a consumer to reverse the phone charges, along with a reference number to be used by consumers to obtain additional cost information.

An Internet or paper ad for a loan secured by the consumer’s principal dwelling may not be misleading with regard to the tax deductibility of the interest paid on the loan. If it states that the advertised credit may exceed the dwelling’s fair market value, it must also clearly and conspicuously state that:

  • any interest on the amount of credit exceeding the dwelling’s fair market value is not tax deductible; and
  • the consumer should consult a tax adviser for further information.

Prohibited Acts(12 CFR 1026.24(i))
An ad for credit secured by a dwelling must avoid causing confusion between fixed- and variable-rate loans. Therefore, it may not use the word “fixed”:

  • in a variable-rate transaction, to refer to rates, payments or the credit transaction unless:
    • the phrase “adjustable-rate mortgage,” “variable-rate mortgage” or “ARM” appears in the advertisement before the first use of the word “fixed” and is at least as conspicuous as any use of the word “fixed” in the ad; and
    • each use of the word “fixed” to refer to a rate or payment is accompanied by an equally prominent and closely proximate statement of:
      • the time period for which the rate or payment is fixed; and
      • the fact that the rate may vary or the payment may increase after that period.
  • in any other transaction where the payment will increase (e.g., a stepped-rate mortgage transaction with an initial lower payment), to refer to rates, payments or the credit transaction unless each use of the word “fixed” in relation to the payment is accompanied by an equally prominent and closely proximate statement of the time period for which the payment is fixed and the fact that the payment will increase after that period.
  • in an ad for both variable-rate transactions and nonvariable-rate transactions, to refer to rates, payments or the credit transaction unless:
    • the phrase “adjustable-rate mortgage,” “variable-rate mortgage” or “ARM” appears in the advertisement with equal prominence as any use of the term “fixed,” “fixed-rate mortgage” or similar terms; and
    • each use of the word “fixed” either:
      • refers only to the transactions for which rates are fixed; or
      • if it refers to a variable-rate transaction, is accompanied by an equally prominent and closely proximate statement of the time period for which the rate or payment is fixed and the fact that the rate may vary, or the payment may increase, after that period.

The ad may not include any comparison between actual or hypothetical credit payments or rates and any payment or simple annual rate that will be available under the advertised product if the comparison is for a period less than the full term of the loan, unless:

  • the ad includes a clear and conspicuous comparison to the rates and payments required to be disclosed; and
  • if the ad is for a variable-rate transaction and the advertised payment or simple annual rate is based on the index and margin that will be used to make rate or payment adjustments over the term of the loan, it includes an equally prominent statement that the payment or rate is subject to adjustment, and the time period when the first adjustment will occur.


Additionally, an ad for credit secured by a dwelling may not:

  • state that a product is a “government loan program,” “government-supported loan,” or otherwise endorsed or sponsored by any government entity, unless the ad is for an FHA loan, VA loan or similar loan program that is, in fact, endorsed or sponsored by a government entity.
  • use the name of the consumer’s current creditor if the ad is not sent by or on behalf of that creditor, unless:
    • the name of the person or lender making the advertisement is disclosed with equal prominence; and
    • the ad includes a clear and conspicuous statement that the person making the advertisement is not associated with, or acting on behalf of, the consumer’s current creditor.
  • make any misleading claim that the product offered will eliminate debt or result in a waiver or forgiveness of a consumer’s existing loan terms with, or obligations to, another lender.
  • use the term “counselor” to refer to a for-profit mortgage broker or mortgage lender, its employees, or any other person working for the broker or lender that are involved in offering, originating or selling mortgages.
  • provide information about some trigger terms or required disclosures, such as an initial rate or payment, in a foreign language while providing information about other trigger terms or required disclosures, such as information about the fully indexed rate or fully amortizing payment, only in English.


An ad for a home equity plan may not refer to the plan as “free money” or contain a similarly misleading term.

If an ad shows any finance charges or payment terms related to a home equity plan, it must also clearly and conspicuously show:

  • any loan fee based on a percentage of the plan’s credit limit and an estimate of any other fees imposed for opening the plan, stated as a single dollar amount or a reasonable range.
  • the APR.
  • if it is a variable-rate plan, the maximum APR that may be imposed.

An ad stating an initial APR that is not based on the index and margin that will be used to make adjustments during the term of the loan must state, with equal prominence and in close proximity to the initial rate:

  • the period of time the initial rate will be in effect; and
  • a reasonably current APR that would have been in effect if the index and margin had been used.


If an ad states a minimum periodic payment and a balloon payment may result if only the minimum periodic payments are made, it must state with equal prominence and in close proximity to the stated payment:

  • that a balloon payment may result; and
  • the amount and timing of that payment based on an assumption that the minimum payments for the maximum period of time permitted are made.


