By: Timothy A. Raty, Sr. Regulatory Compliance Specialist
During the implementation of the “Integrated Mortgage Disclosures Under the Real Estate Settlement Procedures Act (Regulation X) and the Truth in Lending Act (Regulation Z)” (78 FR 79730 ; commonly referred to as “TRID” or “TRID 1.0”) between 2012 and 2015, many questions arose from the mortgage industry as to how, exactly, the terms of construction loans should be properly disclosed on the new Integrated Disclosures. Even after implementation, so many questions were raised that the Bureau of Consumer Financial Protection (the “Bureau”) hosted a webinar fielding “Q&As” on some of these questions (see https://consumercomplianceoutlook.org/outlook-live/archives/; “Know Before You Owe Mortgage Disclosure Rule – Construction Lending” dated March 1, 2016).
Much of the guidance (and more) from this webinar was incorporated into the “Amendments to Federal Mortgage Disclosure Requirements under the Truth in Lending Act (Regulation Z)” (82 FR 37656 ; commonly referred to as “TRID 2.0”). While not as comprehensive as members of the mortgage industry would like, they do provide further guidelines on basic principles and specifics that creditors should use in determining how terms of the construction loan are to be disclosed on the Loan Estimate (“LE”) and Closing Disclosure (“CD”).
This is a multi-part article, which categorizes these guidelines into several parts:
- General Subpart C Guidance;
- Specific LE and CD Guidance; and
- Appendix D Guidance
Part I – General Subpart C Guidance
A key subsection concerning construction loans, which is applicable to all disclosures provided under Subpart C of Regulation Z (12 CFR §§ 1026.17 through 1026.24), is 12 CFR § 1026.17(c)(6) which states the following:
“i. A series of advances under an agreement to extend credit up to a certain amount may be considered as one transaction.
ii. When a multiple-advance loan to finance the construction of a dwelling may be permanently financed by the same creditor, the construction phase and the permanent phase may be treated as either one transaction or more than one transaction.”
This subsection has formed a part of Regulation Z ever since its current incarnation in 1981 (see 46 FR 20848 ). The Official Staff Commentary to this subsection has also been in place since the Commentary was formally created in the same year (see 46 FR 50288 ).
These provisions permit the creditors to treat construction loans (which are characterized by having a series of advancements or disbursements of the loan proceeds throughout construction) as either one transaction or multiple transactions. For example, a construction-to-permanent to loan (a transaction consisting a construction- and a permanent-phase, where loan proceeds extended during the construction phase are “refinanced” into different terms during the permanent-phase) can be treated as one transaction (with a single LE and CD provided reflecting the terms of both phases of the loan) or as two (two separate LEs and CDs are provided, each reflecting the terms of either the construction- or permanent-phase).
When treated as separate transactions, questions have arisen as to how the costs associated with the transaction should be distributed between the two. For example, if the creditor charges a flat origination charge for both phases of the loan, would such charge be disclosed on the LE/CD for the construction-phase or for the permanent-phase?
The Bureau provides guidance on this matter by amending current 12 CFR Pt. 1026, Supp. I, Paragraph 17(c)(6) – 5 to state the following:
“Allocation of costs. When a creditor uses the special rule in § 1026.17(c)(6) to disclose credit extensions as multiple transactions, fees and charges must be allocated for purposes of calculating disclosures. In the case of a construction-permanent loan that a creditor chooses to disclose as multiple transactions, the creditor must allocate to the construction transaction finance charges under § 1026.4 and points and fees under § 1026.32(b)(1) that would not be imposed but for the construction financing. For example, inspection and handling fees for the staged disbursement of construction loan proceeds must be included in the disclosures for the construction phase and may not be included in the disclosures for the permanent phase. If a creditor charges separate amounts for finance charges under § 1026.4 and points and fees under § 1026.32(b)(1) for the construction phase and the permanent phase, such amounts must be allocated to the phase for which they are charged. If a creditor charges an origination fee for construction financing only but charges a greater origination fee for construction-permanent financing, the difference between the two fees must be allocated to the permanent phase. All other finance charges under § 1026.4 and points and fees under § 1026.32(b)(1) must be allocated to the permanent financing. Fees and charges that are not used to compute the finance charge under § 1026.4 or points and fees under § 1026.32(b)(1) may be allocated between the transactions in any manner the creditor chooses. For example, a reasonable appraisal fee paid to an independent, third-party appraiser may be allocated in any manner the creditor chooses because it would be excluded from the finance charge pursuant to § 1026.4(c)(7) and excluded from points and fees pursuant to § 1026.32(b)(1)(iii).”
