Let’s say you are doing a mailer or webpage ad promoting a 5-1 LIBOR ARM product that your company offers mortgage clients. What disclosures under Regulation Z do you need to add? Is there more than one right way to do make the disclosures? What do the rules under Reg Z say you need to do a minimum?
ARM Loan Disclosure Rules are Complex and Detailed.
I always found ARM products to be the most complicated of all mortgage products to advertise. We know we need to let the consumer know that their interest rate on the loan is not fixed and that it can change. Do we need to tell them how much it can change? Do we need to explain the index? Do we need to explain what the margin is? Do we have to tell them what LIBOR stands for and how to find out what the current LIBOR value is? Do we need to estimate how much the payment might be after the initial five year fixed period ends? How can we possibly know what that payment will be today at the origination of the loan? How do Compliance Officers get this right? Do we just look at what our competitors are doing in their ads? Are they doing it right? Lots of questions …. Where we do start?
What does Regulation Z Say about Advertising ARMs?
Let’s start with Regulation Z Advertising Rules in Section 1026.24. There’s a lot of advertising rules in Section 1026.4 starting with paragraph (a) and ending with paragraph (i) in that section of Regulation Z.
Section (i) Rules – Be careful about using the words “Fixed Rate” in your ARM Loan
Let’s start with paragraph (i) of 026.24. Paragraph (i) states that you cannot engage in certain prohibited acts or practices advertisements for credit secured by a dwelling. The first prohibition discussed in that section involves “misleading advertising of ‘fixed’ rates and payments”. This rule goes on to say that you can’t discuss a fixed payment period of the ARM product before you first identify the loan product you are promoting as an ARM product.
So this part of the rule says that you must use the phrase “Adjustable-Rate Mortgage,” “Variable-Rate Mortgage,” or “ARM” appears in the advertisement before the first use of the word “fixed” and is at least as conspicuous as any use of the word “fixed” in the advertisement.
Section (f) Rules – Disclosures of Rates and Payments.
Disclosure of Rates (f)(2) Rules – What else needs to be disclosed about ARMs? The next most important part of the rule that applies to ARMs can be found in Section 1026.24(f) which lays out the requirements related to the disclosure of rates and payments in mortgage ads. The (f) rules talk about disclosures of rates and these rules provide that specific disclosures about payments need to be made where more than one simple annual rate of interest will apply over the term of the advertised loan For ARM loans, this section states that the advertising lender must disclose:
- A rate determined by adding an index and margin and this rate shall be disclosed based on a reasonably current index and margin. This is the one area where we see a difference in disclosure approaches by different lenders. We see some lenders just disclose the margin plus index rate that is applicable after the five year fixed period ends (this is based on today’s margin value since we don’t know what it will be five years from now). The margin on a five year ARM is often 2.25%.
- The period of time during which each simple annual rate of interest will apply, and
- The Annual Percentage Rate (APR) applicable to the particular loan scenario shown in the advertisement.
Disclosure of Payments (f)(3) Rules– If an ARM ad discloses the amount of any payment, the ad must also disclose:
- The amount of each payment that will apply over the term of the loan, including any balloon payment.
- In variable-rate transactions, payments that will be determined based on the application of the sum of an index and margin shall be disclosed based on a reasonably current index and margin;
- The period of time during which each payment will apply; and
- For first lien ARMs, the fact that the payments do not include amounts for taxes and insurance premiums, if applicable, and that the actual payment obligation will be greater.
Here’s how one bank handles the ARM disclosure on its website: 5-1 ARM 2.650% Interest Rate at 0 points, 2.782% APR
Here’s the Bank’s Disclosure:
Rate effective as of 10/24/12. Savings example based on a 30 yr fixed rate mortgage versus a 5/1 Smart Rate Adjustable Mortgage. EXAMPLE for 30 yr fixed loan, 4.04% 0 points: A $200,000 mortgage loan will be paid in 360 monthly installments of $959.45. EXAMPLE for 5/1 Smart Rate Adjustable Mortgage, 2.39% Interest Rate, 3.02% APR, 3.25% Fully Indexed Rate, 0 points: A $200,000 mortgage loan will be paid in 360 monthly installments. There will be a payment of $778.85 during the first 60 months and the payment would adjust to $722.34 for the remaining 300 months.
Initial discount rate for the 5/1 Smart Rate reflects a reduction in effective rate until the first adjustment after the fifth year. Rates subject to increase after 5 years. All stated payments include principal and interest only. All above rates available for purchases or refinances with automatic payment program on single-family, owner-occupied homes. Annual Percentage Rates (APR) reflect 20% equity based on appraisal or sale price, whichever is lower. APR with lower down payments and refinances may vary. Rates are subject to change without notice. Additional terms and conditions apply.
Final Comment about the above disclosure made by this bank:
This bank could have done a better job at expressly stating that payments do not include amounts for taxes and insurance premiums, if applicable, and that the actual payment obligation will be greater.