An advertisement for a home equity plan that is distributed in paper form or through the Internet must:

  • if it states that the credit limit may exceed the fair market value of the dwelling, also state that the interest on the amount exceeding the fair market value of the dwelling is not tax deductible and that a tax adviser should be consulted for further information.
  • clearly and conspicuously, with equal prominence and in close proximity to each listing of any promotional APR or promotional payment, disclose:
    • the period of time during which the promotional rate or promotional payment will apply;
    • in the case of a promotional rate, any APR that will apply; and
    • in the case of a promotional payment, the amounts and time periods during which those payments will apply.


If a consumer asks about the cost of credit and the lender responds orally, the response must state the APR. However, for closed-end credit, a periodic or simple interest rate may also be provided if it is applied to an unpaid balance. If the lender cannot determine the APR for a specific closed-end credit transaction, it may disclose instead the APR in a sample transaction. Other information that applies to the consumer’s specific transaction may also be given (e.g., the contract interest rates and points).

For open-end credit, once a lender states the APR, it may also give the periodic rate.


All loan applicants must be provided with the new federally required disclosures. The Loan Estimate provides information related to the interest rate and principal and interest payments for the loan’s term, as well as insurance and tax information. In the event the loan is a variable-rate loan, it indicates, among many other things, the margin and index upon which the interest rate is based and information regarding the frequency of rate changes.

How to Calculate Loan-to-Value Ratios and PMI in Residential Mortgage



The relationship of the loan amount to the value or sales price of the property securing the loan is called a loan-to-value ratio. The loan-to-value ratio (LTV) relates the loan to the lesser of the appraised value or sales price.

LTV = loan amount, divided by property value or sales price (whichever is less)

Or, shown another way:

                       Loan Amount                                     =     Loan-to-Value Ratio
Property Value or Sales Price (whichever is less)

For Example
The appraised value of a house is $200,000, the sales price of the house is $210,000, and the borrower has a $25,000 down payment. The LTV can be calculated as follows:$210,000 – $25,000 = $185,000.
$185,000 ÷ $200,000 = 92.5%The LTV would be 92.5%.


The basic idea of LTV can be utilized for other purposes as follows:

For Example
A buyer wants to make an offer of $190,000 on a property. He has $6,000 available in earnest money. His lender will issue a 95% loan. The property is appraised at $192,000. The loan amount can be calculated as follows:Loan = 95% x Sales Price (because sales price is less than the appraised value)
$190,000 x 0.95 = $180,500The loan amount would be $180,500.



The earnest money does not affect the calculation of the loan. The earnest money will be applied to the down payment, so it is not considered at all when calculating the loan amount.
For Example
For Example
For a $380,000 property, an applicant is offered a loan at 95% of the first $250,000 of value and 90% of the value above $250,000.The loan amount would be calculated in two steps:

  1. Calculate the loan on the first $250,000 of value.
  2. Calculate the loan on the balance of the value above $250,000, which is $130,000 ($380,000 – $250,000).

The total loan would consist of:

95% x $250,000 =      $237,500
90% x $130,000 =   + $117,000
Total Loan =              $354,500



When a loan is more than 80 percent, the lender may require that the borrower purchase mortgage insurance. However, some lenders may charge a higher interest rate and not require the mortgage insurance regardless of the LTV, as in lender-paid mortgage insurance (LPMI). This was common practice during the subprime debacle and is not likely to be found today.

As an option, when the LTV exceeds 80 percent, a loan officer may offer two separate loans in such a fashion that neither loan will require mortgage insurance. These are called piggyback loans, or simultaneous seconds. The first loan will be for 80 percent of the loan value, and the second loan will cover the remainder.

If there will be two loans on the property, the ratio calculation remains the same except that the loan amount will be the sum of the first and second mortgages. This ratio is called a combined loan-to-value ratio (CLTV).

Under the Ability to Repay Rule, which went into effect in January of 2014, a creditor would have to ensure that the borrower had the ability to repay not only the first loan, but also any simultaneous loans securing the same property. This rule will be discussed in more detail later in this course.
For Example
A buyer wants to purchase a property with a sales price of $300,000 and a down payment of $20,000.

$300,000 – $20,000   = $280,000
$280,000 ÷ $300,000 = 0.93
LTV  = 93%.

Because the LTV is more than 80 percent, the lender may offer two loans: one for $240,000 and the other for $40,000.

If there will be two loans on the property, the ratio calculation remains the same except that the loan amount will be the sum of the first and second mortgages.

1st Mortgage + 2nd Mortgage = Loan Amount
Sales Price

If a sales price is $300,000, the down payment is $25,000 and a second mortgage is $35,000, the first loan will be $240,000 ($300,000 – $60,000) and the resulting CLTV is:

$240,000 + $35,000 = $275,000

CLTV = $275,000 ÷ $300,000 = 0.9166 = 91.7%.



In addition to the LTV and CLTV, with a home equity line of credit (HELOC), there is also a high combined loan-to-value ratio (HCLTV) and a total loan-to-value ratio (TLTV). When secondary financing is a HELOC, the loan balance plus any draw amount is used to calculate the CLTV. The loan balance plus the total line limit is used to calculate the HCLTV or TLTV.