This guidance can be broken down simply into the following process:
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Whether a fee is a finance charge or a “points and fee” is too lengthy of a discussion for this article, due to the complexities involved in such determinations. A finance charge generally includes “any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit.” (12 CFR § 1026.4[a]) This can include some construction-type fees, such as inspection and handling fees (see 12 CFR Pt. 1026, Supp. I, Paragraph 4[a] – 1.ii). A “point and fee” – which is generally used to determine whether a closed-end loan is a “high cost mortgage loan”, includes some charges which are not considered “finance charges”, while also excluding other fees which are considered “finance charges.”
Thus, how such fees are to be disclosed will depend greatly on whether they are a “finance charge” or a “points and fee.” Even if the charge is a finance charge, it may need to be disclosed in a special way, such as in the case where separate origination charges are assessed for both phases of the loan.
After determining that the fee is a “finance charge” or a “points and fee” (or both), the creditor must then determine whether the fee is attributable to a specific phase for the loan. The example provided (inspection and handling fees) illustrates this point. These fees would not be assessed if it were not for the construction aspect of the loan (i.e., the charges would not exist “but for” the construction), thus they must be attributed to the construction-phase Integrated Disclosures. If such a determination cannot be made (e.g., the unusual case where insurance premiums are escrowed during both phases of the loan), then the fees are disclosed in the permanent-phase Integrated Disclosures.
If a charge is neither a “finance charge” nor a “points and fee”, the creditor is free to attribute it at the creditor’s discretion.
Why the use of the criteria of “finance charge” and “points and fee” to determine what fees should be disclosed in which documents? The Bureau explains:
“. . . In response to comments that sought clarification of the scope of costs covered by the ‘but for’ approach, the Bureau is revising comment 17(c)(6)-5 to identify more precisely the costs to which the ‘but for’ allocation applies. As revised, comment 17(c)(6)-5 specifies that the ‘but for’ test only applies to the finance charges under § 1026.4 and the points and fees under § 1026.32(b)(1), the amounts that are most relevant in determining whether the loan is a high-cost mortgage under § 1026.32 or a higher-priced mortgage loan under § 1026.35 or a qualified mortgage under § 1026.43(e). . . .
. . . Using the ‘but for’ allocation for these amounts when separate disclosures are provided for the phases of a construction-permanent loan will allow creditors to determine more accurately whether the permanent phase is a high-cost mortgage or higher-priced mortgage loan or qualified mortgage.” (82 FR 37669 )
Thus, the purpose of this criteria is to help creditors determine whether either phase of the loan is an HCL, HPML, or QM.
Part II – Specific LE and CD Guidance
While the bulk of guidance for filling out the LE and CD for construction-type loans is set forth in 12 CFR Pt. 1026, App. D (which will be covered in Part III), there is some specific guidance which was incorporated into 12 CFR §§ 1026.19, 1026.37, & 1026.38 as well.
