Title: Troubleshooting Your ARM Practices Pays Off
Abstract: In the past several years, community reinvestment and related concerns have been casting a long shadow in the compliance arena--so much so that many senior managers have taken an active interest in CRA while relegating other compliance issues to the background. This practical can be shortsighted. Before CRA emerged as a dominant topic, there was one regulation that had, for the better part of two decades, caused banks far more compliance problems than any other. That rule is Regulation Z, which implements the Truth in Lending Act. Reg Z has always caused problems and always will. Its scope is enormous, and it is fraught with complexity. And it carries the most severe combination of statutory and regulatory penalties of any consumer rule. In recent months, bank problems with Reg Z have again been in the spotlight with exceptional recent cases involving adjustable rate mortgages. ARMs present special challenges. They are complex instruments subject to special Reg Z requirements for real estate loans. They are subject to additional rules developed just to protect the public from perceived dangers of ARMs. They involve large sums and long maturities, which tend to magnify the impact of errors. And finally, as credit products go, ARMs are a new offering for many institutions, creating the opportunity for ignorance of the rules and start-up glitches to wreak havoc. Common errors, results. Banks make two extremely serious mistakes in handling ARMs. One is failing to make proper initial disclosures on ARMs that feature discounted initial or teaser rates. The second is some banks'--reportedly a great many--not making correct rate adjustments on outstanding ARMs. The potential magnitude of both problems is daunting. With respect to inaccurate initial disclosures, there have been instances in the past several years of banks being required to reimburse customers hundreds of thousands of dollars for errors that arose out of innocent but careless mistakes. One $250 million-assets bank reportedly paid customers approximately $250,000 for these violations. Two rural affiliates of a midwestern holding company were ordered to reimburse customers $290,600 for the same type of error. In October, a $200,000 reimbursement order against a $160 million thrift institution was upheld by a federal appeals court. With respect to inaccurate payment adjustments on existing loans, the challenges are coming not from regulatory agencies, but in court. At least ten financial institutions in six states have been hit with lawsuits--many of which are class actions--claiming damages. The litigants' attorneys allege that the violations involved are common throughout the industry. Truth in lending provides for punitive damages in class action suits, up to the lesser of $500,000 or 1% of the institution's net worth, as well as recovery of actual damages, court costs, and attorney's fees. If these suits are successful, it seems plausible that they may be replicated in other areas of the country. Let's take these two issues in turn, look at the errors causing the problems, and identify the appropriate preventive and remedial steps. Initial disclosures. Many lenders have designed ARMs featuring a lower rate for an initial period, such as a year, in order to make the home purchase more affordable. When creditors offer such loans, they are required by Reg Z to disclose a composite or blended annual percentage rate (APR) that takes into account both the initial low rate and the rate that would be in effect for the remaining term of the loan. Some banks have made the mistake of disclosing the discounted rate as if it would apply for the entire term--perhaps 20 to 30 years. When they engage in a pattern or practice of making this error, the agencies, by law, must require them to reimburse customers for the difference between the disclosed amount and the rate that should have been disclosed, through the first rate adjustment date. …
Publication Year: 1991
Publication Date: 1991-12-01
Language: en
Type: article
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Cited By Count: 1
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