What Is a High-Cost Loan and How Do You Identify One?
Unpack what makes a loan high-cost and gain the essential understanding to recognize them effectively.
High-cost loans are a category of credit products for consumers who may struggle to secure traditional lending. Understanding this classification is important because these loans carry additional regulatory protections due to their elevated costs and risks. The framework aims to ensure transparency and safeguard borrowers from practices that could lead to financial distress. This classification helps consumers evaluate loan offers and make informed decisions.
Defining High-Cost Loans
A loan is classified as “high-cost” under federal regulations, specifically the Home Ownership and Equity Protection Act (HOEPA), part of the Truth in Lending Act (TILA). This designation triggers enhanced consumer protections. The classification depends on whether the loan’s Annual Percentage Rate (APR) or its total points and fees exceed specific thresholds. These thresholds are adjusted annually by the Consumer Financial Protection Bureau (CFPB) to account for inflation and market changes.
For 2025, a loan secured by a borrower’s principal dwelling is considered high-cost if its APR exceeds the Average Prime Offer Rate (APOR) for a comparable transaction by more than 6.5 percentage points for first-lien mortgages. For junior-lien (subordinate-lien) mortgages, or first-lien mortgages less than $50,000 secured by personal property like a manufactured home, the threshold is 8.5 percentage points above the APOR. The APOR serves as a benchmark, representing the average interest rates, points, and other loan pricing terms offered to low-risk borrowers, and it is updated weekly.
Alternatively, a loan can be high-cost if its total points and fees exceed a certain percentage of the loan amount or a specific dollar amount. For 2025, if the total loan amount is $26,968 or more, the points and fees cannot exceed 5% of the total loan amount. If the total loan amount is less than $26,968, the points and fees cannot exceed the lesser of 8% of the total loan amount or $1,348. These “points and fees” encompass various charges, including loan origination fees, discount points, broker fees, and premiums for credit life, accident, or disability insurance if the lender is the beneficiary. They also include the maximum prepayment penalty that could be charged and any prepayment penalties paid when refinancing an existing loan with the same lender or an affiliate.
Common Characteristics of High-Cost Loans
High-cost loans often have structural features that can make them financially demanding. While the regulatory definition focuses on specific APR and fee thresholds, their characteristics often reflect the underlying risk profile or market segment. Understanding these attributes can help identify loans that might qualify as high-cost.
Such loans may feature very high interest rates, even if they do not solely trigger the HOEPA APR threshold. Excessive fees are also typical, extending beyond those strictly counted for the regulatory “points and fees” test, and can include various administrative or service charges. Short repayment periods are another characteristic, which can lead to disproportionately high monthly payments that strain a borrower’s budget.
Some high-cost loans may include balloon payments, requiring a large lump sum at the end of the loan term, which can be difficult to manage without refinancing. Prepayment penalties, which charge a fee for paying off the loan early, are also frequently associated with these loans, trapping borrowers in unfavorable terms. Negative amortization, where the loan balance increases because payments are not sufficient to cover the interest due, represents another burdensome feature sometimes found in these loans.
Regulatory Framework and Consumer Protections
When a loan is identified as high-cost, specific federal regulations, primarily HOEPA, trigger enhanced consumer protections. These regulations aim to prevent abusive lending practices and ensure borrowers receive comprehensive information before committing to a significant financial obligation. This framework imposes strict requirements on lenders and offers borrowers specific rights and remedies.
One protection is the mandatory disclosure requirement: lenders must provide borrowers with detailed loan information at least three business days before closing. This disclosure must clearly state that the loan is secured by the borrower’s home and explain the potential for losing the home if payments are not made. It must also outline the APR, monthly payment, and any balloon payments or variable interest rate features.
HOEPA also prohibits certain loan terms and practices in high-cost mortgages. These prohibitions include negative amortization, where the principal balance increases, and most balloon payments, unless specific conditions are met. Prepayment penalties are generally prohibited, and lenders cannot finance points and fees into the loan amount. Additionally, lenders are restricted from engaging in “loan flipping,” which involves repeatedly refinancing a loan without a tangible net benefit to the borrower.
A significant protection is the homeownership counseling requirement. Borrowers must receive a list of approved housing counseling agencies within three business days of applying for a high-cost mortgage and must complete counseling with a HUD-approved agency before closing. This ensures borrowers understand the loan terms and their financial implications. If a lender violates HOEPA, borrowers may have the right to seek damages, including a refund of finance charges and fees.
How to Identify a High-Cost Loan
Consumers can identify a high-cost loan by reviewing key documents and understanding the thresholds that trigger federal protections. This knowledge allows for a thorough evaluation of loan offers before committing to a financial product. The process involves examining loan disclosures and comparing specific financial metrics against regulatory benchmarks.
Begin by examining the Loan Estimate, which lenders must provide within three business days of a mortgage application. This document provides a summary of the loan terms, estimated closing costs, and the APR. The Closing Disclosure, provided at least three business days before closing, presents the final terms and costs. Both documents are essential for comparing the proposed loan against high-cost thresholds.
To assess the APR, compare the loan’s stated APR on the Loan Estimate or Closing Disclosure to the current Average Prime Offer Rate (APOR) for a comparable transaction, as defined in the “Defining High-Cost Loans” section. The APOR is publicly available from sources like the Federal Financial Institutions Examination Council (FFIEC). Next, calculate the total points and fees associated with the loan, including origination fees, discount points, and other charges that fall under the regulatory definition. Compare this sum to the current year’s dollar thresholds, as outlined previously. Additionally, scrutinize the loan terms for characteristics like balloon payments, prepayment penalties, or negative amortization. While sometimes permissible with restrictions, these can signal a burdensome loan structure.