QUESTION
I have a question about the annual percentage rate (APR) that needs to be calculated for adjustable-rate mortgages.
Our adjustable mortgages can change the rate during the first five years after the first payment is due. You may have heard of these types of loans. They are called “short reset ARMS.”
We price these QMs by using the General QM rule to calculate the APR.
When we reviewed our loan servicing system, the auditor found that the programming rules for calculating prepaid interest were not explained in the rule descriptions stated for each rule. So, we need to have those descriptions.
What is the interest rate used for calculating prepaid interest under the General Qualified Mortgage (QM) annual percentage rate (APR) calculation rule for certain adjustable-rate mortgages (ARMs) and short reset ARMs?
ANSWER
Your question obviously pertains to price-based General QMs. If you want to make a QM loan under the price-based General QM definition, you must calculate the APR to determine whether the loan satisfies the price-based General QM definition.
Let me explain. The priced-based General QM definition contains a special rule for calculating the APR for loans where the interest rate may or will change within the first five years after the date on which the first regular periodic payment will be due. These loans are sometimes referred to as short-reset ARMs and step-rate loans.
For loans with this characteristic, the creditor must treat the maximum interest rate that may apply during those five years as the interest rate for the loan's full term when determining the APR for purposes of the price-based QM definition.
The special rule also applies for the purpose of determining whether the loan receives a conclusive or a rebuttable presumption of compliance with the ability-to-repay (ATR) requirement.
For a loan to satisfy the price-based General QM definition, the loan APR cannot exceed the average prime offer rate (APOR) for a comparable transaction by the amounts set forth in the rule as of the date the interest rate is set.
The
difference between the loan’s APR and APOR – the “rate spread” – is also used
to determine whether the loan will receive a conclusive or rebuttable presumption
of compliance with the ATR requirement.
Now, concerning the interest rate to use for calculating prepaid interest under the special rule of General QM ARMS, per Regulation Z, the APR includes any prepaid interest, sometimes referred to as “odd-days” or “per diem interest.” Typically, mortgage interest is paid one month in arrears.
For instance, if the first scheduled periodic payment due is on November 1, it will cover interest accrued in the preceding month of October. Thus, if the borrower consummates the mortgage loan on September 20, interest starts to accrue on September 20, and at consummation the consumer will typically prepay interest for the 11-day period through the end of September. That amount is prepaid interest.
Sometimes, a creditor may provide the borrower a prepaid interest credit, often referred to as “negative prepaid interest.” Negative prepaid interest can result if consummation occurs after interest begins accruing for periodic payments.
Thus, to apply negative prepaid interest to the example above, if the borrower instead consummates the mortgage loan on October 4, but the first scheduled periodic payment is due on November 1 and will cover interest accrued in the preceding month of October, then at consummation the creditor will typically credit the consumer for the preceding three days in October to offset some of that first scheduled periodic payment. That prepaid interest credit is also a component of the APR.
Finally, take note, for purposes of calculating the APR for the General QM ARM’s special rule, the maximum interest rate that may apply during the five-year period after the date on which the first regular periodic payment will be due is used to calculate prepaid interest and negative prepaid interest.