Uncertainty Remains Under CFPB's Proposed Changes to Prohibition on Financing Credit Insurance Premiums

by Ballard Spahr LLP

The CFPB has proposed changes to the Regulation Z prohibition on financing credit insurance premiums (Section 1026.36(i)) as part of several new proposed amendments to the mortgage rules it adopted in January 2013. The prohibition was one of the amendments to Regulation Z made by the CFPB's final rule on loan originator compensation.

Although the CFPB acknowledged in the proposal's background discussion that its interpretation of the prohibition in the final rule may have been "overbroad," the proposal continues to reflect an overly broad reading that does not provide a clear safe harbor for many credit insurance programs. Comments on the proposed amendments are due by July 22, 2013.

The Regulation Z prohibition was intended to implement the new Truth in Lending Act Section 129C(d) added by the Dodd-Frank Act. Section 129C(d) generally prohibits a creditor from financing the purchase of credit insurance in connection with any residential mortgage loan or extension of credit under an open-end plan secured by the consumer's principal dwelling. It also provides that fees for credit insurance "calculated and paid in full on a monthly basis shall not be considered financed by the creditor."

The proposal is intended to clarify the prohibition's applicability to transactions in which credit insurance premiums are charged periodically rather than added as a lump sum at closing. In particular, in the proposal's background discussion, the CFPB stated that the proposal responds to industry concerns raised by language in the preamble to the final loan originator compensation rule. That language suggested that the prohibition extended to premiums "charged to the consumer on a 'levelized' basis, meaning that the premiums remain the same each month, even as the consumer pays down the outstanding balance of the loan." The CFPB observed that its interpretation "may have been overbroad and left ambiguity about when a creditor violates the prohibition on financing credit insurance premiums."

The proposed amendments address two issues: when premiums are considered to be "calculated and paid in full on a monthly basis" for purposes of the exclusion from the prohibition as well as what constitutes financing of premiums by a creditor. In the background discussion, the CFPB noted the distinction made by industry between "levelized" and "level" premium payments. According to the CFPB, the term "levelized" premiums refers to "a flat monthly payment that is derived from a decreasing monthly premium payment arrangement," and the term "level" premiums refers to premiums "for which there is no decreasing monthly premium payment arrangement available, such as for level mortgage life insurance."

Premium Calculation

Despite no indication in the Dodd-Frank Act that "calculated on a monthly basis," for purposes of the exclusion from the prohibition, was intended to be limited to calculation methods in which premiums decrease, the proposal takes this approach. The proposal would add new language providing that premiums "are calculated on a monthly basis if they are determined mathematically by multiplying a rate by the actual outstanding loan balance."

Industry had argued that levelized and level premiums are "calculated on a monthly basis" even though they do not decrease each month as the loan balance decreases. In the background discussion, however, the CFPB stated that the "factors in the calculation" must change monthly for premiums to be "calculated on a monthly basis" and confirmed that the proposal does not categorically exclude credit insurance from the scope of the prohibition "on the ground that it is 'calculated and fully paid on a monthly basis' if its premium or fee does not decline as the consumer pays down the outstanding principal balance."

Financing Premiums

The proposal would add new language providing that "a creditor finances a premium or fee for credit insurance if it provides a consumer the right to defer payment of a credit insurance premium or fee owed by the consumer." The proposal includes a request for comments on whether the CFPB should instead consider a creditor to be financing premiums only if it imposes a finance charge on the premiums.

"Level" or "levelized" premiums are separate, monthly transactions that are collected along with the loan's principal and interest payment, are paid in full each month, and are not added to the amount borrowed. Despite no indication in the Dodd-Frank Act that the prohibition was intended to ban such monthly-pay programs, it is not clear that the CFPB would interpret the proposed language to categorically exclude such programs from the scope of the prohibition on the basis that premiums are not "financed."  Rather, the proposal's background discussion suggests that such programs would only be categorically excluded when creditors are deemed to be "acting as passive conduits collecting and transmitting monthly premiums from the consumer to a credit insurer."

The CFPB previously issued a final rule delaying the original effective date of the prohibition, June 1, 2013, until January 10, 2014. In the proposal, the CFPB requested comments on whether the effective date could be set earlier than January 10 when the proposed changes are finalized "and still permit sufficient time for creditors to adjust credit insurance premium practices as necessary."

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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