by Fredric J. Gooch
From time to time DocuTech is asked provide guidance on how a seller paid buydown should be disclosed on the Truth-in-Lending disclosures. This question has become more frequent with the implementation of the new payment table disclosure requirements introduced by the Federal Reserve Board effective on January 30, 2011. There are two separate issues to consider when examining this question. First, how should the buydown be reflected in the calculations such as the Annual Percentage Rate and the Finance Charge? The second consideration is whether the payment table should disclose the buydown using the adjustable rate model or the model for an increase in payment without an increase in interest rate.
Under the present regulations the analysis to answer these questions appears to be the same. Regulation Z simply states: “The disclosures shall reflect the terms of the legal obligation between the parties.” 12 CFR 226.17(c)(1). This is the only statement in the regulation itself but further clarification is given in the Official Staff Commentary. “The disclosures shall reflect the credit terms to which the parties are legally bound as of the outset of the transaction…The legal obligation is determined by applicable state or other law. (Certain transactions are specifically address in this commentary. See, for example, the discussion of buydown transactions elsewhere in the commentary to §226.17(c).). Supplement I, 226.17, Paragraph 17(c)(1). Under this framework the analysis to answer the disclosure questions regarding buydown disclosure is the same, determine the legal obligations of the parties under the documents and then disclose accordingly.
Third-party buydowns are addressed directly in the official staff commentary. Supplement I, 226.17 Paragraph 17(c)(1), 3:
In certain transactions, a seller or other third party may pay an amount either to the creditor or to the consumer, in order to reduce the consumer’s payments or buy down the interest rate for all or a portion of the credit term. For example, a consumer and a bank agree to a mortgage with an interest rate of 15% and level payments over 25 years. By a separate agreement, the seller of the property agrees to subsidize the consumer’s payments for the first 2 years of the mortgage, giving the consumer an effective rate of 12% for that period.
- If the lower rate is reflected in the credit contract between the consumer and the bank, the disclosures must take the buydown into account. For example, the annual percentage rate must be a composite rate that takes account of both the lower initial rate and the higher subsequent rate, and the payment schedule disclosures must reflect the 2 payment levels. However, the amount paid by the seller would not be specifically reflected in the disclosures given by the bank, since that amount constitutes seller’s points and thus is not part of the finance charge.
- If the lower rate is not reflected in the credit contract between the consumer and the bank and the consumer is legally bound to the 15% rate from the outset, the disclosures given by the bank must not reflect the seller buydown in any way. For example, the annual percentage rate and payment schedule would not take into account the reduction in the interest rate and payment level for the first 2 years resulting from the buydown.
The commentary gives the proper analysis, the credit contract must be examined to determine the appropriate disclosure. In most circumstances, the credit contract would include the promissory note, security instrument and the buydown agreement. If the lower rate is reflected in the credit contract between the consumer and the bank then the disclosures must reflect the buydown. If the lower rate is not reflected in the credit contract then the disclosures must ignore the buydown in the calculations.
If the buydown is reflected in the disclosures the next question is whether it should be disclosed as an adjustable or step rate loan in the payment table or if it should be disclosed as a loan with an increase in payment without regard to an interest rate adjustment. The analysis for this question is the same as the previous inquiry; the credit contract must be examined to determine the legal obligation between the parties. If the borrower’s interest rate is actually modified then it should be disclosed as an ARM, but if the rate is not changed and it is only who is making the interest payment that is modified then it should be disclosed as a change in payment without an interest rate adjustment.
DocuTech currently accounts for the buydown funds in the TILA disclosures and, based on informal discussions with staff from the Federal Reserve, uses the payment table for loans with a change in payment without an interest rate adjustment. When the new payment table rules became effective most lenders and investors ceased making loans with buydown options due to uncertainty as to which payment table format should be used. We are starting to see more investors and lenders venturing back into offering buydown loan products. There is still much disagreement on how these loans should be disclosed. In order to accommodate differing interpretations DocuTech is planning on adding functionality to support the differing interpretations in its January release. The Consumer Finance Protection Bureau is also working on new combined RESPA/TILA rules and disclosures, so hopefully the new regulations will give clear guidance with respect to buydown disclosure going forward, in the meantime this area of disclosure law will remain unsettled.