QUESTION
We had asked our loan officers to tell us what areas in originating loans seem most complicated to them. Then, we compiled their answers.
Many things confused them about TILA. They had a decent understanding of consummation and timeliness. However, they were unable to make sense of the finance charge.
In the 2021 year-end meeting, we decided to contact you.
What goes into making a finance charge?
ANSWER
The finance charge has baffled loan officers and consumers virtually from its inception. There is so much case law and disputes and settlements relating to the finance charge that one would need a detailed map to navigate through the iterations, zooming in and out of the ever-circuitous fractals. I will respond within the limits of this space, so whereas brevity is the soul of wit, for now, it will suffice as no more than a teaser. If there is an ongoing concern, I think you might want to do some training on finance charges. Use a reliable trainer or us.
Let’s get consummation and timeliness out of the way, as they, along with the finance charge, are three essential concepts that underlie Regulation Z, the implementing regulation of the Truth-in-Lending Act (TILA).
We can define consummation to mean the time when a consumer becomes contractually obligated on a credit transaction. This definition is critical because Regulation Z requires all closed-end credit disclosures to be made to the consumer before consummation. A creditor should not require a consumer to sign and return a commitment letter or other binding loan contract for a closed-end consumer credit transaction unless: (1) timely TILA disclosures have been provided before the document was signed, or (2) the document has been carefully drafted to avoid obligating the consumer to complete the loan transaction.
With respect to timeliness, while TILA disclosures must be in a form the consumer can keep, the TILA-related disclosures typically are given when the form, such as a note (or retail installment contract), containing the disclosures (on its face) is handed to the consumer to be read and then signed (certainly, before consummation – that is, before the consumer is in any manner obligated on the transaction). Regulation Z states: “The disclosures need not be given any particular time before consummation.”[i]
But, special timing rules do apply to the integrated disclosures required by TILA and the Real Estate Settlement Procedures Act (RESPA) (viz., Loan Estimates and Closing Disclosures), high-cost mortgage (HCM) disclosures, variable-rate transactions secured by the consumer’s principal dwelling with a term greater than one year, and private education loans. A creditor should not simply show a copy of the disclosures to the consumer before the consumer signs and becomes obligated,[ii] given specific performance requirements:
“The disclosure requirement is satisfied if the creditor gives a copy of the document containing the unexecuted credit contract and disclosures to the consumer to read and sign; and the consumer receives a copy to keep at the time the consumer becomes obligated. It is not sufficient for the creditor merely to show the consumer the document containing the disclosures before the consumer signs and becomes obligated. The consumer must be free to take possession of and review the document in its entirety before signing."[iii]
Now, let’s move on to the finance charge.
As a generic approach to understanding the finance charge, a recent case in the federal district court in Connecticut helps to set us off on the discussion. It not only defined consummation and timeliness but also provided a good definition of a finance charge. In Sparano v. JLO Auto,[iv] the court noted the specific – some might even say “peculiar” – rules regarding the term “finance charge.” Regulation Z defines “finance charge” as “the cost of consumer credit as a dollar amount.” The term includes[v]
“… any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or as a condition of the extension of credit. It does not include any charge of a type payable in a comparable cash transaction.”[vi]
I have given you a broad starting point. So, now I would like to offer a response directed at your loan officers, those individuals who need practical advice more than cringe-worthy legal theory. I will provide a categorized outline of the types of concerns that often befuddle and confound loan officers.
Dollar Amount
The finance charge is the cost of consumer credit as a dollar amount.[vii] This is not often recognized. It includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the lender as an incident to or a condition of the extension of credit. It does not include any charge of a type payable in a comparable cash transaction.
To determine whether an item is a finance charge, a lender should compare the credit transaction in question with a similar cash transaction. For instance, taxes or registration fees paid by both cash and credit customers are not finance charges. However, inspection and handling fees for the staged disbursement of construction loan proceeds are finance charges. Charges absorbed by a lender as a cost of doing business are not finance charges, even though the lender may consider the costs in determining the interest rate to be charged or the cash price of the property or service sold. Thus, a discount imposed on a credit obligation when a seller-creditor assigns it to another party is not a finance charge as long as the discount is not separately imposed on the consumer.[viii]
Rule of Thumb
Here’s a utilitarian rule of thumb:
Generally, it is typical to begin looking at a charge with the assumption that it is a finance charge. Then, search for specific exclusions in Regulation Z or the commentary. If you cannot find an exclusion, the assumption that it is a finance charge controls.
