Avoiding adjustable-rate mortgage loan compliance challenges
- ARM compliance requires accurate, timely disclosures. Early ARM disclosures often have stricter timing requirements than other loan disclosures and errors in loan program disclosures, such as outdated indexes, incorrect margins or missing discounted-rate information, create compliance risks.
- Rate adjustment calculations require close oversight. Using the wrong index, applying incorrect periodic caps or failing to update systems for subsequent rate changes can lead to inaccurate interest rates and payments, increasing both regulatory and operational risk.
- Financial institutions should carefully review notice content, projected payment calculations and required delivery timelines to help ensure borrowers receive accurate information and all Regulation Z requirements are met.
Adjustable-rate mortgage (ARM) loans can present compliance challenges throughout the entire loan life cycle. From application disclosures to rate adjustment notices, even minor errors can result in regulatory violations, customer confusion and operational risk.
Keep reading to learn about several common ARM compliance errors and for guidance on avoiding them.
Timing of early disclosures
A common mistake is the timing of early ARM disclosures, including the Consumer Handbook on Adjustable-Rate Mortgages or a suitable substitute and a loan program disclosure for each variable-rate program in which the consumer expresses an interest. These do not always allow you three business days from the application date to provide the disclosures, like other early disclosures. Regulation Z states that these disclosures must be provided at the time an application form is provided or before the consumer pays a non-refundable fee, whichever is earlier (except that the disclosures may be delivered or placed in the mail not later than three business days following receipt of a consumer’s application when the application reaches the creditor by telephone, or through an intermediary agent or broker). Based on that requirement, an in-person application request requires the disclosures to be provided on the date of application and cannot be mailed later.
Common mistakes with loan program disclosures
Other common issues include incorrect information in the ARM loan program disclosure. If the initial interest rate is a discounted or premium rate (not based on the index and margin in effect), this fact must be disclosed in the early disclosure, but it is often missing. If using the optional 15-year historical example, make sure the disclosure identifies the month and day being used for each year in the table, verify the indexes disclosed are correct, and the margin used was one in effect within the prior six months. Often, the table is not updated properly or quickly enough. When disclosing the initial interest rate and payment example for a $10,000 loan, make sure a current rate is being used. Also, when updating the index and margin, make sure the example payment reflects the newly disclosed rate.
Avoiding violations with ARM rate changes
ARM rate changes and notification requirements probably cause the most errors. Using the wrong index is a common mistake. For example, an index that specifies a weekly average may be inaccurately disclosed with the daily version of the index. The weekly average is calculated on Friday and is generally published the following Monday, but the daily index is often used instead of the weekly average, resulting in errors and incorrect interest rates being assigned to borrowers. Make sure the index is pulled from the correct source and matches what was disclosed in the promissory note.
Another common issue involves periodic caps. Institutions should verify that the caps disclosed in the promissory note match those being used to calculate rate adjustments. It is common to have different caps for the first-rate change than for subsequent rate changes. The system might be set up for those initial caps, but not updated for the caps that will follow for any subsequent rate changes.
Errors in rate change notices are common
Rate change notices present additional challenges. An example of an error is failing to provide sufficient detail when describing the index used to determine the new rate. Some systems limit the number of characters, so it takes a bit of creativity to fit the required details, especially when trying to spell out the “X”-year weekly average constant maturity U.S. treasury securities index, which is quite lengthy. The weekly average part is often omitted when truncating, but it is an important distinction in the index used and should be included.
Also, the estimated balance and projected new payment must be based on the projected balance and number of remaining payments due at the time the rate will be changed. But some notices include the current balance at the time the notice is generated rather than a projected balance, which also results in the new payment being inaccurately calculated on the notice.
In addition, the requirement to disclose rate limits and foregone interest rate increases can be confusing, as the disclosures required by § 1026.20(c)(2)(iv) regarding foregone interest rate increases apply only to transactions permitting interest rate carryover. Usually, a promissory note does not include such a provision, yet the foregone interest disclosure is being included anyway. Even though the interest rate was not increased fully due to a limit or cap percentage, there is no foregone interest when the note does not allow for such carryover of interest.
Another issue is the required timing of the ARM adjustment notices. An initial notice must be sent at least 210 days, but no more than 240 days, before the new payment at the adjusted rate is due. The subsequent notices must be sent at least 60 days, but no more than 120 days, before the new payment at the adjusted rate is due. Occasionally, the credit agreement for an ARM originated AFTER January 1, 2015 (the date Regulation Z ARM notice requirements were effective) does not have an adequate lookback period for selecting the index prior to the change date (at least 45 days), resulting in issues with meeting the timing requirements for the ARM adjustment notices. For example, if the credit agreement does not contain a lookback period and requires the index to be selected on the change date, it is not possible to send an ARM adjustment notice at least 60 days before the new payment at the new rate is due, because the index will not yet have been published.
Remaining compliant
While ARM loans present numerous compliance challenges, many of the most common errors can be prevented through strong procedures, staff training and periodic quality-control reviews. Regular validation of disclosures, rate calculations and notice content can help institutions remain compliant while providing accurate information to borrowers.
How Wipfli can help
Wipfli has a team of compliance professionals, including former compliance managers, examiners, lending specialists and BSA officers, who can work with you to help ensure your lending practices meet all current regulations. We leverage a comprehensive, risk-based audit approach to identify and analyze risks, enabling your business to better manage ongoing compliance. Start a conversation.