For Example
A person has a house worth $100,000 and an existing $70,000 loan balance. He has a HELOC of $20,000, of which he has drawn $10,000.His LTV = $70,000 ÷ $100,000 = 70%
His CLTV = $80,000 ($70,000 + $10,000) ÷ $100,000 = 80%
His TLTV = $90,000 ($70,000 + $20,000) ÷ $100,000 = 90%

down payment is the difference between the purchase price and loan amount. It does not include closing costs. As a percentage, it is 100 percent of the price less the LTV or the CLTV. If the LTV is 80 percent, the down payment is 20 percent.

Monthly Payments


An amortization schedule shows the schedule of individual annual or monthly payments over the term of a level payment loan. It includes the following:

  • Payment
  • Principal paid
  • Interest paid
  • Remaining balance

Amortization schedules can be produced by going online to any number of sites and providing the principal loan balance, the interest rate, the term of the loan and the starting month and year.

When such a schedule is not available, a monthly payment for an amortized loan may be determined in a number of ways. One is an amortization table. This shows the monthly payment amount of principal and interest, the loan term, the interest rate, and the original loan amount. It will not show the allocation of principal and interest, or the additional payments to tax and insurance reserves.

10% Monthly Loan Amortization Payments 10%

Loan Amount

Term of Loan

3 yr

5 yr

10 yr

15 yr

20 yr

25 yr

30 yr

40 yr


$ 3.23

$ 2.13

$ 1.33

$ 1.08

$ 0.97

$ 0.91

$ 0.88

$ 0.85














































































































Amortization tables have, for the most part, been replaced by online and handheld financial (mortgage or real estate) calculators. The online calculators simply require entry of the loan amount, interest rate and loan term into the appropriate boxes to produce the monthly payment for a level payment mortgage loan. They are easy to find and operate.

A completed loan package for a borrower with a fixed loan rate will always contain an amortization table specific to the loan, showing the actual amount of interest and principal applied every month. It can be interesting to see how the amount of principal accrued increases gradually throughout the term because of the monthly payment remaining the same.


Private Mortgage Insurance


Loans with an LTV higher than 80 percent generally require private mortgage insurance (PMI). The cost of this insurance varies based on the actual LTV and is expressed as an annual factor. For example, a loan between 80 percent and 85 percent might have a factor of 0.32 percent (or 0.0032), while a loan between 90 percent and 95 percent might have a factor of 0.0078.

To determine the monthly cost of the PMI, multiply the loan amount by the factor and divide by 12.

For Example
To calculate the PMI costs for a loan of $200,000 that has a factor of 0.0032:$200,000 x 0.0032 = $640 annual PMI
$640 ÷ 12 months = $53.33 monthly PMI


Buydowns Defined

nterest rates can be reduced by paying prepaid interest at closing. This prepaid interest is called discount points or a buydown. The buydown money can come from the homebuilder or seller of the property; from the borrower; or from a third party, such as a relative, employer or investor.

There are two types of buydowns:

  1. Permanent
  2. Temporary

What are Discount Points

A permanent buydown is a payment of discount points to lower the interest rate for the entire term of the mortgage. One discount point is equal to 1 percent of the loan amount. Therefore, a charge of 3 points on a $100,000 loan would be $3,000.

As a general rule, it costs about 6 discount points (6 percent of the loan amount) to reduce the interest rate by 1 percent. So if a borrower wanted to reduce his interest rate by a full 1 percent, he would have to pay 6 points, which would be an additional 6 percent of the loan amount. If he wanted to reduce his interest rate by one-half of a percent, he would need to pay 3 percent of the loan amount in points.

It is illegal to describe a point as a “discount point” without actually reducing the interest rate.


The actual cost of reducing the rate will vary from lender to lender, may fluctuate depending on market conditions, and will be limited in amount. For instance, it will never be possible to buy enough discount points to reduce the interest rate to 0 percent.

The amount of change in interest rates is often expressed in terms of basis points. A basis point is equal to one-hundredth of 1 percent. Therefore, a reduction in mortgage interest rates of 0.25 percent (25/100 of 1 percent) is a reduction of 25 basis points.

For Example
Lenders offer loans at different interest rates based on charges of a certain number of discount points:

  • 6 percent loan with no discount points
  • 5.75 percent loan with 1.5 discount points
  • 5.5 percent loan with 3 discount points

A reduction of the interest rate on a $150,000 loan from 6 percent to 5 percent for the entire loan term would require a buydown of about $9,000 (6 percent of $150,000). This 1 percent prepayment of interest would net the borrower about $1,128 per year (or about $94 a month) in reduced mortgage payments.  It would take eight years, the average length of time a person holds a loan, before the borrower’s savings under the mortgage payments would total about $9,020, the amount paid for the buydown. If he does not keep the loan that long, the permanent buydown was not a good choice.


What Are Temporary Buydowns

A temporary buydown, usually paid for by a person other than the buyer, reduces the monthly payments considerably for a short period of time (e.g., one, two or three years). At the end of this period, the borrower’s payment will be the amount computed without the buydown.

