If a consumer balloon mortgage is past maturity and we extend the maturity date, increase the fixed interest rate, and charge a small fee, can we consider this a modification instead of a new transaction requiring new disclosures (i.e., a refinancing)? Does it make a difference if the loan is past maturity? We do not want to replace the original loan.

Yes, we believe you may extend a consumer balloon mortgage, increase the fixed interest rate, and charge a small fee without the transaction being considered a refinancing requiring new disclosures, provided that your modification agreement does not satisfy and replace the existing mortgage loan with a new transaction. Further, we do not believe this answer would change if the loan already is past maturity.

For consumer balloon loans, Regulation Z requires new disclosures when an existing loan is “refinanced,” which Regulation Z treats as a new transaction. However, new disclosures are not required when an existing loan is modified without being refinanced. 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. The difference depends on the specific language that you use in the documentation to modify the loan. For example, one federal court in Illinois that a modification agreement did not constitute a refinancing because it specifically stated that it was merely amending and supplementing the original loan agreement and not satisfying or releasing the existing obligation.

Regulation Z’s Official Interpretations state new disclosures are required if you are amending a consumer loan to increase the interest rate based on a variable rate feature, 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. . . . long as the new rate remains fixed during the remaining life of the loan.” Consequently, we do not believe that increasing the fixed interest rate would be considered a refinancing if the modification agreement does not satisfy and replace the existing mortgage loan with a new transaction.

Additionally, we do not believe this answer would change if the balloon mortgage has already matured. The Seventh Circuit Court of Appeals has considered a similar issue, albeit in the context of a lump sum payday loan. The court found that the loan did not “expire” when it matured and held that it was permissible to renew the loan after the maturity date without triggering Regulation Z’s refinancing requirements. Similarly, we believe that it is permissible to extend a balloon mortgage after the original maturity date without triggering Regulation Z’s refinancing requirements.

For resources related to our guidance, please see:

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, 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.”)

Jackson v. American Loan Co., Inc., 202 F.3d 911, 913 (7th Cir. 2000) (“American Loan does not ‘cancel’ the old loan and note, or substitute a new one, when it agrees to defer repayment until another payday, and thus it does not ‘refinance’ the loan. . . . To say, as plaintiffs do, that a loan ‘expires by its terms’ on the original due date is fanciful. All of the loan’s terms, including the repayment obligation, persist.”)