By: Timothy A. Raty; Sr. Regulatory Compliance Specialist
“Arrakis teaches the attitude of the knife –
chopping off what’s incomplete and saying:
‘Now it’s complete because it’s ended here.’” (Dune)
Under TRID 2.0, there are several clauses in the regulations governing the “Calculating Cash to Close” tables on the Loan Estimate (“LE”) and Closing Disclosure (“CD”) which raise a few eyebrows due to the logical leaps taken from one subject to another. The first of these is the following clause (and other, similar ones), found in the Official Staff Commentary applicable to the “Closing Costs Financed (Paid from your Loan Amount)” row:
“The amount of closing costs financed disclosed under § 1026.37(h)(1)(ii) [‘Closing Costs Financed (Paid from your Loan Amount)’ row] is determined by subtracting the estimated total amount of payments to third parties not otherwise disclosed under § 1026.37(f) and (g) [‘Loan Costs’ and ‘Other Costs’, respectively) from the loan amount disclosed under § 1026.37(b)(1). The estimated total amount of payments to third parties includes the sale price disclosed under § 1026.37(a)(7)(i), if applicable, unless otherwise excluded under comment 37(h)(1)-2. . . .” (12 CFR Pt. 1026, Supp. I, Paragraph 37[h][1][ii] – 1; emphasis added)[i]
The logical leap here is how, in a transaction involving the purchase of the subject property, can the sales price be considered a payment to a third party? Are the seller and the buyer not the principal parties in the transaction?
The second of these is the following clause (and other, similar ones), which is applicable to both the “Down payment/Funds from Borrower” and “Funds for Borrower” rows:
“. . . Pursuant to § 1026.37(h)(1)(v), the amount to be disclosed under § 1026.37(h)(1)(iii)(A)(2) or (B) [certain purchase transactions and all non-purchase transactions] is determined by subtracting the sum of the loan amount disclosed under § 1026.37(b)(1) and any amount of existing loans assumed or taken subject to that will be disclosed under § 1026.38(j)(2)(iv) [Line L.03] (excluding any closing costs financed disclosed under § 1026.37(h)(1)(ii)) from the total amount of all existing debt being satisfied in the transaction. The total amount of all existing debt being satisfied in the transaction is the sum of the amounts that will be disclosed on the Closing Disclosure in the summaries of transactions table under § 1026.38(j)(1)(ii), (iii), and (v) [Lines K.01, K.02, and K.04 – K.07], as applicable. . . .” (Supra Paragraph 37[h][1][iii] – 2; emphasis added)[ii]
While not necessarily problematic at first, it does raise questions when coupled with the following Official Staff Comment:
“A creditor discloses the amount of construction costs on the Closing Disclosure under § 1026.38(j)(1)(v) in the summaries of transactions table [Lines K.04 – K.07] and factors them into the down payment/funds from borrower and funds for borrower calculation under § 1026.38(i)(4) and (6). For transactions without a seller or for simultaneous subordinate financing, construction costs may instead by disclosed under § 1026.38(t)(5)(vii)(B) in the optional alternative calculating cash to close table.” (Supra Paragraph App. D-7.vi.C; emphasis added)
Taken together, TRID 2.0 considers construction costs to be part of the “total amount of all existing debt being satisfied in the transaction”, which raises the question of how construction costs could be considered part of an amount for paying off existing debts?
The terms “payments to third parties” and “total amount of all existing debt being satisfied in the transaction” are apparent on their faces, but such apparentness becomes questionable when the former includes the sales price of the subject property and the latter includes construction costs. While the CFPB does not explain the logical connections between these and presents them as “givens” (hence the reason for the quote at the beginning of this article), there actually is a logical (rather than arbitrary) structure behind these provisions.