The following are some examples of temporary buydowns:

  • A 2/1 buydown determines a payment using an interest rate of:
    • 2 percent less than the stated note rate the first year;
    • 1 percent less the second year; and
    • the fixed rate starting the third year.
  •    A 3/2/1 buydown uses rates that are:
    • 3 percent less than the note rate the first year;
    • 2 percent less the second year; and
    • 1 percent less the third.
For Example
In a 3/2/1 buydown, the 3% reduction on a $150,000 loan with an interest rate of 6% would reduce monthly payments by $267 the first year.If the buyer remains in the property no more than eight years, his total interest reduction would be greater than it would be under the permanent buydown.


The cost of a buydown is equal to the difference between the monthly payments with the buydown and those without the buydown.

 For ExampleA 30-year $200,000 loan with a 6.5% interest rate has a monthly payment of $1,264.14.

With a 1/1 buydown, the interest rate used to compute the payments would be 1% lower (5.5%) for each of the first two years. The borrower would make a monthly payment of $1,135.57.

Therefore, the cost of the buydown would be:
$1,264.14 – $1,135.57 = $128.57 per month x 24 months = $3,085.68.

What is an Interest in Residential Mortgage

The interest rate for a loan is not the annual percentage rate. The interest rate is the rate at which the loan amount produces the monthly loan payment. An annual percentage rate (APR), a term established by the Truth in Lending Act, is the rate at which the amount financed (i.e., the loan amount less the prepaid finance costs) produces the monthly loan payment.

The amount of a loan payment that is interest and the amount that is principal can be determined from the monthly payment. The interest can be directly calculated based on the unpaid loan balance as of the last payment. The principal can be determined by deducting the interest from the total loan payment.

For most real estate loans, the interest charged is simple interest. Therefore, if a person owes $10,000, he would be charged interest on the $10,000. If he pays $1,000 of principal to reduce the principal balance to $9,000, his next interest charge will be based on the remaining $9,000.

The formula for interest is: Annual Interest = Percent Interest x Loan Balance

The phrase “6 percent interest” translates to: Annual Interest = 6% x Loan Balance.

To get the annual interest amount, multiply the loan balance by the interest rate.

To determine the interest for a period of time other than one year, first calculate the annual interest and then convert the answer accordingly.

For Example
If a lender charged 6% on a $100,000 loan secured by a home purchased for $120,000:
Annual Interest = 6% x $100,000 = $6,000
Monthly Interest = $6,000 ÷ 12 = $500
Daily Interest = $6,000 ÷ 365 = $16.44

What Is a Principal Reduction (Equity Growth)

When a monthly payment includes principal and interest, there is no formula to calculate the portion paid to principal directly. This can be determined, however, by calculating and deducting the interest portion of the payment from the total payment.

To calculate the amount of the monthly payment that would go toward principal, take the following steps:

  1. Loan Balance x Annual Interest Rate = Annual Interest
  2. Annual Interest ÷ 12 = Monthly Interest
  3. Monthly Payment – Monthly Interest = Principal Paid that Month
  4. Loan Balance – Principal Paid = Remaining Loan Balance
For Example
The loan inception date is February 1. The first payment is due March 1. The interest portion of that payment is charged for the principal outstanding as of February 1 for the use of the funds during February.The loan is a 30-year loan at 10% interest and had an original loan balance on February 1 of $400,000. The monthly payment due March 1 is $3,510.29.The interest portion of that is 1/12 of 10% of $400,000.$400,000 x 10% = $40,000
$40,000 ÷12 = $3,333.33The $176.96 difference between the $3,510.29 payment and the $3,333.33 interest is the amount by which the loan balance will be reduced.

The amount of principal outstanding on March 1 will be: $400,000 – $176.96 = $399,823.04

The next payment, due April 1, will include interest of 1/12 of 10% of $399,823.04.

10% x $399,823.04 = $39,982.30
$39,982.30 ÷12 = $3,331.86

The principal portion of the payment will be: $3,510.29 – $3,331.86 = $178.43

With each payment, the principal balance is reduced, so the amount of interest included in the next payment is reduced. The amount of principal in that payment will increase by the same amount the interest is reduced.

In the example above, the interest was reduced from $3,333.33 to $3,331.86, for a total reduction of $1.47. At the same time, the principal portion of the payment increased from $176.96 to $178.43, for a total increase of $1.47. As long as the monthly payments exceed the amount of interest due for the month, they will reduce the debt and result in each payment allocating less for interest and more for the principal amount.

This continues until the entire principal balance is paid in full. In the early years of this type of loan, most of the periodic payment consists of interest. However, in later years, most of the installment consists of principal repayment because there is not much principal left on which to accrue interest from month to month.