Like any rule of thumb, there are caveats. Obviously, you do not want to be wrong in the conclusion; however, it usually safer to be wrong on the high side (i.e., concluding that a fee is a finance charge when it is not and overstating the APR and related disclosures) than on the low side (i.e., concluding that the fee is not a finance charge and understating the APR and related disclosures). On real property-secured credit, two tolerance rules are critical. TILA disclosures for this type of credit typically are considered accurate if the amount disclosed as the finance charge:
· Does not vary from the actual finance charge by more than $100; or
· Is greater than the amount required to be disclosed by TILA.[ix]
Right to Cancel
For purposes of the right to cancel, the disclosure of the finance charge and other disclosures affected by any finance charge are treated as accurate if the amount disclosed as the finance charge does not vary from the actual finance charge by more than an amount equal to one-half of 1 percent of the total amount of credit extended.[x]
Thus, for purposes of the right to cancel, being wrong on the high side can be as risky as being wrong on the low side. That pesky rule of thumb!
Common Charges
I could write a treatise on categorizing each charge as a finance charge or not as a finance charge. Regulation Z and its commentary provide a few rules that I want to highlight.
Charges by Third Parties
Unless otherwise excluded, the finance charge includes fees and amounts charged by someone other than the creditor if (1) the lender requires the use of the third party as a condition of or an incident to the extension of credit (even if the consumer can choose the third party) or (2) if the lender retains a portion of the third-party charge, to the extent of the portion retained.
For example, the cost of required mortgage insurance, and the cost of annuities required by a lender in connection with a reverse mortgage transaction, are finance charges. [xi]
Closing Agent Charges
Fees charged by a third party that conducts the loan closing (i.e., a settlement agent, attorney, or escrow or title company) are finance charges only if the lender (1) requires the particular services for which the fees are charged, (2) requires the imposition of the charge, or (3) retains a portion of the third-party charge, to the extent of the portion retained.[xii] An example of a closing agent charge that is a finance charge is a courier fee when the lender requires the use of a courier.[xiii]
Mortgage Broker Fees
Fees charged by a mortgage broker (including fees paid by the consumer directly to the broker or the lender for delivery to the broker) are finance charges even if the lender does not require the consumer to use a mortgage broker and even if the lender does not retain any portion of the charge.[xiv] A fee charged by a mortgage broker is excluded from the finance charge, however, if it is the type of fee that is also excluded when charged by the lender.
For example, to exclude an application fee from the finance charge, the broker must charge the fee to all applicants for credit, whether or not credit is extended.[xv] Yield spread premiums, which are paid to the broker by the lender, ultimately come from the interest rate to be paid by the borrower, so they are not separately disclosed as finance charges, as to do so would be to double-count them.[xvi]
Examples of Finance Charges
Regulation Z specifically includes the following types of charges as finance charges:[xvii]
· Interest, time price differential, and any amount payable under an add-on or discount system of additional charges
· Service, transaction, activity, and carrying charges
· Points, loan fees, assumption fees,[xviii] finder’s fees, and similar charges.
· Premiums or other charges for any guarantee or insurance protecting the lender against the consumer’s default or other credit loss (i.e., mortgage guaranty insurance)
· Charges imposed on a lender by another person for purchasing or accepting a consumer’s obligation, if the consumer is required to pay the charges in cash, as an addition to the obligation, or as a deduction from the proceeds of the obligation
Examples of Non-Finance Charges
Regulation Z also expressly excludes the following types of fees from the finance charge:[xix]
· Application fees charged to all applicants for credit, whether or not credit is actually extended. The fee may cover the cost of services such as credit reports, credit investigations, and appraisals and might be imposed only in certain loan programs, but it must be charged to all applicants for the program.[xx]
· Charges for an actual unanticipated late payment, for exceeding a credit limit, or for delinquency, default, or a similar occurrence.
· Fees charged for participation in a credit plan, whether assessed on an annual or other periodic basis.
