HMDA Refresher: Temporary Finance Exemptions
Mortgage Industry Insight: One of the great things about SCA is the range of issues we get to see, and the wealth of knowledge we get to tap into while working with dozens of clients on a monthly basis. Today, we'll share some important information about HMDA.
By Gregg Oberg:
The first full year of “new” HMDA reporting is in the books, but there’s no time to rest. We’re already onto the next season; but not everyone “has the answers to the test” yet. That’s OK—year one was “diagnostic” in the words of the CFPB. Let’s get back to basics, and look back at some of the topics we heard questions on most often in 2018. Todays topic, as the headline may have implied, is how to determine whether a loan meets a “temporary finance” exemption.
When is Financing “Temporary?”
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 bride 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. 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. Although I’d agree this loan was “designed to be replaced,” it actually goes further. It IS GOING TO BE replaced.
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.
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?
Spillane Consulting Associates has served the residential mortgage lending business since 1991. We have specialized in mortgage banking consulting services and provided quality control reviews, risk management and process consulting and employee training to credit unions, community banks and non-depository institutions. We are a thought leader on the strategic growth of residential mortgage lending. You can learn more by visiting our website, or scheduling a meeting with me or one of my colleagues.
SCA Compliance Hotline: Need a question answered quick?
Thanks so much for reading our weekly newsletters. We're not always going to be perfect, but because we always do our best and try not to overpromise, we hope that we're always going to be trustworthy. Your calls and e-mails are very helpful - please keep contributing.