RSK.IQ Question of the Week 2/24/14

HMDA Reporting for Temporary Home Improvement to Permanent Financing

Bank has approved a construction/permanent loan to gut a single family residence and add rooms to it. The so-called construction phase is underway. When completed, the construction loan and the existing permanent loan made by another lender will be refinanced. How should the loan be characterized for HMDA purposes? As a construction loan or a home improvement loan?

This is not a question the Home Mortgage Disclosure Act or Regulation C (“HMDA”) addresses directly. Breaking down the legal and regulatory requirements allows for an acceptable answer. Where HMDA itself does not provide a clear and unambiguous answer, however, the Bank must select an approach, have a rationale for it, and apply it consistently.

Ordinarily, temporary financing is not HMDA-reportable. 12 CFR 1003.4(d)(3). If the permanent phase of the financing was treated as a refinancing, the purpose of the temporary loan would not be relevant, as per section 1002.2(k)(2). Where there is a commitment for permanent financing from the same lender, however, it does become HMDA-reportable. In the case of construction/permanent financing, the Staff Commentary says that it would be coded as a home purchase loan. Staff Commentary, 2(h)-2. If the characterization by the Bank of the loan as construction/permanent is valid, it would be reported on the HMDA/LAR with the code for “home purchase.”

Unfortunately, this is the only example of temporary-to-permanent financing that the Staff Commentary provides.

A commentator in the Consumer Compliance Outlook (Second Quarter, 2011) of the Federal Reserve Bank of Philadelphia noted that a short-term home improvement loan with a documented take-out commitment is not a temporary loan and should be reported, just as a the construction/permanent loan would be. If the short-term home improvement loan will be replaced with permanent financing of a much longer term, the bank would report the permanent take-out loan.

While “construction loan” is not defined by HMDA, “construction” does have a commonly understood meaning, such as “the creation of something new, as opposed to the repair or improvement of something existing.” Black’s Law Dictionary, 6th Edition. Under section 1003.2(g)(1) of Regulation C, a home improvement loan includes a dwelling-secured loan made for the purpose, in whole or in part, of repairing, rehabilitating, remodeling, or improving a dwelling or the real property on which it is located. This sounds closer to what is actually being done in the case of the loan in question, since the work financed is being done to an existing structure, which can only be constructed once.

In describing the purpose of the loan for HMDA-reporting, one approach taken by some compliance officers when there is two-phase financing is to use the purpose of the first phase to characterize the loan as a whole. Since this loan was not a construction loan, it would not be characterized as a home purchase loan for HMDA-reporting purposes. Since the temporary phase was made for home improvement purposes and since HMDA does not assign a special meaning to such a purpose in temporary/permanent financing, as it does to construction loans, the loan should be characterized as a home improvement loan.

This entry was posted on Monday, February 24th, 2014 at 3:12 pm.

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