By: William J. Showalter, CRCM, CRP, Senior Consultant
Now that interest rates are moving up, many bankers are blowing the dust off their adjustable-rate mortgage (ARM) loan offerings. Interest rates for fixed-rate loans have been so low for quite some time, which made them much more appealing to mortgage loan customers. But now with rates increasing, the lower initial rates of ARM loans are beginning to look more appealing to at least some borrowers.
The problem is that many of us are so out of practice at making ARMs that we need a refresher to remind us of what we need to do. This article will serve as a primer to help us re-learn how to meet disclosure requirements for ARM loans.
Different Types of ARMs
When we think of an adjustable-rate mortgage, the first thing that comes to mind is likely the classic loan with an interest rate that can change at some regular interval based on the movement of some external index. There is a wide variety of initial time periods for which the rate is fixed and later intervals for rate changes over the life of the loan. Common initial fixed periods are one, three, five, seven, or 10 years, while probably the most common interval for later rate changes is one year.
But that is not where the variety of ARMs ends. The Official Staff Commentary on Regulation Z discusses a number of other loan structures that are considered to be variable-rate transactions subject to the ARM disclosure requirements. These additional loan structures are:
- Renewable balloon-payment loans where the creditor is both unconditionally obligated to renew the balloon-payment loan at the consumer’s option (or is obligated to renew subject to conditions within the consumer’s control) and has the option of increasing the interest rate at the time of renewal
- Preferred-rate loans where the terms of the legal obligation provide that the initial underlying rate is fixed but will increase upon the occurrence of some event (e.g., an employee leaving the employ of the creditor, or an automatic payment arrangement being ended) and the note reflects the preferred rate (though a number of the ARM disclosures are not required for preferred-rate loans)
- “Price-level-adjusted mortgages” or other indexed mortgages that have a fixed rate of interest but provide for periodic adjustments to payments and the loan balance to reflect changes in an index measuring prices or inflation (again a number of the ARM disclosures are not required for price-level-adjusted loans)
It is important to note that graduated-payment mortgages and step-rate transactions without a variable-rate feature are not considered variable-rate transactions under Regulation Z. This is likely because changes over the term of the loan are known at the outset – specified payment and/or interest rate increases.
Two ARM disclosures must be given to applicants for such loans at the time an application form is provided or before the consumer pays a non-refundable fee, whichever is earlier. There is an exception allowing the disclosures to 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.
For an application that is accessed by the consumer in electronic form – including an online application portal – the required ARM disclosures may be provided to the consumer in electronic form on or with the application.
These two early ARM disclosures are:
- The booklet titled Consumer Handbook on Adjustable-Rate Mortgages (CHARM booklet), or a suitable substitute, and
- A loan program disclosure for each variable-rate program in which the consumer expresses an interest (each comprised of 12 specified pieces of information about the ARM program)
The Loan Estimate (LE) and Closing Disclosure (CD) both require some additional disclosures for ARMs. The LE must be provided to an applicant no later than the third business day after their application is received by the lender, while the CD must be provided no later than three business days before consummation. (There are also situations permitting or requiring these disclosures to be revised, but that’s a subject for another time.)
The particular TRID (TILA-RESPA Integrated Disclosures) items impacted by a loan being an ARM are:
- “Interest Rate” in the “Loan Terms” section – If the interest rate at consummation is not known, the rate disclosed must be the fully-indexed rate, which means the interest rate calculated using the index value and margin at the time of consummation. The lender also should disclose “Yes” for the question “Can this amount increase after closing?” In addition, 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, followed by a reference to the Adjustable Interest Rate (AIR) Table (discussed below).
- “Monthly Principal & Interest Payment” in the “Loan Terms” section – If the initial periodic payment is not known because it will be based on an interest rate at consummation that is not known at the time the LE must be provided, for example, if it is based on an external index that may fluctuate before consummation, this disclosure must be based on the fully-indexed rate disclosed above. The lender also should disclose “Yes” for the question “Can this amount increase after closing?” In addition, disclose the scheduled frequency of adjustments to the periodic principal and interest payment, the due date of the first adjusted principal and interest payment, the maximum possible periodic principal and interest payment, and the date when the periodic principal and interest payment may first equal the maximum principal and interest payment.
- “Principal & Interest” payment in the “Projected Payments” section – The table of payments (principal and interest, mortgage insurance, etc.) will include more than one column due to the possible (projected) changes in the interest rate, up to a maximum of four columns. The maximum principal and interest payment amounts (in each column) are determined by assuming that the interest rate in effect throughout the loan term is the maximum possible interest rate, and the minimum amounts are determined by assuming that the interest rate in effect throughout the loan term is the minimum possible interest rate. If the ARM has a negative amortization feature, the maximum payment amounts must reflect this feature, as spelled out in Regulation Z.
- “Adjustable Interest Rate (AIR) Table” – An ARM must disclose a separate table in the “Closing Cost Details” section on the LE and the “Additional Information About This Loan” section on the CD, under the heading “Adjustable Interest Rate (AIR) Table,” that contains specified information about the index and margin, increases in the interest rate, initial interest rate, minimum and maximum interest rate, frequency of adjustments, and limits on interest rate changes.
- “Annual Percentage Rate (APR)” and “Total Interest Percentage (TIP)” in the “Comparisons” section on the LE and the Loan Calculations section on the CD – Calculation of both these values must account for variations in the interest rate permitted for the ARM.
Interest Rate/Payment Change Notices
The creditor, assignee, or servicer of an ARM secured by a borrower’s principal dwelling must provide consumers with written notices in connection with the adjustment of interest rates in accordance with the loan contract that results in a corresponding adjustment to the payment. These notices must be separate from any other disclosures or notices.
There are exemptions for the following: ARMs with a term of one year or less; first interest rate adjustment to an ARM if the first payment at the adjusted level is due within 210 days after consummation and the new interest rate disclosed at consummation was not an estimate; or when the lender/servicer is subject to the Fair Debt Collection Practices Act (FDCPA) for the loan and the customer has sent a notice to cease communications.
The content for these change notices is spelled out in detail in Regulation Z and the timing depends on whether the rate/payment change is the first one to occur for the ARM loan or a subsequent change.
- The initial adjustment notice must be provided to consumers at least 210 days (but no more than 240 days) before the first payment at the adjusted level is due. If the first payment at the adjusted level is due within the first 210 days after consummation, the disclosures must be provided at consummation.
- All subsequent adjustment notices generally must be provided to consumers at least 60 day (but no more than 120 days) before the first payment at the adjusted level is due. The disclosures must be provided to consumers at least 25 days (but no more than 120 days) before the first payment at the adjusted level is due for ARMs with uniformly scheduled interest rate adjustments occurring every 60 days or more frequently and for ARMs originated prior to January 10, 2015 in which the loan contract requires the adjusted interest rate and payment to be calculated based on the index figure available as of a date that is less than 45 days prior to the adjustment date.
If your bank has taken advantage of the “coupon book” exception from periodic statements for mortgage loans with fixed rates, you will have to begin producing periodic statements when you begin originating ARMs. Or, you will need to expand your statement output as more of the bank’s loan production shifts to ARMs from fixed-rate loans (if you still want to use the coupon books exception for your fixed-rate lending).
If your institution is like many community banks and has not been making ARMs for some time, you likely have some work to do to ramp ARM lending back up. Systems and disclosures need to be updated and/or activated. Disclosures need to be procured or prepared. Staff needs to be trained, at least some refresher training. Good luck re-ARMing up.