We want to offer a HELOC with interest-only payments and no annual fees. Are there any restrictions on interest-only loans or other compliance issues that we should be aware of?

No, we are not aware of any Illinois or federal law that would generally prohibit interest-only HELOCs, although you should be aware that such a HELOC may result in a prohibited balloon payment if the HELOC qualifies as a high-risk or high-cost mortgage.

Subsection 4(1) of the Interest Act expressly permits savings banks to collect “interest and charges at any rate agreed upon by the savings bank or savings association and the borrower” and provides that 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, which exempts banks) for loans secured by a mortgage on real estate. In addition, with respect to open-end credit, the Illinois Financial Services Development Act provides that Illinois financial institutions may collect interest and other charges for revolving credit plans as “the financial institution and borrower may agree upon from time to time.”

However, if the HELOC is secured by the borrower’s primary dwelling and triggers the definition of “high risk” in the Illinois High Risk Home Loan Act or “high cost” under Regulation Z, the HELOC would be subject to prohibitions on interest-only features that result in balloon payments (“a scheduled payment that is more than twice as large as the average of earlier scheduled payments” under Illinois law or “a payment that is more than two times a regular periodic payment” under Regulation Z).

Additionally, Regulation Z imposes additional disclosure requirements for HELOCs with a balloon payment or interest-only feature (“if paying only the minimum periodic payments may not repay any of the principal”).

For resources related to our guidance, please see:

Interest Act, 815 ILCS 205/4 (“It is lawful for a savings bank chartered under the Savings Bank Act or a savings association chartered under the Illinois Savings and Loan Act of 1985 to receive or contract to receive and collect interest and charges at any rate agreed upon by the savings bank or savings association and the borrower.”)

Interest Act, 815 ILCS 205/4 (“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 transaction . . . (l) Loans secured by a mortgage on real estate.”)

Illinois Financial Services Development Act, 205 ILCS 675/4 (“Notwithstanding the provisions of any other laws in connection with revolving credit plans, any financial institution may, subject to the other provisions of this Section 4 offer and extend credit under a revolving credit plan to a borrower and in connection therewith may charge and collect interest and other charges, may take real and personal property as security therefor and may provide in the agreement governing the revolving credit plan for such other terms and conditions as the financial institution and borrower may agree upon from time to time.”)

High Risk Home Loan Act, 815 ILCS 137/35.5 (“No high risk home loan may contain a scheduled payment that is more than twice as large as the average of earlier scheduled payments. This Section does not apply when the payment schedule is adjusted to the seasonal or irregular income of the consumer.”)

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, (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 (iii) the total points and fees payable in connection with the transaction, other than bona fide third-party charges not retained by the mortgage originator, creditor, or an affiliate of the mortgage originator or creditor, will exceed (1) 5% of the total loan amount in the case of a transaction for $20,000 (or such other dollar amount as prescribed by federal regulation pursuant to the federal Dodd-Frank Act) or more or (2) the lesser of 8% of the total loan amount or $1,000 (or such other dollar amount as prescribed by federal regulation pursuant to the federal Dodd-Frank Act) in the case of a transaction for less than $20,000 (or such other dollar amount as prescribed by federal regulation pursuant to the federal Dodd-Frank Act), except that, with respect to all transactions, bona fide loan discount points may be excluded as provided for in Section 35 of this Act. ‘High risk home loan’ does not include a loan that is made primarily for a business purpose unrelated to the residential real property securing the loan or a consumer credit transaction made by a natural person who provides seller financing secured by a principal residence no more than 3 times in a 12-month period, provided such consumer credit transaction is not made by a person that has constructed or acted as a contractor for the construction of the residence in the ordinary course of business of such person.”)

Regulation Z, 12 CFR 1026.32(d) (“A high-cost mortgage shall not include the following terms: . . . Except as provided by paragraphs (d)(1)(ii) and (iii) of this section, a payment schedule with a payment that is more than two times a regular periodic payment.”)

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; or

(ii) The transaction’s total points and fees, as defined in paragraphs (b)(1) and (2) of this section, will exceed:

(A) 5 percent of the total loan amount for a transaction with a loan amount of
  $20,000 or more; the $20,000 figure shall be adjusted annually on January 1
  by the annual percentage change in the Consumer Price Index that was
  reported on the preceding June 1; or

(B) The lesser of 8 percent of the total loan amount or $1,000 for a transaction
  with a loan amount of less than $20,000; the $1,000 and $20,000 figures
  shall be adjusted annually on January 1 by the annual percentage change in
  the Consumer Price Index that was reported on the preceding June 1; or

(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, 12 CFR 1026.40(d)(5) (“The requirements of this section apply to open-end credit plans secured by the consumer’s dwelling. . . . (d) The creditor shall provide the following disclosures, as applicable: . . .

(5)(i) The length of the draw period and any repayment period.

(ii) An explanation of how the minimum periodic payment will be determined and the timing of the payments. If paying only the minimum periodic payments may not repay any of the principal or may repay less than the outstanding balance, a statement of this fact, as well as a statement that a balloon payment may result. A balloon payment results if paying the minimum periodic payments does not fully amortize the outstanding balance by a specified date or time, and the consumer must repay the entire outstanding balance at such time.

(iii) An example, based on a $10,000 outstanding balance and a recent annual percentage rate, showing the minimum periodic payment, any balloon payment, and the time it would take to repay the $10,000 outstanding balance if the consumer made only those payments and obtained no additional extensions of credit. For fixed-rate plans, a recent annual percentage rate is a rate that has been in effect under the plan within the twelve months preceding the date the disclosures are provided to the consumer. For variable-rate plans, a recent annual percentage rate is the most recent rate provided in the historical example described in paragraph (d)(12)(xi) of this section or a rate that has been in effect under the plan since the date of the most recent rate in the table.”)