Payments to Third Parties and the Sales Price
Black’s Law Dictionary – the bible of the legal profession – defines a “third party” as follows:
“Someone who is not a party to a lawsuit, agreement, or other transaction but who is usu[ally] somehow implicated in it; someone other than the principal parties.” (THIRD PARTY, Black’s Law Dictionary [10th ed. 2014])
In a transaction involving the sale and purchase of real property, the seller is unquestionably a principal party to the purchase and sale agreement with the buyer and, thus, could not in any way be considered a “third party” under the definition outlined in Black’s Law . . .
But that is within the context of a purchase and sale agreement. What about within the context of the chief financial part of the transaction, namely the mortgage loan?
The LE and the CD are required to be given in connection with “a closed-end consumer credit transaction” (see 12 CFR § 1026.19[e][1][i] & [f][1][i]), the “consumer credit” part being defined (in part) as “credit offered or extended to a consumer” (Ibid. § 1026.2[a][12]). Credit can only be “offered or extended” to a consumer by a creditor. The legally binding documents of the transaction (primarily the promissory note and security instrument) are strictly between the consumer and the creditor. As such, a seller cannot be a principal party to a “consumer credit transaction” (unless the seller is also the creditor). However, because the “consumer credit transaction” is connected to the purchase and sale of real property, the seller is “implicated” into the “consumer credit transaction” and, as such, is considered a “third party”, using Black’s Law’s definition.
Since the seller is considered a third party to the consumer credit transaction and the sales price is paid to such party, the first logical leap has been bridged.
This logical construction is implicitly supported in the Official Staff Commentary to 12 CFR § 1026.17(c)(1), which states that the disclosures required under Subpart C of Regulation Z (which includes the LE and the CD) “shall reflect the terms of the legal obligation between the parties.” The Commentary expounds upon this clause by stating that “the disclosures shall reflect the terms to which the consumer and creditor are legally bound at the outset of the transaction.” (12 CFR Pt. 1026, Supp. I, Paragraph 17[c][1] – 1; emphasis added) Also, “the legal obligation normally is presumed to be contained in the note or contract that evidences the agreement between the consumer and the creditor” (Ibid. Paragraph 17[c][1] – 2; emphasis added). In describing buydowns, the Commentary states that “in certain transactions, a seller or other third party” (Ibid. Paragraph 17[c][1] – 3), thus implying that a seller is considered a third party.
Existing Debt and Construction Costs
The “total amount of all existing debt being satisfied in the transaction” is defined in TRID 2.0 as “the sum of the amounts that will be disclosed on the Closing Disclosure in the summaries of transactions table under § 1026.38(j)(1)(ii), (iii), and (v) [Lines K.01, K.02, and K.04 – K.07], as applicable” (12 CFR Pt. 1026, Supp. I, Paragraph 37[h][1][iii] – 2). The phrase “as applicable” is a caveat, particularly when it is coupled with the provisions of Ibid. Paragraph 37(h)(1)(vii) – 6, which states that the purchase price of personal property (disclosed in K.02) and adjustments (disclosed in Lines K.05 – K.07) “are only included in the amount disclosed [in the ‘Adjustments and Other Credits’ row] if such amounts are not included in the calculation[s of the ‘Down payment/Funds from Borrower’ and ‘Funds for Borrower’ rows] as debt being satisfied in the transaction.”
All together, this means that not all amounts disclosed in Lines K.02 and K.05 – K.07 are to be automatically considered “existing debt being satisfied in the transaction” and they may be factored into the calculations of different rows, depending upon the context. But what exactly are “existing debts being satisfied in the transaction”? The CFPB did request feedback on this matter in their proposed TRID 2.0 rule, asking for feedback on “how else the Bureau might provide greater clarity around amounts that must be included in this calculation.”