How to Fill 1003 Mortagage Application Case Study

Section X – Information for Government Monitoring Purposes


If the originator needed more room to add a previous employer and another asset, a savings account, which would normally go on Pages 2 and 3, he would fill in the header information with the names of the borrower and co-borrower, the case number, and the lender number (if known). He would then show the following:

IV. Employment Information – cont’d. from page 2
“C” for Co-Borrower
Sears Dept. Store
Omaha Village Mall, Omaha, NE 60993
(555) 123-4567
Employed from 11/2008 thru current date as part-time retail sales associate
Approximately $250 per month ($8 per hour for average 40 hrs. per month)

VI. Assets & Liabilities – cont’d. from page 3
First National Bank of the Plains
1234 North Front Street, Omaha, NE 60999
Savings Account # 999999-99 balance = $ 1,000.00

he must have all borrowers both sign and date the sheet.

Special Notice for Balloon Mortgages – For each balloon mortgage, Fannie Mae requires that the following notice, in capital letters, regarding the nature of the balloon features must be included on the application form or in a separate attachment to the form signed by the borrower(s):


Loan Processing

Once the application is complete, it is processed. Loan processing is the preparation of the loan package (i.e., the application and supporting documents) for underwriting. It includes the collection and verification of detailed information about the borrower and the real estate transaction itself to help determine the borrower’s ability and desire to repay the loan. If any information appears suspicious, the processor or originator should attempt to verify it with the source or take appropriate steps to have the application denied.

Key steps in processing include the following:

  • Creating a loan file. The processor may use:
  • a processing checklist to list needed documents and indicate when they are in the file;
  • a conversation log to record conversations with the borrower or third-party vendors; and
  • a particular stacking order so that all documents are in the same location in each file making it easy to locate file documents
  • Ordering required verifications and supporting documents
  • Reviewing all documents to ensure:
  • disclosures are accurate, properly delivered and, if necessary, updated; and
  • verifications and supporting documents match the information on the loan application (e.g., Social Security numbers are consistent, names on the title commitment match that of the borrower[s], all liabilities shown on the credit report with more than 10 payments [10 months] remaining are included in the application, etc.)
  • Updating the application to match the information provided in the verifications and supporting documents
For Example
Fannie Mae requires that credit documents must be no more than four months old on the date the note is signed for all mortgage loans (existing and construction).
Both Fannie Mae and Freddie Mac also require verbal verification of employment within 10 days of the note date for a borrower who is salaried and within 30 days for a borrower who is self-employed.

Limited Documentation (Alt-A)

Applicants not able or willing to provide details of their finances or to otherwise satisfy standard conventional loan guidelines have been able to get Alt-A loans despite providing no documentation or only limited documentation. This type of processing has been useful in qualifying an applicant who is self-employed, is paid on commission, or is recently divorced and lacks payroll stubs, W-2 forms, 1099s or other documentation showing qualifying income from the past two years.

When Alt-A loans were made available to borrowers with low credit scores, their rate of default and foreclosure soared, so these loans are not prevalent now. New amendments to the Truth in Lending Act’s Regulation Z require documentation of a borrower’s ability to pay for most available mortgage loan products, which includes verification of income, assets and employment using reasonably reliable third-party records.

Mortgage Originator Quiz 1

Retail lender
Correspondent lender
Wholesale lender
Closed-end financing
Open-end financing
Fixed-rate mortgage
Interest-only mortgage
Funds loans and sells them to wholesale lenders
No amortization during loan term; balloon payment
Provides fixed amount repayable over fixed period
Funds loans applied for through mortgage brokers
Borrower may repay and reborrow up to credit limit
Interest rate and payments don’t change for set term
Interacts directly with borrower, actually makes loan



For more than 30 years, Federal law has required lenders to provide two different disclosure forms to consumers applying for a mortgage. The law also has generally required two different forms at or shortly before closing on the loan. Two different Federal agencies developed these forms separately, under two Federal statutes: the Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act of 1974 (RESPA). The information on these forms is overlapping and the language is inconsistent. Not surprisingly, consumers often find the forms confusing. It is also not surprising that lenders and settlement agents find the forms burdensome to provide and explain. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) directs the Consumer Financial Protection Bureau (the Bureau) to integrate the mortgage loan disclosures under TILA and RESPA sections 4 and 5. Section 1032(f) of the Dodd-Frank Act mandated that the Bureau propose for public comment rules and model disclosures that integrate the TILA and RESPA disclosures by July 21, 2012. The Bureau satisfied this statutory mandate and issued proposed rules and forms on July 9, 2012. To accomplish this, the Bureau engaged in extensive consumer and industry research, analysis of public comment, and public outreach for more than a year. After issuing the proposal, the Bureau conducted a largescale quantitative study of its integrated disclosures with approximately 850 consumers, which concluded that the Bureau’s integrated disclosures had on average statistically significant better performance than the current disclosures under TILA and RESPA. The Bureau has now finalized a rule with new, integrated disclosures (TILA-RESPA rule).1 The TILA-RESPA rule also provides a detailed explanation of how the forms should be filled out and used.

