HMDA and Temporary Loan Used for the Purchase and Renovation of a Dwelling

Issue/Inquiry

Borrowers are applying to the Bank for a “construction loan” to purchase a two-family home, which they will renovate and keep as an investment property. They intend to apply for permanent financing after the 12 month construction period.  It has not been decided yet if they will obtain permanent financing through the Bank or another institution. Would this be HMDA reportable?

Response Summary

For HMDA purposes, the loan is being used for the purchase and improvement of a dwelling. If it was HMDA-reportable, it would be reported as a home purchase loan. As it is temporary financing intended to be replaced by permanent financing, it would be HMDA-reportable only if the Bank also gave a commitment to provide the permanent financing.

Response Detail

The Bank’s question is not addressed directly by the Home Mortgage Disclosure Act (“HMDA”) or Regulation C. Breaking down the legal and regulatory requirements will allow for an acceptable answer, but where HMDA itself is not clear or unambiguous, the Bank must choose an approach, develop a rationale for the approach, and apply it consistently.

The Bank has classified the loan as a “construction loan,” but this alone does not determine whether or not such is HMDA-reportable. The question is whether a loan meets the definition of a home purchase loan, a home improvement loan, or a refinancing. Loans in these categories are HMDA-reportable. 12 CFR §1003.4(a).

The term “construction loan” is used, but not defined by Regulation C. The commonly understood meaning of the term is “the creation of something new, as opposed to the repair or improvement of something existing.” Black’s Law Dictionary, 6^th Edition. Regulation C does define “home improvement loan” as:

• A loan secured by a lien on a dwelling that is for the purpose, in whole or in part, of repairing, rehabilitating, remodeling, or improving a dwelling on the real property on which it is located

• A non-dwelling secured loan that is for the purpose, in whole or in part, of repairing, rehabilitating, remodeling, or improving a dwelling on the real property on which it is located, and that is classified by the financial institution as a home improvement loan. 12 CFR §1003.2.

A house can be erected only once. From that point on, any work completed on it is in the nature of an improvement.  An argument can be made that the renovation of a structure can be so extensive as to be less the improvement of an existing structure and more the construction of a new one. The Staff Commentary to Regulation C, however, does not address this aspect, so the more reasonable approach is to regard a loan such as the one in question as a home improvement loan rather than a construction loan.

The loan will also be used to purchase the property on which the dwelling was erected. Under Regulation C, a “home purchase loan” is a home secured by and made for the purpose of purchasing a dwelling. While a portion of the proceeds will be used to renovate the property, HMDA prescribes an order of priority to multiple-category loans. If a loan is a home purchase loan as well as a home improvement loan, a financial institution reports the loan as a home purchase loan. 12 CFR §1003.2; Staff Commentary, ¶1003.2  (home purchase loan) – 7.

Home purchase loans are HMDA-reportable. The Bank has indicated, however, that the financing for the purchase and renovation of the property will be temporary, as permanent financing will be provided by the Bank or another financial institution. Regulation C provides that a financial institution shall not report:

Temporary financing (such as bridge or construction loans). 12 CFR §1003.4(d)(3).

Neither HMDA nor Regulation C defines “temporary financing” or “bridge loan,” but Federal guidance provides a degree of clarity:

Construction and bridge loans are illustrative, not exclusive examples of temporary financing. The examples indicate that financing is temporary if it is designed to be replaced by permanent financing of a much longer term. A loan is not temporary financing merely because the term is short. FFIEC, HMDA Frequently Asked Questions.

Therefore, temporary financing is not HMDA-reportable, with the exception of when there is a commitment for permanent financing from the same lender. In the case of construction/permanent financing, the Staff Commentary states that this would be coded as a home purchase loan. Staff Commentary, ¶1003.2 (home purchase) – 2.

Neither the regulation nor its commentary address situations other than construction/permanent financing. Nevertheless, a commentator in the Federal Reserve Bank of Philadelphia’s “Consumer Compliance Outlook” (Second Quarter, 2011) was of the opinion that a temporary loan used for home improvement but with a documented take-out should be reported just as a construction/permanent loan would be; that is, as a home purchase loan.

Where does this leave us, then? The loan will be used for the purchase and renovation of a property. As the property is being renovated, that portion of the loan proceeds will be used for home improvement rather than construction. As the loan proceeds will also be used for the purchase of the property, however, such will be given priority under HMDA in determining the purpose of the loan. Because the financing is temporary and intended to be replaced with permanent financing, it would be reportable as a home purchase loan only if the Bank made a commitment for the permanent financing. If no such commitment is made, the loan will be considered temporary financing, which is not HMDA-reportable.

This entry was posted on Monday, July 11th, 2016 at 3:00 pm.