Article By: Gregg Oberg, Spillane Consulting Associates, Inc.
When is Financing “Temporary?”
Today I want to take a look at one of the least understood topics in HMDA—temporary financing exemptions. These exemptions most often come up in the context of construction loans (read: commercial loan dept); but the classic “bridge loan” scenario we often see on consumer residential transactions is also captured under the 12 C.F.R. 1003.3(c).
The language of the “Temporary Financing” exemption provides some guidance but by no means makes applying the exemption simple. However, those of you familiar with the old HMDA rules will note that the new rules provide substantially more guidance than the old. If only that was the end of the issue…
Under the rules effective 2018, a “Temporary Financing” is “[a] loan or line of credit that is designed to be replaced by a separate permanent financing extended by any financial institution to the same borrower at a later time.” Fortunately for us, the CFPB has provided 5 example scenarios to describe what is and is not “Temporary Financing”.
One thing you should have noticed is that “Temporary” does not have a bright line with respect to duration of the loan. Just because a loan is short term does not mean that it is exempt from HMDA as temporary financing. This is the most common misconception I see on the issue. Many people start (and end) the analysis with “how long is the loan for.” The language of the rule at least makes this clear, stating “… a transaction is not temporary financing under § 1003.3(c)(3) merely because its term is short.” 12 C.F.R. 1003.3(c)(3) Official Interpretation-2.
Step by Step Analysis
Although there is not much of it, the language of the exemption itself does provide some help. Let’s chop up the sentence and see what we can glean.
“Designed to be replaced”
This seems to be a forward-looking statement. The Official Interpretation supports this, by clarifying that “[if] the loan automatically will convert to permanent financing extended to the same borrower with [the same lender] … the loan is not designed to be replaced by a separate permanent financing … and therefore the temporary financing exclusion does not apply.” (12 C.F.R. 1003.3(c)(3) Official Interpretation 1-iv (emphasis added)).
“Separate permanent financing”
I don’t think this part helps much, but it does clarify that there must be a SEPARATE financing in order for the initial financing to be considered temporary. This is in line with the above bullet point. Additionally, although “permanent” is not defined, I would read it to be mutually exclusive of “temporary.” Again, remember the duration of the loan is not what is important, the intent is.
“By any financial institution”
Actually, quite helpful. This clause makes clear that the second step in financing may be made by any institution, not just the original lender.
“To the same borrower”
Equally helpful and confusing in my opinion. On the “helpful” side, it makes clear that if the permanent financing will be extended to anybody other than the original borrower, then the first stage of the loan is not considered to be temporary.
However, the confusion comes because there is an exemption to the exemption. Under 12 C.F.R. 1003.3(c)(3) Official Interpretation-2, a loan exclusively to finance construction of a dwelling for sale is considered temporary. Think about that one for a second. A builder gets a loan, to build a dwelling, and then sell the dwelling to a third party. One would think this doesn’t meet the “same borrower” qualification.
Walkthrough of Examples
Example i: The Official Interpretation provides five examples, the first of which relates to bridge or swing loans. Suppose a homeowner is in the process of moving. Most of us can’t afford to make a five (or six) figure down payment out of pocket. To solve this, financing will be obtained, secured by the homeowners existing residence, which is then used to make the down payment on the new home. This is a “bridge” loan. Once the sale of the original home is consummated, the borrower will pay off that “bridge” from the sale proceeds and obtain permanent financing for the new home. The commentary makes clear that in this instance, the “bridge” portion is not reportable. Easy enough.
Example ii and iii: The second and third example are interconnected. Example ii is the prototype “Temporary Financing,” in that a loan to finance construction of a dwelling, made to a borrower, and replaced by permanent financing to the same borrower after completion of construction is exempt from HMDA. Example iii deals with renewals of the loan in that scenario. Even if the loan can, or actually does, renew (including multiple renewals) during the construction phase, the exemption still holds.
