On January 29, the CFPB proposed amendments to the portions of Regulation Z governing mortgages made by small creditors. In the same notice, the CFPB also proposed amendments to Regulation Z’s definition of the term “rural,” which controls certain special permissions for small creditors operating predominately in areas that satisfy the definition. The proposed amendments follow the Bureau’s May 2013 announcement that it intended to study potential adjustments to the terms “rural” and “underserved,” as well as its May 2014 request for comments regarding the small creditor loan origination threshold. Comments on the proposed amendments are due on or before March 30, 2015, and the Bureau proposes that the amendments would become effective January 1, 2016.

Three of the CFPB’s major mortgage rules feature special provisions and exemptions for small creditors: The escrow rule exempts certain small creditors from the requirement to establish escrow accounts for certain higher-priced mortgages; the ability-to-repay (ATR) rule includes three varieties of qualified mortgages—two permanent, one temporary—that are available only to small creditors; and the Home Ownership and Equity Protection Act (HOEPA) rule exempts small creditors from its prohibition on balloon payment features for certain high-cost mortgages.

Both the current rule and the proposed rule define a small creditor, generally, according to two thresholds—loan origination and asset size. Currently, a small creditor is one which

1. originates, together with any affiliates, 500 or fewer covered transactions annually (subject to certain exceptions, covered transactions are first-lien consumer credit transactions secured by a dwelling); and
2.  holds assets totaling less than $2 billion, as adjusted annually for inflation (the dollar amount for 2015 is set at $2.060 billion).

The amendments propose to define a small creditor as one which

1. originates, together with any affiliates, 2,000 or fewer first-lien covered transactions annually, excluding loans that were not transferred by the creditor or its affiliates; and
2. holds, together with any mortgage-originating affiliates, assets totaling less than $2 billion, as adjusted annually for inflation.

According to the Bureau, these amendments serve two main goals. First, the higher origination threshold (and the exclusion of loans that are not transferred) should ease the rules’ implicit limitations on smaller creditors’ ability to provide credit to qualified borrowers. Second, the reconfigured asset-size threshold should prevent larger creditors from using creative organizational structures to take advantage of the special provisions intended only for their smaller counterparts.

The most significant effect of the proposed changes to the small creditor thresholds may be to the three qualified mortgage categories under the ATR rule that are available only to such creditors. The small creditor qualified mortgage categories are (1) the category for loans that small creditors retain in portfolio, which are not subject to the strict 43% debt-to-income limit that applies to the general qualified mortgage; (2) the category for loans with balloon payments made by small creditors that operate predominantly in rural or underserved areas (balloon payments are prohibited for qualified mortgages made by non-small creditors); and (3) the temporary category for loans with balloon payments made by small creditors regardless of whether they operate predominantly in rural or underserved areas. The CFPB proposes to extend the sunset of the temporary balloon-payment qualified mortgage by roughly three months, from January 10, 2016, to April 1, 2016.

Regulation Z’s definition of a “rural” area is relevant not only to the permanent balloon-payment qualified mortgage for small creditors, but to several other Bureau rules, as well. The exception from the requirement to maintain an escrow account in connection with a higher-priced mortgage loan is available for small creditors operating predominately in rural or underserved areas, subject to certain conditions. Also, while balloon payment features generally are prohibited with HOEPA loans (also known as “high-cost loans”), small creditors operating predominately in rural or underserved areas may make HOEPA loans with balloon payment features, subject to certain conditions. As a practical matter, however, few creditors are likely to make HOEPA loans.

Currently, Regulation Z designates “rural” areas by county. A county is considered “rural” if it is neither a metropolitan statistical area nor in a micropolitan statistical area that is adjacent to a metropolitan statistical area. The CFPB publishes on its website a list of rural counties on which the industry may rely. This approach has been the subject of substantial criticism, arguing, among other things, that it excludes rural portions of counties that also include urban areas.

The CFPB proposes to amend the definition of a “rural” area to include both rural counties and all census blocks—a more finite unit of geographical measure—that are not designated as “urban.” The CFPB does not propose to amend the definition of an “underserved” area, having concluded that the proposed amendment to “rural” should sufficiently allay any concerns regarding availability of the relevant exemptions.

The remaining proposed amendments would modify a lender’s timeline for determining whether it qualifies as a small creditor and whether, for purposes of the allowable exemptions, it is operating predominately in a rural or underserved area. Most notably, the CFPB proposes to adjust the allowable look-back period for determining whether a lender is operating predominately in a rural or underserved area. Currently, lenders may look back to any of the last three years; in other words, if data confirms that a lender operated predominately in a rural or underserved area in any of the last three calendar years, it may continue to operate as such this calendar year. The CFPB explained that it adopted this approach out of concern for volatility in the concepts of “rural” and “underserved” during the period that the CFPB re-examined them. Based on its proposed approach to the definition of a “rural” area, along with a new grace period (discussed below) that is also proposed, the CFPB decided to propose revising the look-back period to only the preceding year.

The CFPB also proposes to install a three-month grace period following the expiration of a lender’s status as a small creditor or as a creditor operating predominately in a rural or underserved area. If, during a calendar year, a creditor exceeds the loan origination or asset size thresholds necessary to retain status as a small creditor for the following calendar year, it may continue to operate as a small creditor with respect to applications received before April 1 of the following year. Likewise, if a creditor no longer has operated predominately in a rural or underserved area within the preceding calendar year, it may continue to operate as such with respect to applications received before April 1 of the following year.