Timing – New Official Staff Comment 12 CFR Pt. 1026, Supp. I, Paragraph 19(e)(1)(iii) – 5 clarifies when an LE must be provided when a construction-to-permanent loan is treated as either one transaction or as separate transactions (including cases where the borrower submits separate applications for the construction and permanent phases). Essentially, the LE must be delivered within three (general) business days after each application is received and no later than seven (specific) business days prior to consummation (see 82 FR 37672 – 37673 ). To illustrate with one of the examples:
“Assume the creditor receives a consumer’s application for construction financing only on Monday, June 1. Assume further that the creditor receives the consumer’s application for permanent financing on Monday, June 8. The creditor must deliver or place in the mail the [LE] for the construction financing no later than Thursday, June 4, the third business day after the creditor received the consumer’s application for the construction financing only, and not later than the seventh business day before consummation of the construction transaction. The creditor must deliver or place in the mail the [LE] for the permanent financing no later than Thursday, June 11, the third business day after the creditor received the consumer’s application for the permanent financing, and not later than the seventh business day before consummation of the permanent financing transaction.” (12 CFR Pt. 1026, Supp. I, Paragraph 19[e][iii] – 5.iii)
In addition to this guidance, the Bureau also provides guidance concerning whether multiple CDs may be provided in connection with construction-to-permanent loans. Essentially, a creditor may provide separate CDs for both phases of the transaction, if the creditor also opts to provide multiple LEs:
“Assume [the creditor receives a consumer’s application for both construction and permanent financing on Monday, June 1], under which the creditor provides the [LE] for both construction financing and permanent financing. If the creditor generally conducts separate closings for the construction financing and the permanent financing or expects that the construction financing and the permanent financing may have separate closings, providing separate Loan Estimates for the construction financing and for the permanent financing allows the creditor to deliver separate Closing Disclosures for the separate phases. For example, assume further that the consumer has requested permanent financing after receiving separate Loan Estimates for the construction financing and for the permanent financing, that consummation of the construction financing is scheduled for July 1, and that consummation of the permanent financing is scheduled on or about June 1 of the following year. The creditor may provide the construction financing Closing Disclosure at least three business days before consummation of that transaction on July 1 and delay providing the permanent financing Closing Disclosure until three business days before consummation of that transaction on or about June 1 of the following year, in accordance with § 1026.19(f)(1)(ii). The creditor may also issue a revised Loan Estimate for the permanent financing at any time prior to 60 days before consummation, following the procedures under § 1026.19(e)(3)(iv)(F).” (Ibid. Paragraph 19[e][iii] – 5.iv)
Property Value – Revisions to 12 CFR Pt. 1026, Supp. I, Paragraphs 37(a)(7) – 1 & 38(a)(3)(vii) – 1 provide further guidance as to what should be disclosed for “Estimated Value” and “Est. Property Value” on the LE and CD, respectively (which replace the “Sale Price” disclosures on the first page of both documents for transactions which do not involve a seller). They permit creditors the option to disclose the estimated value of the property after construction work is completed. To wit:
“[For the LE.] In transactions where there is no seller, such as in a refinancing, § 1026.37(a)(7)(ii) requires the creditor to disclose the estimated value of the property . . . based on the best information reasonably available to the creditor at the time the disclosure is provided to the consumer, which may include, at the creditor’s option, the estimated value of the improvements to be made on the property in transactions involving construction. . . .” (Ibid. Paragraph 37[a] – 1)
“[For the CD.] . . . For transactions involving construction where there is no seller, the creditor must disclose the value of the property that is used to determine the approval of the credit transaction, including improvements to be made on the property if those improvements are used in determining the approval of the credit transaction.” (Ibid. Paragraph 38[a][vii] – 1)
Inspection and Handling Fees – Please see https://compliance.docutech.com/2018/04/02/post-consummation-fees-and-trid/ for details on this major change.