The first new form (the Loan Estimate) is designed to provide disclosures that will be helpful to consumers in understanding the key features, costs, and risks of the mortgage loan for which they are applying. The Loan Estimate must be provided to consumers no later than three business days after they submit a loan application. The second form (the Closing Disclosure) is designed to provide disclosures that will be helpful to consumers in understanding all of the costs of the transaction. The Closing Disclosure must be provided to consumers three business days before they close on the loan. The forms use clear language and design to make it easier for consumers to locate key information, such as interest rate, monthly payments, and costs to close the loan. The forms also provide more information to help consumers decide whether they can afford the loan and to compare the cost of different loan offers, including the cost of the loans over time. The Loan Estimate and Closing Disclosure must be used for most closedend consumer mortgages. Home equity lines of credit, reverse mortgages, or mortgages secured by a mobile home or by a dwelling that is not attached to real property (i.e., land) must continue to use current disclosure forms required by TILA and RESPA separately. The TILA-RESPA rule does not apply to loans made by persons who are not considered “creditors” because they make five or fewer mortgages as year. Generally, the Loan Estimate and Closing Disclosure require the disclosure of categories of information that will vary due to the type of loan, the payment schedule of the loan, the fees charged, the terms of the transaction, and State law provisions. The extent of these variations cannot be shown on a single, static example. This Guide includes most of the requirements concerning completing the Loan Estimate and Closing Disclosure. However, this Guide may not illustrate all of the permutations of the information required or omitted from the Loan Estimate or Closing Disclosure for any particular transaction. Only the TILA-RESPA rule and its official interpretations can provide complete and definitive information regarding its requirements.

Loan Estimate

Issuance and Delivery

You must provide a Loan Estimate to the consumer, either by delivering by hand or placing in the mail, no later than three business days of the receipt of an application. An application is considered received when the consumer provides the following information: § Consumer’s name, § Consumer’s income, § Consumer’s Social Security number to obtain a credit report, § Address of the property, § Estimate of the value of the property, and § The mortgage loan amount sought.

Revised Loan Estimate

When there is a changed circumstance after the Loan Estimate has been provided, the creditor can revise the Loan Estimate within three business days. A revised Loan Estimate generally can be provided no later than seven business days before consummation. (See section 2.1.5 below)

Use of Compliance Guide

Please see Compliance Guide, sections 6, 7, 8, and 9, for additional information on details of these requirements. The information that follows discusses how to complete the Loan Estimate. Samples of completed Loan Estimates can be found at consumerfinance.gov/regulatory-implementation/tila-respa/.


Dollar amounts must be rounded to the nearest whole dollar where noted in the regulation. (§ 1026. 37(o)(4)) If an amount is required to be rounded but is composed of other amounts that are not required or permitted to be rounded, use the unrounded amounts in calculating the total and then round the final sum. Conversely, if an amount is required to be rounded and is composed of rounded amounts, use the rounded amounts in calculating the total. (Comment 37(o)(4)-2) Percentage amounts may not be rounded and should be shown up to two or three decimals, as needed, except where noted in the regulation. (§ 1026.37(o)(4)(ii)) If a percentage amount is a whole number, show the whole number only with no decimals. (§ 1026.37(o)(4)(ii); Comment 37(o)(4)(ii)-1).


Consummation is not the same thing as closing or settlement. Consummation occurs when the consumer becomes contractually obligated to the creditor on the loan, not, for example, when the consumer becomes contractually obligated to a seller on a real estate transaction. (§ 1026.2(a)(13)) The point in time when a consumer becomes contractually obligated to the creditor on the loan depends on applicable State law. (§ 1026.2(a)(13); Comment 2(a)(13)-1) Creditors and settlement agents should verify the applicable State laws to determine when consummation will occur, and make sure delivery of the Loan Estimate occurs within three business days of the receipt of an application.


The point in time when a consumer becomes contractually obligated to the creditor on the loan depends on applicable State law. (§ 1026.2(a)(13); Comment 2(a)(13)-1) Creditors and settlement agents should verify the applicable State laws to determine when consummation will occur, and make sure delivery of the Loan Estimate occurs within three business days of the receipt of an application.

Good To Know
This Guide uses references to the legal obligation, which includes the promissory note plus any other agreements between the creditor and consumer concerning the extension of credit.

loan estimate

Page 1 of the Loan Estimate includes general information, a Loan Terms table with descriptions of applicable information about the loan, a Projected Payments table, a Costs at Closing table, and a link for consumers to obtain more information about loans secured by real property at a website maintained by the Bureau. Page 1 of the Loan Estimate includes the title “Loan Estimate” and a statement of “Save this Loan Estimate to compare with your Closing Disclosure.” (§ 1026.37(a)(1),(2)) The top of page 1 also includes the name and address of the creditor. (§ 1026.37(a)(3)) A logo or slogan can be used along with the creditor’s name and address, so long as the logo or slogan does not exceed the space provided for that information. (§ 1026.37(o)(5)(iii)) If there are multiple creditors, use only the name of the creditor completing the Loan Estimate. (Comment 37(a)(3)-1) If a mortgage broker is completing the Loan Estimate, use the name and address of the creditor if known. If not yet known, leave this space blank.