· Seller’s points, including any charges imposed by the lender on the non-creditor seller of property for providing credit to the buyer or for providing credit on certain terms. These are excluded even in they are passed on to the buyer, for example, in the form of a higher sales price. Seller’s points are frequently involved in real estate transactions guaranteed or insured by governmental agencies. A commitment fee paid by a non-creditor seller (such as a real estate developer) to the lender should be treated as seller’s points. Buyer’s points, however, are finance charges.[xxi]
· Interest forfeited as a result of an interest reduction required by law on a time deposit used as security for an extension of credit.[xxii]
Examples of Real Estate-related Fees
Regulation Z lists several fees that are excluded from the finance charge if they are incurred in a transaction secured by real property or in a residential mortgage transaction and if they are bona fide and reasonable in amount:[xxiii]
· Fees for title examination, abstract of title, title insurance, property survey, and similar purposes[xxiv]
· Fees for preparing loan-related documents, such as deeds, mortgages, and reconveyance or settlement documents
· Notary[xxv] and credit report fees[xxvi]
· Property appraisal fees or fees for inspections to assess the value or condition of the property if the service is performed before closing, including fees related to pest infestation or flood hazard determinations[xxvii]
· Amounts required to be paid into escrow or trustee accounts if the amounts would not otherwise be included in the finance charge
If a lump sum charged for several services includes a charge that is a finance charge, a portion of the total should be allocated to that service and included in the finance charge. However, a lump sum charged for conducting or attending a closing (i.e., by a lawyer or a title company) is excluded from the finance charge if the charge is primarily for services related to these listed real estate-related services (i.e., reviewing or completing documents), even if other incidental services such as explaining various documents or disbursing funds for the parties are performed. The entire charge is excluded even if a fee for the incidental services would be a finance charge if it were imposed separately.[xxviii]
These real estate-related fees include only those charges imposed solely in connection with the initial decision to grant credit. For instance, this would include a fee to search for tax liens on the property or to determine if flood insurance is required. The exclusion does not apply to fees for services to be performed periodically during the loan term, regardless of when the fee is collected. Example: a fee for one or more determinations during the loan term of the current tax lien status or flood insurance requirements is a finance charge, regardless of whether the fee is imposed at closing, or when the service is performed. If a lender is uncertain about what portion of a fee to be paid at consummation or loan closing is related to the initial decision to grant credit, the entire fee may be treated as a finance charge.[xxix]
Closing Thoughts
I have only grazed the surface. Given space considerations, I will end the article here. However, before I go, there are many other areas of importance involving finance charges. I will enumerate just two of particular significance, insurance and debt cancellation coverage (viz., voluntary credit insurance premiums, property insurance premiums, and voluntary debt cancellation fees), and certain security interest charges.
I may discuss those charges in another article. Many companies defer to their loan origination system for finance charge applicability and calculations. However, loan origination systems are unfortunately not always correct. We provide guidance to them on just such matters. You need to be your own monitor and not totally rely on system solutions. They are not always reliable! You can contact me if you need our compliance support in discerning finance charges for your policies, procedures, applications, and LOS rules.
Jonathan Foxx, Ph.D., MBA[i] Regulation Z, Comment 17(b)-1
[ii] Comment 17(b)-3
[iii] Idem
[iv] Sparano v.
JLO Auto, Inc., 2021 U.S. Dist. (D. Conn. Sept. 30, 2021)
[v] Ibid
[vi] The rules
generally include in the finance charge any premiums or other charges for any
guaranty or insurance protecting the creditor against default or credit loss
and any charges or premiums paid for debt cancellation of debt suspension
coverage written in connection with a credit transaction, whether or not the
coverage is considered “insurance” under applicable law. However, take note,
the rules exclude premiums for credit life, accident, health, or loss-of-income
insurance, and amounts paid for debt cancellation or debt suspension coverage,
if three conditions are met: (1) the creditor does not require the insurance or
coverage and the creditor discloses this fact in writing; (2) the premium or
fee for the initial term of coverage is disclosed in writing, with the term of
coverage stated if the term of coverage is less than the term of the
transaction; and (3) the consumer signs or initials an affirmative written
request for the coverage after receiving the disclosures specified in (1) and
(2).
