IBA Compliance Connection

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We would like to waive our upfront costs for HELOC borrowers. However, some borrowers use the account as a short-term bridge loan and pay the loan off when their home sells, usually in the first year of the loan. Would we violate the Illinois Interest Act if we charge those waived costs on payoff of these loans?

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No, we do not believe you would be violating the Illinois Interest Act if you charge HELOC borrowers  for waived, upfront costs on an early payoff, if agreed to in the loan agreement, but such charges could implicate the restrictions on prepayment penalties under Regulation Z and the Illinois High Risk Home Loan Act for “high-cost” and “high-risk” home loans if they are not recouping bona fide, third-party charges.

The Illinois Banking Act permits banks to charge fees on loans, provided that the bank sets these charges based on its “prudent business judgment and safe and sound operating standards.” Additionally, the Interest Act authorizes a bank to collect interest and charges at any rate agreed on by the bank and the borrower. Consequently, for many loans, you may impose a prepayment charge that recoups waived, upfront costs, provided that your customers have agreed to the charge in their loan agreements.

However, Regulation Z and the Illinois High Risk Home Loan Act (HRHLA) effectively ban prepayment penalties that can be charged more than 36 months after consummation or exceed 2% of the amount prepaid for loans secured by a consumer’s principal dwelling. Both Regulation Z and the Illinois HRHLA define “prepayment penalty” as a charge imposed when a consumer pays off a closed-end loan “before the date on which the principal is due” or, in the case of an open-end loan, terminates the plan “prior to the end of its term.” In either case, a narrow exception permits lenders to recoup “waived, bona fide third-party” fees that the lender paid at closing if the consumer prepays all of the transaction’s principal sooner than 36 months after consummation. If the upfront costs that you are recouping are “bona fide third-party charges,” then the charges should not be considered prepayment penalties.

For resources related to our guidance, please see:

  • Illinois Banking Act, 205 ILCS 5/5e(a) (“Notwithstanding the provisions of any other law in connection with extensions of credit, a State bank may elect to contract for and receive interest, fees, and other charges for extensions of credit subject only to the provisions of subsection (1) of Section 4 of the Interest Act, except for extensions of credit secured by residential real estate, which shall be subject to the laws applicable thereto.”)
  • Illinois Banking Act, 205 ILCS 5/5e(b) (“The establishment of account service charges and the amounts of the charges not otherwise limited or prescribed by law is a business decision to be made by a bank according to prudent business judgment and safe and sound operating standards. In establishing account service charges, the bank may consider, but is not limited to considering, the costs incurred by the bank, plus a profit margin, for providing the service, the deterrence of misuse of the bank’s services, the establishment of the competitive position of the bank in accordance with the bank’s marketing strategy, and the maintenance of the safety and soundness of the bank..”)
  • Interest Act, 815 ILCS 205/4(1) (“It is lawful for a state bank or a branch of an out-of-state bank . . . to receive or to contract to receive and collect interest and charges at any rate or rates agreed upon by the bank or branch and the borrower. . . .”)
  • Regulation Z, 12 CFR 1026.32(d) (“A high-cost mortgage shall not include the following terms: . . . (6) A prepayment penalty, as defined in paragraph (b)(6) of this section.”)
  • Regulation Z, 12 CFR 1026.32(a)(1) (“The requirements of this section apply to a high-cost mortgage, which is any consumer credit transaction that is secured by the consumer’s principal dwelling, other than as provided in paragraph (a)(2) of this section, and in which: . . . (iii) Under the terms of the loan contract or open-end credit agreement, the creditor can charge a prepayment penalty, as defined in paragraph (b)(6) of this section, more than 36 months after consummation or account opening, or prepayment penalties that can exceed, in total, more than 2 percent of the amount prepaid.”)
  • Regulation Z Official Interpretations, Paragraph 32(a)(1)(iii), Comment 1 (“As a result, § 1026.32(a)(1)(iii) effectively establishes a maximum period during which a prepayment penalty may be imposed, and a maximum prepayment penalty amount that may be imposed, on a closed-end credit transaction or open-end credit plan (other than such a mortgage as described in § 1026.32(a)(2)) secured by a consumer’s principal dwelling.”)
  • Regulation Z, 12 CFR 1026.32(b)(6)(i) (“For a closed-end credit transaction, prepayment penalty means a charge imposed for paying all or part of the transaction’s principal before the date on which the principal is due, other than a waived, bona fide third-party charge that the creditor imposes if the consumer prepays all of the transaction’s principal sooner than 36 months after consummation, provided, however, that interest charged consistent with the monthly interest accrual amortization method is not a prepayment penalty for extensions of credit insured by the Federal Housing Administration that are consummated before January 21, 2015.”)
  • Regulation Z, 12 CFR 1026.32(b)(6)(ii) (“For an open-end credit plan, prepayment penalty means a charge imposed by the creditor if the consumer terminates the open-end credit plan prior to the end of its term, other than a waived, bona fide third-party charge that the creditor imposes if the consumer terminates the open-end credit plan sooner than 36 months after account opening.”)
  • Regulation Z, Official Interpretations, Paragraph 32(b)(6), Comment 1 (“Examples of prepayment penalties; closed-end credit transactions. For purposes of § 1026.32(b)(6)(i), the following are examples of prepayment penalties: . . .

ii. A fee, such as an origination or other loan closing cost, that is waived by the creditor on the condition that the consumer does not prepay the loan. However, the term prepayment penalty does not include a waived bona fide third-party charge imposed by the creditor if the consumer pays all of a covered transaction’s principal before the date on which the principal is due sooner than 36 months after consummation. For example, assume that at consummation, the creditor waives $3,000 in closing costs to cover bona fide third-party charges but the terms of the loan agreement provide that the creditor may recoup the $3,000 in waived charges if the consumer repays the entire loan balance sooner than 36 months after consummation. The $3,000 charge is not a prepayment penalty. In contrast, for example, assume that at consummation, the creditor waives $3,000 in closing costs to cover bona fide third-party charges but the terms of the loan agreement provide that the creditor may recoup $4,500, in part to recoup waived charges, if the consumer repays the entire loan balance sooner than 36 months after consummation. The $3,000 that the creditor may impose to cover the waived bona fide third-party charges is not a prepayment penalty, but the additional $1,500 charge is a prepayment penalty and subject to the restrictions under § 1026.43(g).”)

  • Illinois High Risk Home Loan Act, 815 ILCS 137/30 (“A high risk home loan may not contain terms under which a consumer must pay a prepayment penalty for paying all or part of the principal before the date on which the principal is due. . . .”)
  • Illinois High Risk Home Loan Act, 815 ILCS 137/10 (“‘High risk home loan’ means a consumer credit transaction, other than a reverse mortgage, that is secured by the consumer’s principal dwelling if: . . . (ii) the loan documents permit the creditor to charge or collect prepayment fees or penalties more than 36 months after the transaction closing or such fees exceed, in the aggregate, more than 2% of the amount prepaid, or . . . .”)
  • Illinois High Risk Home Loan Act, 815 ILCS 137/10 (“‘Prepayment penalty’ and ‘prepayment fees or penalties’ mean: (i) for a closed-end credit transaction, a charge imposed for paying all or part of the transaction’s principal before the date on which the principal is due, other than a waived, bona fide third-party charge that the creditor imposes if the consumer prepays all of the transaction’s principal sooner than 36 months after consummation and (ii) for an open-end credit plan, a charge imposed by the creditor if the consumer terminates the open-end credit plan prior to the end of its term, other than a waived, bona fide third-party charge that the creditor imposes if the consumer terminates the open-end credit plan sooner than 36 months after account opening.”)