Date Issued

The date the Loan Estimate is mailed or delivered to the consumer. (§ 1026.37(a)(4)) Applicants Applicants includes the name and mailing address of the consumer(s) applying for the loan. Use each Applicant’s name and mailing address if there are multiple Applicants. An additional page may be added to the Loan Estimate if the space provided is insufficient to list all of the Applicants.


Property is the address of the property (which must include the zip code) that will secure the transaction. If the address of the Property is unavailable, use a description of the location of the property, for example a lot number. Always use a zip code.  Personal property such as furniture or appliances that also secures the credit transaction may be, but is not required to be included as Property. An additional page may not be appended to the Loan Estimate to disclose a description of personal property.

Sale Price or Appraised Value or Estimated Value

If the loan is for a purchase money mortgage, use Sale Price. (§ 1026.37(a)(7)(i)) If personal property is included in the Sale Price of the Property, use that price without any reduction for the appraised or estimated value of the personal property.  If the loan is for a transaction without a seller, use Appraised Value or Estimated Value.

Loan Term

Loan Term is the term of the debt obligation. Describe the Loan Term as “years” when the Loan Term is in whole years. For example “1 year” or “30 years.”  For a Loan Term that is more than 24 months but is not whole years, describe using years and months with the abbreviations “yr.” and “mo.,” respectively. For example, a loan term of 185 months is disclosed as “15 yr., 5mo.” For a Loan Term that is less than 24 months and not whole years, use months only with the abbreviation “mo.” For example, “6 mo.” or “16 mo.”


Describe the consumer’s intended use for the loan. (§ 1026.37(a)(9)) Purpose is disclosed using one of four descriptions: Purchase, Refinance, Construction, or Home Equity Loan.

  • Purchase is disclosed if the loan will be used to finance the Property’s acquisition.
  • Refinance is disclosed if the loan will be used for the refinance of an existing obligation that is secured by the Property (even if the creditor is not the holder or servicer of the original obligation).
  • Construction is disclosed if the loan will be used to finance the initial construction of a dwelling on the property disclosed on the Loan Estimate.
  • Home Equity Loan is disclosed if the loan will be used for any other purpose.


Provide a description of the loan.  You are required to include two pieces of information in this disclosure: The first piece of information is any payment feature that may change the periodic payment, which includes Negative Amortization, Interest Only, Step Payment, Balloon Payment, or Seasonal Payment. (§ 1026.37(a)(10)(ii)) Additionally, the duration of the relevant payment feature must be disclosed with a Negative Amortization, Interest Only, Step Payment, or Balloon Payment.  For example, a payment feature where there is a five-year period during which the payments cover only interest, and are not applied to the principal balance, would be disclosed as a 5 Year Interest Only for the payment feature.

  1. Negative Amortization is when the principal balance of the loan may increase due to the addition of accrued interest to the principal balance. § Interest Only is when one or more regular periodic payments may be applied only to interest accrued and not to the principal of the loan.
  2. Step Payment is when the scheduled variations in regular periodic payment amounts occur that are not caused by changes to the interest rate during the loan term.
  3. Balloon Payment is when the terms of the legal obligation include a payment that is more than two times that of a regular periodic payment.
  4. Seasonal Payment is when the terms of the legal obligation expressly provide that regular periodic payments are not scheduled between specified unitperiods on a regular basis. For example, a “teacher” loan that does not require monthly payments during summer months has a Seasonal Payment.
  5. If the loan can be described with more than one of these descriptions, only the first applicable feature is disclosed. For example, a loan that would result in both Negative Amortization and a Balloon Payment would only disclose Negative Amortization as part of Product

The second piece of information disclosed is whether the loan uses an Adjustable Rate, Step Rate, or Fixed Rate to determine the interest rate applied to the principal balance.