[vii] 12 CFR § 1026.4(a)
[viii] Commentary
§ 1026.4(a)-1 and -2
[ix] See 15 USC
§ 1605(f)(1). The U.S. Court of Appeals for the Seventh Circuit applied this
rule in 2003, holding that an overstatement of the finance charge was not an
actionable inaccuracy. Carmichael v. Payment Center, Inc., 2003 U.S. App. (7th
Cir. July 17, 2003)
[x] 15 USC
§ 1605(f)(2). A broader tolerance of 1 percent of the total amount of credit
extended applies to a refinancing of a residential mortgage transaction without
any new consolidation or advance.
[xi] Commentary
§ 1026.4(a)(1)-1 and -2
[xii] 12 CFR
§ 1026.4(a)(2)
[xiii] Commentary
§ 1026.4(a)(2)-1.
[xiv] 12 CFR
§ 1026.4(a)(3). See also Chow v. Aegis Mortgage Corp., 2003 U.S. Dist. (ND Ill.
Oct. 7, 2003).
[xv] Commentary
§ 1026.4(a)(3)-1
[xvi] See , i.e.,
Davis v. Deutsche Bank National Trust Co., 2007 U.S. Dist. (E.D. Pa. Nov. 9,
2007)
[xvii] 12 CFR
§ 1026.4(b)
[xviii] See
Commentary § 1026.4(b)(3)-1. An assumption fee is a finance charge only when
the assumption occurs and the fee is imposed on the new buyer, in which case the
assumption fee is a finance charge in the new buyer’s transaction.
[xix] 12 CFR
§ 1026.4(c)(1)-(6).
[xx] Commentary § 1026.4(c)(1)-1
[xxi] See
Commentary § 1026.4(c)(5)-1. Mortgage insurance premiums and other charges are
sometimes paid at or before consummation or settlement on the borrower’s behalf
by a non-creditor seller. The lender should treat the payment made by the seller
as seller’s points and exclude it from the finance charge if, based on the
seller’s payment, the consumer is not legally bound to the lender for the
charge. See Commentary § 1026.4(c)(5)-2.
[xxii] See
Commentary § 1026.4(a)-3. If the lender reduces the interest rate it pays or
stops paying interest on the consumer’s deposit account or any portion of it
for the term of a credit transaction, the interest lost is a finance charge.
However, the consumer must be entitled to the interest that is not paid in
order for the lost interest to be a finance charge.
[xxiii] 12 CFR
§ 1026.4(c)(7). The fees are excluded from the finance charge even if the
services for which the fees are imposed are performed by the lender’s employees
rather than a third party. See Inge v. Rock Financial Corp., 388 F3d 930 (6th
Cir. 2004), rehearing denied, 2004 U.S. App. (in-house document preparation fee
was bona fide and reasonable in amount and properly excluded from the
finance charge). Note, the cost of verifying or confirming information
connected to the item also is excluded. For example, credit report fees cover
not only the cost of the report, but also the cost of verifying information in
the report. See Commentary § 1026.4(c)(7)-1.
[xxiv] See
Ricciardi v. Ameriquest Mortgage Co., 2005 U.S. Dist. (ED Pa. Jan. 10, 2005)
vis-à-vis reasonable title insurance costs were properly excluded from the
finance charge.
[xxv] Commentary
§ 225.4(e)-3. To exclude a notary fee, the document to be notarized must be one
used to perfect, release, or continue a security interest; the document must be
required by law to be notarized; the notary must be considered a public
official under applicable law; and the amount of the fee must be set or
authorized by law.
[xxvi] 12 CFR
§ 1026.4(b)(4). It should be noted that credit report fees are specifically
listed as finance charges when they are incurred in a transaction other than a
residential mortgage transaction or transaction secured by real property.
[xxvii] 12 CFR
§ 225.4(b)(4). It should be noted that appraisal and investigation fees are
specifically listed as finance charges when they are incurred in a transaction
other than a residential mortgage transaction or transaction secured by real
property.
[xxviii] Commentary
§ 1026.4(c)(7)-2
[xxix] Commentary
§ 1026.4(c)(7)-3
