YOUR MORTGAGE : New Refinancing Protections for High-Rate Loans

WASHINGTON — If you’re one of the millions of American homeowners with a less-than-perfect credit file, you should know about a major legal deadline looming in the mortgage market.

Lenders nationwide are gearing up this summer for the High Cost Mortgage Act, which takes effect Oct. 1. On that date, consumers will get new federal Truth-in-Lending protections when they refinance their homes or take out home-equity loans with rates or fees that qualify as “high cost.”

Though aimed primarily at loan-scam artists who prey on unsuspecting homeowners, the law cuts a far wider swath. Large numbers of mainstream borrowers who face temporary credit squeezes--and the lenders who serve them--are likely to be affected as well. Some of the impacts may not be what Congress intended.

Here’s what’s happening:

Under the definition in the new law, a high-cost mortgage is one carrying the greater of $400 or 8% of the loan amount in fees as part of the financing transaction. Alternatively, the rate on the mortgage must be 10 percentage points above comparable Treasury note rates. Fixed-term home equity loans and mortgage refinancings are covered by the law; home purchase loans and equity lines of credit are exempt.

The $400 or 8% test touches many mortgage applicants who might not otherwise think of their loans as high rate or high cost. That’s because under the law, all “points,” mortgage brokerage commissions and document preparation fees must be counted against the 8% threshold. A point is 1% of the loan amount. On a modest-sized mortgage, 8% in fees mounts up fast. For example, on a $30,000 home equity loan, the threshold is $2,800. On a $40,000 loan, it’s $3,200.

In lower- and moderate-cost neighborhoods--especially in central cities and rural areas--loan expenses on this level are not uncommon. Ditto in the so-called “B” and “C” segments of the national mortgage market, where borrowers who’ve encountered job layoffs or income disruptions have missed payments on debts and are no longer A-grade credit risks.

For loans that meet any of the new high-cost tests, applicants will receive special new disclosures and rights:

* No less than three business days before loan closing, the lender must deliver a written warning statement to the borrower. The statement advises applicants that they can still cancel the deal, even though they signed up for it. The statement also warns that because the lender will have a mortgage on the house, “you could lose your home and any money you have put into it” if you go to closing and later fail to make payments.

* Certain commonly used loan terms are banned outright on high-cost mortgages. All balloon payment plans--those requiring a lump-sum final payment--are prohibited for loans with less than five-year terms. The sole exception will be for “bridge” loans of less than one year used by consumers selling one house and building or buying another.

* Prepayment penalties generally are prohibited in high-cost mortgages. So are negative amortization plans, which allow smaller monthly interest payments but add to total principal debt.

Though the new law is helpful to unsophisticated homeowners who are the targets of dishonest loan brokers, some mortgage industry experts say it already is having unintended side effects.

For example, David Shirk, a Eugene, Ore.-based mortgage company executive, says that rather than going through the legal and regulatory hassles of offering high-cost loans, some lenders are preparing to exit the field or eliminate specific loan types. That, in turn, could “very seriously” affect the availability and costs of money for groups of borrowers whose credit has been damaged by regional economic events beyond their control.

When the spotted owl and environmental controversy threw hundreds of Oregon timber workers out of their jobs, according to Shirk, “credit was very tough for these people. They had big gaps in their incomes. They no longer qualified for regular home mortgages.”

Under the new law, he says, his firm would not have been able to offer such families the sort of two- and three-year balloon loans that helped them re-establish credit when they needed it.

Philip H. Myers, a mortgage attorney with the Pittsburgh law firm of Reed Smith Shaw & McClay, warns that the new law’s addition of an extra three-day cancellation period “could surprise and anger lots of borrowers who want their money as soon as possible.” The three-day cool-off period gets tacked on top of the regular three-day truth-in-lending cancellation period--separating borrowers from delivery of their money by six business days.

Myers adds that some large lenders are considering sidestepping the new law’s complications altogether by switching to home equity lines of credit when rates or fees verge into high-cost territory.

Still other lenders, according to Columbia, Md.-based mortgage consultant Allen Hardester, are viewing the 8% threshold very differently from what Congress intended. They are allowing brokers to come in with up to 7.99% in total points and fees, even though in many areas charges in the past would have been two to four points lower.

“Congress has legitimized charging just under eight points,” Hardester said. “That could raise, not lower, what some [credit-impaired] borrowers actually end up paying.”

Distributed by the Washington Post Writers Group.