A borrower receives a $250,000 subprime ARM with a 5-year prepayment penalty equal to 5% of the loan balance in years 1-2 and 3% in years 3-5. The ARM is structured to reset and substantially increase in year 3. The broker told the borrower at closing that 'the rate won't go up for five years.' When the rate resets in year 3, the borrower wants to refinance but faces a $7,500 prepayment penalty. Under Dodd-Frank's current framework, which two provisions would most directly prohibit this type of transaction?

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The ability-to-repay rule requiring genuine assessment of repayment ability including post-reset payments, and the prepayment penalty restrictions limiting penalties on most QMs to a maximum of 3% in year one, 2% in year two, and 1% in year three — prohibiting any penalty extending to year five Two Dodd-Frank/Regulation Z provisions directly address this transaction. First, the ATR rule requires lenders to assess repayment ability using the fully-indexed, fully-amortized rate — not just the initial teaser rate — preventing origination of ARMs where the borrower can only afford payments at the initial rate. Second, Regulation Z prepayment penalty rules cap QM prepayment penalties at 3/2/1% over three years only, and prohibit prepayment penalties entirely beyond year three on most QMs and on all high-cost mortgages. A 5-year penalty at 5% clearly violates these limits. RESPA Section 8(b) addresses unearned settlement fees, not prepayment penalties. The 3% QM points-and-fees cap addresses origination costs, not ongoing payment structure. TILA rescission rights are time-limited and don't address year-3 issues. ECOA adverse action notices are triggered by denial, not loan terms.

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