Due to a change in vendor, we may have to change our 5/1 adjustable-rate mortgage (ARM) to a 5/5 ARM. Our 5/1 ARMs set maximum percentage amounts for the initial rate change and rate change over the life of loan. If we switch to a 5/5 ARM, can we raise the initial rate change and life of loan rate change caps for future loans?

We believe that your bank may charge a higher initial rate and raise the life of loan cap on the interest rate of your adjustable-rate mortgages. Of course, if the rate is raised too high, it may be considered a high risk home loan or a high-cost or higher-priced mortgage, subject to additional requirements and limitations under Illinois and federal law.

As your institution is a national bank, it is subject to the National Bank Act’s restrictions on interest rates. OCC regulations state that national banks may charge interest at the maximum rate permitted to any state-chartered institution by the law of the relevant state.

The Illinois Banking Act permits banks to charge any “interest, fees, and other charges . . . subject only to the provisions of [subsection 4(1)] of the Interest Act” and any laws applicable to “credit secured by residential real estate.” This provision applies to banks “notwithstanding the provisions of any other law.” Subsection 4(1) of the Interest Act permits banks to collect interest at any rate agreed upon by a bank and its borrower and specifies that it is lawful to charge, contract for, and receive any rate or amount of interest for loans secured by a mortgage on real estate.

Note that additional requirements and limitations are imposed under Illinois and federal law for high risk home loans and high-cost and higher-priced mortgages, respectively. Under Illinois law, a “high risk home loan” includes a consumer credit transaction secured by the consumer’s principal dwelling that at the time of origination, has an annual percentage rate that exceeds the average prime offer rate by more than 6% in the case of a first lien mortgage, or by more than 8% in the case of a junior mortgage. Under Regulation Z, a “high-cost mortgage” includes a consumer credit transaction secured by the consumer’s principal dwelling that exceeds the average prime offer rate by more than 6.5% for a first-lien transaction, more than 8.5% for a first-lien transaction if the dwelling is personal property and the loan amount is less than $50,000, or more than 8.5% for a subordinate-lien transaction. Under Regulation Z, a “higher-priced mortgage loan” includes a closed-end consumer transaction secured by the consumer’s principal dwelling that exceeds the average prime offer rate by 1.5% or more for loans secured by a first lien with a principal obligation that does not exceed the limit set for the maximum principal obligation eligible for purchase by Freddie Mac, by 2.5% or more for loans secured by a first lien that do exceed the limit, or by 3.5% or more for loans secured by a subordinate lien.

For resources related to our guidance, please see:

OCC Regulations, 12 CFR 7.4001 (“A national bank located in a state may charge interest at the maximum rate permitted to any state-chartered or licensed lending institution by the law of that state. If state law permits different interest charges on specified classes of loans, a national bank making such loans is subject only to the provisions of state law relating to that class of loans that are material to the determination of the permitted interest. For example, a national bank may lawfully charge the highest rate permitted to be charged by a state-licensed small loan company, without being so licensed, but subject to state law limitations on the size of loans made by small loan companies.”)

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.”)

Interest Act, 815 ILCS 205/4(1) (“It is lawful for a state bank or a branch of an out-of-state bank, as those terms are defined in Section 2 of the Illinois Banking Act, 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. . . . It is lawful to charge, contract for, and receive any rate or amount of interest or compensation, except as otherwise provided in the Predatory Loan Prevention Act, with respect to the following transactions: . . . (l) Loans secured by a mortgage on real estate. . . .”)

Predatory Loan Prevention Act, 815 ILCS 123/5-5 (“Notwithstanding any other provision of law, for loans made or renewed on and after the effective date of this Act, a lender shall not contract for or receive charges exceeding a 36% annual percentage rate on the unpaid balance of the amount financed for a loan. . . .”)

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: (i) at the time of origination, the annual percentage rate exceeds by more than 6 percentage points in the case of a first lien mortgage, or by more than 8 percentage points in the case of a junior mortgage, the average prime offer rate, as defined in Section 129C(b)(2)(B) of the federal Truth in Lending Act, for a comparable transaction as of the date on which the interest rate for the transaction is set, or if the dwelling is personal property, then as provided under 15 U.S.C. 1602(bb), as amended, and any corresponding regulation, as amended. . . .”)

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: (i) The annual percentage rate applicable to the transaction, as determined in accordance with paragraph (a)(3) of this section, will exceed the average prime offer rate, as defined in § 1026.35(a)(2), for a comparable transaction by more than: (A) 6.5 percentage points for a first-lien transaction, other than as described in paragraph (a)(1)(i)(B) of this section; (B) 8.5 percentage points for a first-lien transaction if the dwelling is personal property and the loan amount is less than $50,000; or (C) 8.5 percentage points for a subordinate-lien transaction. . . .”)

Regulation Z, 12 CFR 1026.35(a)(1) (“‘Higher-priced mortgage loan’ means a closed-end consumer credit transaction secured by the consumer’s principal dwelling with an annual percentage rate that exceeds the average prime offer rate for a comparable transaction as of the date the interest rate is set: (i) By 1.5 or more percentage points for loans secured by a first lien with a principal obligation at consummation that does not exceed the limit in effect as of the date the transaction’s interest rate is set for the maximum principal obligation eligible for purchase by Freddie Mac; (ii) By 2.5 or more percentage points for loans secured by a first lien with a principal obligation at consummation that exceeds the limit in effect as of the date the transaction’s interest rate is set for the maximum principal obligation eligible for purchase by Freddie Mac; or (iii) By 3.5 or more percentage points for loans secured by a subordinate lien. . . .”)