Closing Costs Financed – Revisions to 12 CFR Pt. 1026, Supp. I, Paragraph 37(h)(1)(ii) – 1 and new Ibid. Paragraph 38(i)(3) – 1.i incorporate into the “Closing Costs Financed” calculation construction costs; considering it to be a cost to a third party which is not otherwise disclosed in the “Loan Costs” and “Other Costs” tables (which they are not – they are disclosed in Section K of the CD). To wit:
“The amount of closing costs financed disclosed . . . is determined by subtracting the estimated total amount of payments to third parties not otherwise disclosed under [“Loan Costs” and “Other Costs”] from the loan amount . . . examples of payments to third parties not otherwise disclosed under [“Loan Costs” and “Other Costs”] include the amount of construction costs for transactions that involve improvements to be made on the property . . .” (Ibid. Paragraph 37[h][ii] – 1; see also Ibid. Paragraph 38[i] – 1.i)
Down Payment/Funds from Borrower and Funds for Borrower – Under TRID 2.0, further delineations are made between using the “Funds from Borrower” calculation normally used for purchase transactions and the “Funds for Borrower” calculation used for other types of transactions. While the “Funds from Borrower” calculation will still be used for most purchase transactions, the “Funds for Borrower” calculation will be used for those transactions involving “improvements to be made on the property” – i.e., construction loans. To wit:
“In a purchase transaction . . . that . . . involves improvements to be made on the property . . . the amount of estimated funds from the consumer as determined in accordance with paragraph (h)(1)(v) of this section [calculations for ‘Funds for Borrower’] . . .” (12 CFR § 1026.37[h][iii][A]; see also Ibid. § 1026.38[i][ii][A] and 12 CFR Pt. 1026, Supp. I, Paragraphs 37[h][iii] – 2, 38[i][ii][A] – 2, & 38[i][ii][B] – 1)
Section K – On the CD, construction costs are to be disclosed in Section K – specifically in Lines K.04 through K.07, per the following:
“The amounts disclosed under § 1026.38(j)(1)(v) [Lines K.04 through K.07] which are for charges owed by the consumer at the real estate closing not otherwise disclosed under § 1026.38(f), (g), and (j) [“Loan Costs,” “Other Costs,” and Section K, respectively) will not have a corresponding credit in the summary of the seller’s transaction under § 1026.38(k)(1)(iv). For example, the amounts paid to any holders of existing liens on the property in a refinance transaction, construction costs in connection with the transaction that the consumer will be obligated to pay, payoff of other secured or unsecured debt, any outstanding real estate property taxes, and principal reductions are disclosed under § 1026.38(j)(1)(v) without a corresponding credit in the summary of the seller’s transaction under § 1026.38(k)(1)(iv). . . .” (12 CFR Pt. 1026, Supp. I, Paragraph 38[j][v] – 2)
Notably, this differs from the what the CFPB originally proposed, which was that construction costs would be disclosed in Section H (see 82 FR 37728 – 37730 & 37740 ). The CFPB does not specify the rationale for this change, but if it was based on the comments received for the proposed rule, it would have included the fact that the disclosure of the construction costs in Section H would have inflated total closing cost amounts to the point where it may be too much of a “shock” for consumers.
Omitting Sections M & N – Revisions to 12 CFR Pt. 1026, Supp. I, Paragraph 38(k) – 1 now exclude some construction loans from the disclosure requirements for Sections M and N, effectively permitting the creditor or settlement agent to leave these sections blanks for such loans:
“Section 1026.38(k) [Sections M & N] does not apply in a transaction where there is no seller, such as . . . a transaction with a construction purpose as defined in § 1026.37(a)(9)(iii) [“Loan Purpose”] . . .”
Please note that in order for this to apply to construction loans qua constructions loans, the loan cannot be used to purchase the real property (else “Loan Purpose” is “Purchase” and not “Construction”) and cannot be used to refinance a previous loan (else “Loan Purpose” is “Refinance”) – thus, this applies to a limited set of construction loans (e.g., construction of a dwelling on real property which the borrower already owns, free and clear of any liens). See 12 CFR §§ 1026.37(a)(9) & 1026.38(a)(5)(ii) for further details.
Payoffs and Payments – If the alternative “Calculating Cash to Close” table is used on the LE, construction proceeds are disclosed in the “Payoffs and Payments” row, per the following:
“Examples of the amounts incorporated in the total amount disclosed under § 1026.37(h)(2)(iii) [‘Payoffs and Payments’] include, but are not limited to: . . . construction costs associated with the transaction that the consumer will be obligated to pay in any transaction in which the creditor is otherwise permitted to use the alternative calculating cash to close table . . . Amounts that will be paid with funds provided by the consumer, including partial payments, such as a portion of construction costs, or amounts that will be paid by third parties and will be disclosed on the Closing Disclosure under § 1026.38(t)(5)(vii)(B) [‘Payoffs and Payments’ table], are calculated as credits, using positive numbers, in the total amount disclosed under § 1026.37(h)(2)(iii).” (12 CFR Pt. 1026, Supp. I, Paragraph 37[h][iii] – 1)