ARM Loan Servicing Compliance
Consumer Affairs Update - December 2018
Published January 3, 2019 | October 2018 issue
Several recent examinations identified violations and other issues involving the servicing of adjustable rate mortgage (ARM) loans.1 The interest rate on ARM loans typically adjusts after the first three, five, or seven years, and as a result, many banks are complying for the first time with regulatory requirements amended in 2014. In this article, we will cover the issues examiners identified as they relate to ARM rate adjustments, describe how to address these issues, and provide several strategies for managing compliance risk in ARM servicing.
Rate adjustment notices—timing
While mortgage servicing includes a wide range of activities, examiners found issues involving subsequent ARM disclosures, which inform borrowers of upcoming changes to their interest rates and payment amounts. The first time the interest rate changes on covered loans,2 Regulation Z requires that servicers provide the notice at least 210 days but no more than 240 days prior to the due date of the first payment at the newly adjusted rate (notices are only required when the interest rate results in a change to the payment).3 For subsequent rate changes, Regulation Z requires that the servicer provide the notice 60 to 120 days prior to the first payment under the adjusted rate.4 Examiners noted that some banks did not send the notices far enough in advance of the change date for loans subject to these Regulation Z requirements.
Rate adjustment notices—content
In addition to the timing violations, examiners found that several banks did not include all of the required disclosures in the notices. Among other items, missing information included the following:
- A table comparing the previous interest rate and payment amount to the new interest rate and payment amount;
- Any limits on interest rate or payment adjustments; and
- An explanation of how the interest rate was determined.5
Regulation Z, Appendix H, provides model forms for the notices, which should be in a format substantially similar to the model form in most situations.6
ARM rate adjustment terms
ARM loan contracts contain varying terms that address how interest rates will adjust on the loans. Institutions should ensure that they adjust rates as specified in these contracts. This process involves ensuring that the institution uses the appropriate index identified in the contract and adjusts the rate according to this index and other contract terms. Moreover, it is important that the institution confirm whether, under the contract terms, the timing for determining the rate adjustment and the new payment amount is sufficient to allow the institution to meet the timing requirements for rate adjustment notices, particularly for loans originated after January 10, 2015.
Risk management strategies
Servicing ARM loans requires active compliance risk management because of the complexity of these loans. The following list identifies strategies specific to ARM servicing that you may find useful in mitigating compliance risk:
- Ensure that reviews or audits of ARM loans include the process for making and disclosing interest rate adjustments and incorporate a comparison to the contract (note) terms and related mortgage documents.
- Conduct regular training for employees who have mortgage servicing responsibilities.
- Establish policies and procedures on how to select index values, determine interest rates, and deliver rate adjustment notices.
- Review notices for compliance with format and content requirements and verify calculations of the new interest rate, payment amount, and other disclosures.
- Use a tickler or other alert system to monitor timing.
The following list includes links to model forms and to the Bureau of Consumer Financial Protection’s Small Entity Compliance Guide.
Model Forms for notice of subsequent interest rate adjustments
H-4(D)(1) Adjustable-Rate Mortgage Model Form for §1026.20(c)
H-4(D)(2) Sample Form for §1026.20(c)
Real Estate Settlement Procedures Act (Regulation X) and Truth in Lending Act (Regulation Z) Mortgage Servicing Rules Small Entity Compliance Guide
Small Entity Compliance Guide
1 Regulation Z §1026.20(c)(1) defines an ARM as a closed-end consumer credit transaction with a term longer than one year and secured by the consumer’s principal dwelling in which the annual percentage rate may increase after consummation.
2 Official commentary to 2016.20(c) explains that the interest rate adjustment disclosures are required only for interest rate adjustments occurring pursuant to the loan contract.
3 See Regulation Z §1026.20(c) and (d).
4 See Regulation Z §1026.20(c)(2).
5 See Regulation Z §1026.20(c)(2)(i)-(vii) and §1026.20(d)(2)(i)-(x) for the
required content in a subsequent and initial adjustment notice, respectively.
6 See Regulation 2026.20(d)(3)(i).