Illinois Laws on Increased Interest Rates

We are not aware of any Illinois laws that would prevent you from increasing the interest rate with a loan modification. There are very few limitations on interest rates and fees charged by banks under Illinois law. Section 5e of the Banking Act states that a bank may “elect to contract for and receive interest” subject only section 4(1) of the Interest Act and any laws applicable to “credit secured by residential real estate.” 205 ILCS 5/5e. The only provisos in Section 5e limiting a bank’s ability to charge NSF fees are that the customer must agree to the charges and that the bank must set its fees based on its “prudent business judgment and safe and sound operating standards.” 205 ILCS 5/5e.

Similarly, subsection 4(1) of the Illinois Interest Act allows banks to charge any interest that a customer agrees to pay: “It is lawful for a state bank or a branch of an out-of-state bank . . . to receive or contract to receive and collect interest and charges at any rate or rates agreed upon by the bank or branch and the borrower.” 815 ILCS 205/4(1). Paragraph 4(1)(l) explicitly allows a bank to contract for and charge any compensation relating to a loan secured by a mortgage on real estate. 815 ILCS 205/4(1)(l). And, the Illinois Supreme court has confirmed this conclusion specifically as to loans secured by real property (concluding that restrictions on interest rates and charges found elsewhere in the Interest Act were implicitly repealed by the later-enacted Section 4(1)(l) of the Interest Act). 815 ILCS 205/4(1)(l)United States Bank Nat’l Ass’n v. Clark, 216 Ill.2d 334, 349 (2005); see also IDFPR Interpretive Letter 98-01.

Refinancings and “Ability-to-Repay” (ATR) Rules

Note, however, that if you increase a loan’s interest rate, it will likely be considered a refinancing under Regulation Z. As a result, the new ability-to-repay (ATR) rules will apply to any modification with an increased interest rate. If a modification is subject to the ATR rules, it may be possible to make a balloon loan with a term of less than five years, but it would have to otherwise satisfy the general ability-to-repay (ATR) requirements, including a requirement to underwrite the consumer’s ability to repay the final balloon payment.

QMs with Balloon Features

Generally, a qualified mortgage cannot include a balloon payment feature. 12 CFR 1026.43(e)(2)(i)(C). However, there is an exemption for balloon loans originated by small creditors that serve rural and underserved areas, as well as a temporary exemption for balloon loans originated by any small creditor. But even if your institution qualifies as a small creditor for purposes of the temporary balloon loan exemption (meaning that your institution has less than $2 billion in assets and originates 500 or fewer first mortgages per year), any such balloon loan must still have a loan term of five years or longer to qualify as a QM. 12 CFR 1026.43(f)(1)(iv)(C). Therefore, if you wish to make a balloon loan with a term that is shorter than five years, it will not qualify as a QM. (This conclusion is also expressed in the CFPB’s Small Creditor Qualified Mortgages Flowchart.)

Application of ATR Rules to Balloon Loans

While balloon loans with terms shorter than five years will not qualify as QMs, they may still pass muster under the overall ability-to-repay rules. However, for balloon loans with terms of five years or less, you will have to verify that your customer can make each loan payment, including the final balloon payment. For some customers, this may be possible, but we anticipate that this requirement would limit the pool of customers eligible to take out balloon loans with terms of five years or less.

The ATR rules require you to consider eight different factors in order to complete your “ability to repay” analysis. 12 CFR 1026.43(c)(1). Of those factors, the main hurdle for a balloon loan is the requirement to underwrite the consumer’s periodic payments. To satisfy that requirement, you would have to demonstrate that the consumer has the ability to pay the full balloon payment at the loan consummation.

However, if a balloon loan is not a higher-priced loan, you are required to consider only the “maximum payment scheduled during the first five years” of the loan. 12 CFR 1026.43(c)(5)(ii)(A)(1). In other words, you will not have to consider a balloon payment in making an ability-to-repay determination if the loan term is longer than five years and is not a higher-priced loan. But if the loan term is five years or shorter, you will have to consider the balloon payment in making an ability-to-repay determination (regardless of whether the loan is higher-priced or not). For examples of determining the ability to repay for balloon loan payments, see Official Interpretations, 12 CFR 1026.43, Paragraph 43(c)(5)(ii)(A), Comment 4.

When making a determination of a consumer’s ability to repay a balloon payment, the rules permit you to consider all sources of the consumer’s income and assets, including property other than the real property that secures the loan. 12 CFR 1026.43(c)(2)(i). The staff commentary includes several examples of other types of income and property that can be considered, such as “rental income, royalty payments . . . amounts vested in a retirement account, stocks, bonds, certificates of deposit, and amounts available to the consumer from a trust fund.” Official Interpretations, 12 CFR 1026.43, Paragraph 43(c)(2)(i), Comment 1.