Residential Lending & Section 35 Rules

By Michael E Carpenter

Section 35 is part of Bank regulation Z and is part of the Truth in Lending requirements for high-priced mortgage loans (HPML). This change was enacted October 1, 2009 and all lenders making first lien mortgage loans must comply with its requirements. The regulation was created to protect consumers from predatory lending practices such as not verifying the borrower's ability to pay or imposing large prepayment penalties.

High Priced Mortgage Loan

High price mortgage loans (HPML) are defined as first mortgage loans where the annual percentage rate exceeds the interest rate on a loan by more than 1.5%. Types of loans that may fall into an HPML category are jumbo loans (loans exceeding $417,000), small mortgage amounts (under $50,000), home equity loans that are the only mortgage against the property, mortgage loans with private mortgage insurance (PMI) and mortgage loans with no up-front closing costs. HPML are not illegal. On HPML the lender has certain tests and a list of restrictions that must be adhered to on each HPML originated.

Borrowers Ability to Pay

For an HPML the lender must conduct a viability test to ensure that the borrower is financially sound enough to make the payment. The lender must verify all income sources and account for any future changes, such as retirement, when making a determination. This also includes any payment changes that may occur over the life of the loan due to changing interest rates on adjustable rate mortgages (ARM). The lender must calculate the maximum payment in the criteria. Lenders must also use the borrower's credit history as an indication of viability and the willingness of the borrower to pay the loan. There are no set definitions, ratios, or credit score requirements. Each lender, if audited, must make the case for each HPML they have underwritten.

Prepayment Penalties

Lenders are restricted on the prepayment penalties they may associate with an HPML. The lender cannot have a prepayment penalty longer than 2 years. The initial rate on an adjustable mortgage loan must last for at least four years.

Escrow Account

On any HPML, the lender is required to escrow for property taxes and homeowners' insurance. First-lien home equity loans also carry this requirement. The escrow requirement covers all stick-built homes, modular homes, mobile homes, and boats or trailers used as a primary residence. Condominium property taxes are required to be escrowed.

Negative Amortization Mortgages

Negative amortization is not allowed on HPML. Negative amortization is a mortgage where the outstanding principal balance can rise even if all payments have been made on time. Most negative amortization loans were called "pay-option" mortgages which permitted minimum payments that did not cover the full principal and interest amount each month.

About the Author

Michael Carpenter has been writing blogs since 2007. He is a mortgage specialist with over 12 years of experience as well as an expert in financing, credit, budgeting and real estate. Michael holds licenses in both real estate and life and health insurance.

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