  • An interest rate is an Adjustable Rate if the interest rate may increase after consummation, but the rates that will apply or the periods for which they will apply are not known at consummation. Each description must be preceded by the duration of any introductory rate or payment period, and the first adjustment period, as applicable. For example, a product with an introductory rate that is fixed for the first five years and adjusts every three years starting in year 6 is a 5/3 Adjustable Rate. When there is no introductory period for an Adjustable Rate, disclose “0.”  For example, a product with no introductory rate that adjusts every year after consummation is a 0/1 Adjustable Rate.
  • An interest rate is a Step Rate if the interest rate will change after consummation and the rates that will apply and the periods for which they apply are known at consummation. Each description must be preceded by the duration of any introductory rate or payment period, and the first adjustment period, as applicable. For example, a product with a step rate that lasts for ten years, adjusts every year for five years, and then adjusts every three years for the next 15 years is a 10/1 Step Rate.When there is no introductory rate for a Step Rate, disclose “0” and then the applicable time period until the first adjustment.
  • An interest rate is a Fixed Rate if the interest rate is not an Adjustable Rate or Step Rate. The following are examples of Product with both pieces of information included:
  • Year 7 Balloon Payment, 3/1 Step Rate: a step rate with an introductory interest rate that lasts for three years and adjusts each year thereafter until a balloon payment is due in the seventh year of the loan term.
  • 2 Year Negative Amortization: a fixed rate product with a step-payment feature for the first two years of the legal obligation that may negatively amortize. When the time periods disclosed in Product are not in whole years, for time periods of 24 months or more, disclose the applicable fraction of a year by use of decimals rounded to two places. For time periods of 24 months or less, disclose the number of months with the abbreviation “mo.” For example:
  • An Adjustable Rate Product with an introductory interest rate for 31 months that adjusts every year thereafter is a 2.58/1 Adjustable Rate.
  • An Adjustable Rate Product with an introductory interest rate for 18 months that adjusts every 18 months thereafter is an 18 mo./18 mo. Adjustable Rate.
  • Loan Type Loan Type is the type of the loan, such as Conventional or FHA. For Loan Type, disclose: Conventional if the loan is not guaranteed or insured by a Federal or State government agency,
  • FHA if the loan is insured by the Federal Housing Administration,
  • VA if the loan is guaranteed by the U.S. Department of Veterans Affairs, and § Other with a brief description if the loan is insured or guaranteed by another Federal or a State agency.
  • Loan ID# Loan ID # is the creditor’s loan identification number that may be used by a creditor, consumer, and other parties to identify the transaction. The Loan ID # may contain alpha-numeric characters and must be unique to the particular transaction. The same Loan ID # may not be used for different, but related, loan transactions (such as different loans to the same borrower). When a revised Loan Estimate is issued, the Loan ID # must be sufficient for the purpose of identifying the transaction associated with the initial Loan Estimate.
  • Rate Lock Indicate the rate is locked with Yes, indicate the rate is not locked with No. When the interest rate is locked at the time of the Loan Estimate’s delivery, the date and time (including the applicable time zone) when the lock period ends must be disclosed. The date and time (including the applicable time zone) at which the estimated closing costs expire must be disclosed on every Loan Estimate.

Loan Terms

Disclose in the Loan Terms table:

  • Loan Amount (if the amount is in whole dollars, do not disclose cents)
  • § Initial Interest Rate,
  • Initial Monthly Principal & Interest amount
  • Any adjustments to these amounts after consummation,
  • Whether the loan includes a Prepayment Penalty, and § Whether the loan includes a Balloon Payment.

Interest Rate & Monthly Principal & Interest

If the initial Interest Rate is not known at consummation, the fully-indexed rate is disclosed; a fully-indexed rate is the interest rate calculated using the index value and margin at the time of consummation. The initial principal and interest payment amount also would be calculated using the same fully-indexed rate. Adjustment to Loan Amount, Interest Rate, and Monthly Principal & Interest after consummation Under the subheading Can this amount increase after closing?, if the Loan Amount, Interest Rate, or Monthly Principal & Interest amounts can increase after consummation, disclose Yes where applicable with the information pertinent to the adjustment after consummation.

  • For an adjustment in Loan Amount, the creditor must also disclose the maximum principal balance for the transaction and the due date (expressed as the year or month in which it occurs, rather than an exact date) of the last payment that may cause the principal balance to increase, together with a statement whether the maximum principal balance may or will occur under the terms of the legal obligation.  The date disclosed is the year in which the event occurs, counting from the due date of the initial periodic payment.
  • For an adjustment in the Interest Rate, also disclose the frequency of interest rate adjustments, the date when the interest rate may first adjust, the maximum interest rate, and the first date when the interest rate can reach the maximum interest rate.  The date disclosed is the year in which the event occurs, counting from the date that interest for the first scheduled periodic payment begins to accrue after consummation. Also, disclose and reference the Adjustable Interest Rate (AIR) Table on page 2 of the Loan Estimate.
  • For an adjustment to the Monthly Principal & Interest, the creditor would also disclose the scheduled frequency of adjustments, due date of the first adjustment, and the maximum possible amount (and the earliest date it can occur) of the Monthly Principal & Interest. In addition, if there is a period during which only interest is required to be paid, also disclose that fact and thedue date of the last periodic payment of such period. The date disclosed is the year in which the event occurs, counting from the due date of the initial payment. (Also, disclose and reference the Adjustable Payment (AP) Table on page 2.  When the Loan Amount, Interest Rate, or Monthly Principal & Interest payment cannot increase after consummation, disclose No where applicable. (§ 1026.37(b)(6)) Prepayment Penalty and Balloon Payment A Prepayment Penalty is a charge imposed for paying all or part of a transaction’s principal before the date on which the principal is due. It does not include a waived third-party charge that the creditor imposes if the consumer prepays the loan’s entire principal sooner than 36 months after closing.  A Balloon Payment is a payment that is more than two times a regular periodic payment. Under the subheading Does the loan have these features?, when the loan has a Prepayment Penalty or a Balloon Payment disclose Yes, as applicable.  and (5)) When the answer is Yes to either, also disclose, as applicable: § The maximum amount of the Prepayment Penalty and the date when the period during which the penalty may be imposed terminates. For example, As high as $3,240 if you pay off the loan in the first two years. § The maximum amount of the Balloon Payment and the due date of such payment. For example, You will have to pay $149,263 at the end of year 7.



keywords: adverse action notice