Cut the rate, But Don’t Cut Corners

A Guide to Temporary Buydowns

By Kris Kully

While rates have inched down in recent weeks, they still seem high to members looking for an affordable loan.

Some lenders are turning to temporary buydown loan programs, in which the consumer, the lender, or (more commonly) a third party like a seller or builder agrees to pay an amount up-front in exchange for a lower rate for a temporary time period (usually one, two, or three years). The up-front funds are used going forward essentially to supplement the payments at the buydown rate. When the temporary period expires, the rate increases to a predetermined fixed level for the remaining loan term.

That’s all well and good, but there are lots of compliance considerations related to temporary buydowns. For example: mate and Closing Disclosure should reflect the initial buydown rate. Certainly, consumer-paid buydowns must be reflected as an amendment to the contract’s rate when disclosing the finance charge and other affected disclosures. A composite APR must be calculated, and the various payment levels must be included as required. the need for early intervention. otHer C onsiderAtions: Of course, there are many other issues to consider when offering temporary buydowns. For instance: disClosing: TILA and its regulations generally require that the disclosures reflect the terms to which the consumer and creditor are legally bound at the transaction’s outset. That seems to mean that the Loan Esti- serviCing: The credit union or its servicer will, depending on the buydown program, need access to the buydown funds to supplement the reduced payments. In addition, the servicer should ensure it is providing clear communications to the member regarding the impending termination of the buydown period and the effect on the rate and payments, and be prepared to answer member questions that are certain to arise. In addition, monitoring the performance of buydown loans will be important to detect

Advertising: The Truth in Lending Act (TILA) and other authorities require advertisements to be clear and free from misrepresentations. It is tempting to tout the lower rates available with temporary buydowns. However, advertisements must not be misleading about the temporary nature of those low rates. Regulators are particularly sensitive to the use of the term “fixed” when the rate, payments, or other terms may change. If the advertisement includes the amount of any payment, it must also address repayment obligations over the loan’s term. In addition, the credit union should be prepared to substantiate any claims about how much a member can save with a temporary buydown.

It is tempting to tout the lower rates available with temporary buydowns. However, advertisements must not be misleading about the temporary nature of those low rates.

Underwriting: TILA also requires mortgage lenders to determine whether the consumer can repay a mortgage loan. In making Qualified Mortgage (QM) loans, the consumer must be qualified based on the maximum rate that may apply during the first five years after the first payment is due. Credit unions should in any case consider the effect of a stepped-up rate on the member, who may be counting on increased future income or assuming a refinancing will always provide an exit strategy.

However, if a third party pays for the buydown, and the agreement to do so is not reflected in the credit contract between the member and the credit union, then the member is legally bound at the outset to the rate in the note. The disclosure of the finance charge must then not reflect the seller buydown, although seller-paid amounts must be disclosed as such. Similarly, in lender-paid buydowns, the finance charge and other disclosures affected by it should be based on the terms of the legal obligation between the consumer and the lender.

Consumer-paid buydowns must be reflected as an amendment to the contract’s rate when disclosing the finance charge and other affected disclosures.

The calculation of points and fees is critical in determining whether a loan is a QM or a high-cost loan. While a member’s payment of bona fide discount points may be excluded from that calculation, the amount a member pays for the buydown is a prepaid finance charge (even if deposited in an escrow account).

The credit union also must consider the terms of the buydown plan, including what happens to the buydown funds in the case of a prepayment or foreclosure during the temporary period, or what happens if a third party fails to provide the buydown funds as agreed.

Limitations on buydown programs also may be imposed by investors, insurers, or even, as a practical matter, by the constraints of loan origination systems.

In making Qualified Mortgage (QM) loans, the consumer must be qualified based on the maximum rate that may apply during the first five years after the first payment is due.

Checking with your legal/compliance team will be key in determining how to advertise, originate, and service temporary buydown loans. While they may be a great option for members, these considerations at the outset will ensure no one gets hurt in the process.

Kris Kully is a law partner in Mayer Brown’s Washington, D.C. office. She concentrates her practice on federal and state regulatory compliance matters affecting providers of consumer financial products and services. Kully is a former lawyer for the Department of Housing and Urban Development, where she provided legal counsel on the mission oversight of Fannie Mae and Freddie Mac, the interpretation of the RESPA and the implementation of housing assistance and community development programs.