Unfortunately, no feedback was submitted on this point and the CFPB left the proposed language about “existing debt being satisfied in the transaction” without an explanations or specifications (see 82 FR 37710 & 37712 [2017]). The CFPB’s “TILA-RESPA Integrated Disclosure Guide to the Loan Estimate and Closing Disclosure forms” (v. 2.1) also does not provide much insight (note the use of the caveat “generally”):
“For purposes of calculating the Down Payment/Funds from Borrower, ‘the total amount of all existing debt being satisfied in the transaction’ is the sum of amounts that will be disclosed on the Closing Disclosure in the Summaries of Transactions under § 1026.38(j)(1)(ii), (iii) and (v), as applicable. . . Generally, this includes the Sale Price of Property, the Sale Price of Any Personal Property Included in the Sale as well as the Adjustments and the other consumer charges that may be disclosed on Line K.04.” (p. 50; see also p. 51; bolding omitted)
Breaking down “the total amount of all existing debt being satisfied in the transaction” clause into criteria, there are four elements a charge must meet to qualify as being included in the total:
- The charge must be for a debt;
- More specifically, the charge must be for a debt currently existing (as opposed to, say, a debt planned for the future);
- The charge must “satisfy” the debt; and
- The charge must be satisfied in connection with the transaction.
While K.01 and K.02 amounts are readily identified (leaving aside the conflict between the regulatory provisions concerning which calculations K.02 amounts should be factored into), non-adjustment amounts which are disclosed in Lines K.04 through K.07 include:
“. . . 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 . . .” (12 CFR Pt. 1026, Supp. I, Paragraph 38[j][1][v] – 2)
While it is obvious that payoffs of existing liens, debts, and property taxes meet the criteria of “existing debts being satisfied in the transaction”, it is not so obvious that construction costs fit the same description, yet the Official Staff Commentary is explicit that construction costs should be factored into the “Down payment/Funds from Borrower” and “Funds for Borrower” rows (see Ibid. Paragraph App. D-7.vi.C). Do they meet the criteria or was the CFPB’s requirements that they be included in the calculation simply arbitrary?
“Debt” is defined in Black’s Law Dictionary as follows:
“Liability on a claim; a specific sum of money due by agreement or otherwise . . .” (DEBT, Black’s Law Dictionary [10th ed. 2014])
For construction-type loans (which includes loans for renovations; see Supra Paragraph App. D-7.vi.A), prior to the closing of the loan, the borrower will have already entered into a construction agreement with a general contractor (e.g. see FHA Handbook 4000.1 II.A.8.a.vi[h][1]). Under the terms of this contract, the borrower agrees to pay the general contractor for the costs (including labor) for performing construction-type work.
Because this agreement is a binding contract and, under its terms, the borrower owes the other principal party a certain sum of money, the borrower owes a debt to the general contractor (meeting the first criterion). This debt exists at the time of closing (meeting the second criterion) and will be paid in whole (or in part) through the loan proceeds (meeting the third and fourth criteria). Because the closing costs effectively reflect the “total amount of existing debt” owed to the general contractor, it is logical to include them into the calculations.
Conclusion
The CFPB, of course, may have their own logical structure for their conclusions which are entirely different than what is outlined above. However, based on what information the CFPB has provided us, these conclusions do provide a tenable position for including the sales price and construction costs into certain calculations used for the “Calculating Cash to Close” table.
- A seller is a third-party in a consumer credit transaction, thus paying the seller for the subject property is a “payment to a third party.”
- The borrower owes a sum of money (a “debt”) by contract to a general contractor to pay for the costs of the construction. Some (or all) of the loan proceeds are used to pay this debt, thus they are used to satisfy an existing debt. Because the construction costs adequately reflect the debt owed, they are factored into the calculations.
_________________________________________________________________
[i] See also 12 CFR Pt. 1026, Supp. I, Paragraphs 37(h)(1) – 2 & 38(i)(3) – 1.i
[ii] See also 12 CFR §§ 1026.37(h)(1)(v) & 1026.38(i)(6)(iv) and 12 CFR § 12 CFR Pt. 1026, Supp. I, Paragraphs 37(h)(1)(v), 38(i)(4)(ii)(A) – 2, 38(i)(4)(ii)(B) – 1, & 38(i)(6)(ii) – 1