No, we do not believe that extending, increasing the interest rate of, and re-amortizing your balloon loans would be considered an unfair, deceptive, or abusive act or practice, provided that these changes are clearly and conspicuously disclosed and agreed to by your customers. However, such a modification could be considered a “refinancing” under Regulation Z depending on the specific language that you use in the documentation to modify the loan, which would require you to conduct a new ability to repay analysis.

We believe that re-amortizing the loans when they are extended should generally benefit your customers, since the re-amortization will result in lower loan payments and will not increase the balloon payment due at the end of the extended loan term. While adding a negative amortization feature would raise concerns, we do not foresee any unique UDAAP issues with re-amortizing these loans.

Additionally, we do not believe you would be violating any laws by increasing the interest rate on renewal. There are very few limitations on interest rates charged by banks under Illinois law, provided the rates are agreed to by your customers. 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 (with the exception of transactions covered by the Predatory Loan Prevention Act, which does not apply to banks).

When extending the loans, we recommend analyzing whether the transactions are considered refinancings under Regulation Z (which would require new disclosures and an ability-to-repay analysis). The general rule under Regulation Z is that a “refinancing” occurs only when an existing obligation is “satisfied and replaced” by a new transaction, which is determined by the language in the parties’ contract and applicable state law.

There are a few court decisions that indicate how to structure a transaction as a modification, as opposed to a refinancing. For example, one federal court in Illinois reviewed the language of a modification agreement and determined that it did not constitute a refinancing because the modification agreement specifically stated that it was merely amending and supplementing the original loan agreement and not satisfying or releasing the existing obligation.

Note that if you are amending a consumer loan to add a variable rate feature or increase the interest rate based on a variable rate feature that was not previously disclosed, the amendment is treated as a refinancing, even if the existing loan obligation is not being satisfied and replaced. However, the Federal Reserve’s Consumer Compliance Handbook explains that “if, at the time a loan is renewed, the rate is increased, the increase is not considered a variable rate feature. . . . If the original debt is not canceled in connection with such a renewal, the regulation does not require new disclosures.”

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. . . .”)

• Interest Act, 815 ILCS 205/4(1)(l) (“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 123/15-1-15(c) (“Banks, savings banks, savings and loan associations, credit unions, and insurance companies organized, chartered, or holding a certificate of authority to do business under the laws of this State or any other state or under the laws of the United States are exempt from the provisions of this Act.”)

• Regulation Z, 12 CFR 1026.20(a) (“A refinancing occurs when an existing obligation that was subject to this subpart is satisfied and replaced by a new obligation undertaken by the same consumer. A refinancing is a new transaction requiring new disclosures to the consumer.”)

• Regulation Z, Official Interpretations, Paragraph 20(a), Comment 1 (“A refinancing is a new transaction requiring a complete new set of disclosures. Whether a refinancing has occurred is determined by reference to whether the original obligation has been satisfied or extinguished and replaced by a new obligation, based on the parties’ contract and applicable law. . . .”)

• Regulation Z, 12 CFR 1026.43(c)(1) (“A creditor shall not make a loan that is a covered transaction unless the creditor makes a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms.”)

• Regulation Z, 12 CFR 1026.43(b)(1) (“Covered transaction means a consumer credit transaction that is secured by a dwelling, as defined in § 1026.2(a)(19), including any real property attached to a dwelling, other than a transaction exempt from coverage under paragraph (a) of this section.”)

• Regulation Z, Official Interpretations, Paragraph 43(a), Comment 1 (§1026.43 does not apply to any change to an existing loan that is not treated as a refinancing under § 1026.20(a).”)

• Regulation Z, Official Interpretations, Paragraph 20(a), Comment 3(ii) (“Even if it is not accomplished by the cancellation of the old obligation and substitution of a new one, a new transaction subject to new disclosures results if the creditor either: A. Increases the rate based on a variable-rate feature that was not previously disclosed; or B. Adds a variable-rate feature to the obligation.”)

• Rodriguez v. Chase Home Finance, LLC, No. 10 C 05876 (N.D. Ill. Sept. 23, 2011) (“Here, Rodriguez’s Modification Agreement states that it ‘will amend and supplement (1) the Mortgage on the Property and (2) the Note secured by the Mortgage. . . .’ In short, because the Modification Agreement merely modifies the previous loan rather than cancelling the loan and creating a new obligation, Rodriguez’s modification does not constitute a ‘refinancing.’”)

• Federal Reserve, Consumer Compliance Handbook, page 37 (“If, at the time a loan is renewed, the rate is increased, the increase is not considered a variable rate feature. It is the cost of renewal, similar to a flat fee, as long as the new rate remains fixed during the remaining life of the loan. If the original debt is not canceled in connection with such a renewal, the regulation does not require new disclosures.”)