Example iv: We have touched briefly on this one, when discussing automatic conversion to permanent financing. Automatic conversion=not temporary financing, and thus not exempt. Suppose a borrower takes a loan to finance the construction of a dwelling. Then, upon completion of construction, that loan automatically converts into a permanent financing. This fails the “designed to be replaced” portion of the exemption, at least in a technical sense.
This makes logical sense, as HMDA seeks to collect information on residential loan transactions for the purposes of (among other things) validation of fair lending principles. So why put off reporting on the loan until a later date? There likely will not be a separate closing on the permanent portion, so we treat this as a home purchase loan, despite the “construction” features early in the loan.
Example v: In my opinion, this is the most interesting example. The scenario describes a common transaction in which an investor buys, rehabs, and sells a property (Flipping Boston, anyone?). Obviously the investor/borrower in this case does not intend to obtain permanent financing later—they intend to obtain cash for flipping the property. So it makes sense that we would NOT exempt this from HMDA, as stated in the Official Interpretation.
Now, compare this to 12 C.F.R. 1003.3(c)(3) Official Interpretation-2, in which a borrower obtains a construction only loan (same as example v) to construct a dwelling for sale. One would logically think there is very little difference between these two scenarios. The key is whether there was an existing dwelling. In example v, there was. In Official Interpretation-2, there is not. To me, it makes very little logical sense to exclude Official Interpretation-2 from HMDA, and not example v. But that’s the rule, who am I to disagree with the CFPB? (full disclosure-I disagree with them quite often, but nobody seems to listen…)
What Have We Learned?
Typical bridge loans are excluded.
Construction loans, even if potentially or actually renewed multiple times, are exempt as temporary financing
Construction loans that automatically convert are NOT exempt
When it comes to loans which ultimately finance sale of the dwelling, the key question is whether a dwelling exists already. IF we are flipping houses, that loan is reportable. If we are construction of houses (or condos, etc. Any dwelling) for sale, that loan is NOT reportable.
And finally, we’ve learned that CONSTRUCTION LOANS ARE HARD!
How to Use This Information to Improve Efficiency
There is just so much variance in product and transaction circumstances around construction that it really isn’t possible to put everything in a neat box. But, at the institutional level, those permutations are somewhat more limited. Either you only have a subset of the situations, or you at least know what occurs most often.
Aim for 80/20. If you can figure out what set of facts apply to 80% of your construction loan transactions, you can gameplan around those facts. It isn’t perfect, and you will see some oddball transactions that require increased involvement from compliance and legal, but it is better than analyzing everything on a loan by loan basis. As time goes on, and you see new permutations of the facts, you can update your work instruction documents to account for those situations.
News from Spillane Consulting
We are thrilled to welcome back Kimberly Morris to Spillane Consulting Associates. Kim has worked with us in the past and is returning to our sales team and will head up our staffing services. Whether you need temporary loan officers to ride out the high-volume months, or a permanent placement to run your retail lending department, Kim is your go to person in New England (and beyond).
Kim has hit the ground running, and is already assisting clients in filling roles, examples of which include:
Retail Lending Manager: Large Retail Bank – Boston area
Working under the VP of Retail Lending, overseeing the processing, underwriting, closing and pre-funding areas with managing 8 staff members.
Residential Loan Officers: Large Retail Bank – Boston area
Large retail bank looking to add 5 residential loan officers predominately in the Middlesex area.
Drop Kim a line if you’re looking to fill a role, or just want to say “hi”, at [email protected]
Give us a call or email us! One of our consultants will get back to acknowledging the receipt of the question, and most answers can be provided within 2 business days, at most. We’ll keep you in the loop on expected hours to complete, and follow up with any questions we need to solve the issue.
**These are our opinions. We’re not authorized, or willing, to express those of others.**
Thank you to Gregg Oberg, Spillane Consulting Associates, Inc., who with the support of other experts at SCA have put together this newsletter.