What is required in a loan modification policy that permits capitalization of interest?
Prudent loan modification policies and procedures help borrowers resume affordable, sustainable payments by using an appropriate structure to meet the needs of the borrower while minimizing losses to the credit union.
Consistent with the final rule, the policy should have explicit language prohibiting the authorization of additional advances to finance credit union fees and commissions.
Procedures will include providing borrowers with written disclosures that are accurate, clear, and conspicuous in accordance with federal and state consumer protection laws and regulations. Additionally, policy and procedures will have standards for appropriate documentation that reflect a borrower’s ability to repay, a borrower’s source(s) of repayment, and when appropriate, compliance with the credit union’s valuation policies at the time the modification is approved.Close and return to top
The updated regulation says if we capitalize interest, we have to analyze whether the borrower has the ability to repay the debt. It sounds like we must re-underwrite the loan. How does a credit union determine the ability to repay the debt?
There is no change to the requirement to document whether the borrower is able to repay the debt. The final rule does not prescribe a method for making that determination, as it provides flexibility to the credit union. However, the credit union should maintain documentation in the loan file reflecting how it made that determination, including evidence of the borrower’s source of income. We would expect this documentation to follow loan guidelines such as debt to income ratio or debt service coverage ratio, proof of income, budgets, and business projections, among other items as needed.Close and return to top
What disclosures should a credit union provide to a borrower for a loan modification that includes capitalized unpaid interest?
The final rule does not require the use of specific disclosures. However, Regulations X and Z may apply to some modifications, so a credit union must comply with the applicable disclosure and notice requirements of those regulations. The terms of the modification will dictate which, if any, disclosures or notices the credit union will provide. All disclosures and notices must be accurate, clear, and conspicuous.Close and return to top
What methods are acceptable for capitalization of interest?
The following approaches, among others, may be acceptable:
- Capitalization of deferred interest and adjusting monthly payments upward;
- Capitalization of deferred interest and extending the loan term; or
- Break out deferred interest into a separate note, provided collateral is adequate, or have an unsecured note as needed. The payments on the separate note may be concurrent or could be deferred until a future date, either specified or upon repayment of the primary note.
When choosing a method, the federally insured credit union should fully understand the implications for the various choices including, but not limited to:
- Consistency with safe and sound credit underwriting standards;
- Impacts on the timing of interest recognition;
- Impacts on collateral coverage, including when a secured loan is extended beyond its original terms; and
- Impacts on accrual status and potential cross-defaults when notes are bifurcated.