With all the regulatory changes we have gone through in the past five to ten years, I thought it would be beneficial to revisit some basics of home equity lines of credit because it seems like I have been seeing an increase in errors during client testing.
There are three interdependent disclosures that are important to the home equity line of credit product: the Home Equity Line of Credit Early Program Disclosure, Account Opening Disclosures or credit agreement, and the billing statement.
Let’s start with the Home Equity Line of Credit (HELOC) Early Program Disclosure. This disclosure along with the home equity brochure entitled “What You Should Know About Home Equity Lines of Credit” must be provided at the time the application is provided. The disclosures and the brochure may be delivered or placed in the mail no later than three business days following receipt of a consumer's application in the case of applications contained in magazines or other publications or when the application is received by telephone or through an intermediary agent or broker. Keep in mind, for internet-based applications, the disclosures MUST be given WITH the application.
The contents of the HELOC Early Program Disclosure are also important. While I am not going to go over each required disclosure, I am going to touch on areas where we have recently found errors.
The minimum payment example is an area where we often find inaccuracies. The first part of the minimum payment example is straightforward—use an initial draw of $10,000 without any additional draws through the term of the loan. The errors happen when selecting the rate to determine the payment. A recent annual percentage rate is required to be used for both fixed and variable rate plans to calculate the minimum payment. For fixed-rate plans, a recent annual percentage rate is a rate that has been in effect under the plan within the twelve months preceding the date the disclosures are provided to the consumer. For variable-rate plans, a recent annual percentage rate is the most recent rate provided in the historical table or a rate that has been in effect under the plan since the date of the most recent rate in the table. In both cases, any balloon payment must be listed, as applicable.
Fees imposed by the creditor and fees imposed by third parties are often inaccurate or incomplete. The disclosure should contain an itemization of any fees imposed by the creditor to open, use, or maintain the plan, stated as a dollar amount or percentage, and when such fees are payable. The fees imposed by third parties to open a plan should include a good faith estimate, stated as a single dollar amount or range, of any fees that may be imposed by persons other than the creditor to open the plan, as well as a statement that the consumer may receive, upon request, a good faith itemization of such fees. In lieu of the statement, the itemization of such fees may be provided. Sometimes this list is not updated to reflect current fees or does not correspond to what actually is charged to the borrower at consummation.
The 15-year historical rate table is often error prone because there are a lot of moving parts. Regulation Z indicates the historical example is based on a $10,000 extension of credit, illustrating how annual percentage rates and payments would have been affected by index value changes implemented according to the terms of the plan. The historical example shall be based on the most recent 15 years of index values, selected for the same time period each year and shall reflect all significant plan terms, such as negative amortization, rate carryover, rate discounts, and rate and payment limitations, that would have been affected by the index movement during the period. Most disclosures do list the 15 years in the correct order, but we see the time period missing, i.e., the first business day of January. This is a specific time period that is to be filled in by the financial institution.
The next area where errors are sometimes identified is the number of payments and order of payments in the table. As stated above, the table shall reflect all significant plan terms. This means if the plan has a term of three years, only three years of payments would be listed, starting with the first or oldest year. Often we find all fifteen years completed. The table should also reflect any caps or floors when disclosing the yearly rates.
Moving on to the account opening disclosures, these disclosures typically have errors related to inconsistencies between the credit agreement and how the parameters have been set in the loan system. Rate-related issues crop up in two ways. One issue can be different accrual methodologies between the note and the loan system. For example, the note may state the accrual methodology is 30/360 and the system is set up to use actual/360. The second and more common inconsistency we see is when rate changes are set to occur. The note may read the rate will change on the first day of the month following the rate change. The core system may be set to change the rate on the first of the month after the rate change notification and the notification occurs on the normal billing statement. So, in effect, there is a month delay in the rate change. Other issues may include not setting up the system with the correct interest rate, index, margin, payment calculation method, late fee calculation or rounding criteria.
The final area is the first billing statement. If the first draw is used to pay for loan-related startup costs, those costs must be disclosed in specific ways depending on if the costs are considered finance charges. Finance charges must be itemized by type with the term finance charge next to the fee description; for example, Flood Life of Loan (Finance Charge). Other startup costs that are not finance charges may be disclosed in two ways. The first option is to itemize each fee individually; for example, Appraisal fee. The second option is to lump all the other fees together and label them in the same manner as they are labeled on the account opening disclosure, such as closing costs. The second option is allowed only if the consumer is able to understand what the draw is comprised of, and that is why the terminology must be consistent.
For example, if the credit agreement states the fees as closing costs and those costs are comprised of the appraisal fee, title insurance and lien filing fees totaling $500, the billing statement would then state the description of the disbursement as closing costs $500.
Home equity lines of credit are a great product, but because there are three separate disclosures that may or may not be from the same system, errors may occur. It is important to look at the disclosures in total for mismatches in terminology or system parameters.