This article presents the threshold test for premium yields and high fees on personal-use home equity loans or refinancing which trigger supplemental disclosures under Reg. Z and Cal-32, limitations on the terms of repayment.

Table of Contents

1. Private lenders provide liquidity

2. Added calculations and disclosures

3. The imposing repayment limitations

4. The total loan amount for Section 32

5. The APR Threshold and treasury rates

6. Threshold for points and fees test

7. Payment of loan broker fees, etc.

8. Low rates, high fees combinations

9. Broker judgment and conduct

Loan features establishing a Section 32 loanA Section 32 loan is any interest bearing loan originated by a private lender which includes all the following features:

  • the private lender previously originated at least one other Sec. 32 loan within the prior 12 months or more than five Reg. Z loans secured by the borrower’s principal residence, or this loan is arranged by a broker, classifying the lender as a regular financier [12 CFR §226.2(a)(17)(i)];
  • the loan proceeds fund a personal, family or household use other than the borrower’s acquisition or construction of a principal residence, and exclude loans which fund the borrower’s business, investment or agricultural operations, even if secured by the borrower’s principal residence [15 USC §1602(W),12 CFR §226.3];
  • the loan is an equity loan or refinancing secured by a one-to-four unit residential property owned and occupied by the borrower as his principal residence [12 CFR §226.2]; and
  • the loan’s Section 32 APR exceeds by more than eight percentage points the rate on treasury securities with the same final payoff date (term) as existed on the 15th of the month prior to receiving the loan application; or
  • the points and fees exceed six percent (6%) of the total loan amount. [12 CFR §226.32(a)(1); Calif. Financial Code §4970(b)]
Lender control over services A controlled business arrangement of the private lender is a trade or business the lender has control over, either directly or in concert with others. [12 USC §1841(k)] A private lender has control of a trade or business if the lender:

  • directly or indirectly through others exercises controlling influence over the operations of the trade or business;
  • directly or indirectly owns, controls or has power to vote 25% or more of any class of voting stock in the business; or
  • controls the election of a majority of the directors or trustees of the business. [12 USC §1841(a)(2)]

When a broker or lender in a Reg. Z loan transaction refers the borrower (or seller) to a company providing a service called for in the transaction and the company is controlled by the broker or lender making the referral, a written disclosure is required at the time of the referral. [See first tuesday Form 205]

Private lenders provide liquidity A homeowner responds to an advertisement placed by a real estate broker offering to arrange equity loans on single-family residential property. He needs to borrow $40,000. Refinancing is too costly due to higher rates and prepayment penalties the homeowner would incur. More importantly, a loan application he recently submitted to a bank was rejected due to his lack of sufficient credit history. The broker gathers information from the homeowner as to when he bought his residence, what he paid for it, the property’s probable current value and the amount and terms of the first trust deed loan. It is immediately apparent to the broker that the loan amount requested will encumber the property at a loan-to- value ratio of 80%.
The loan broker knows the real estate sales market is in the recessionary phase of a business cycle which is likely to affect property values for a few years. Inflation rates have not yet returned to within the Federal Reserve bank target range so short term interest rates may raise. These economic events present long-term risks which concern private lenders when setting the rate of interest they need to charge on a second trust deed loan. Canvassing the loan application information before discussing rates and loan fees, the broker asks the homeowner if he intends to use the loan for business, investment or agricultural purposes. The homeowner indicates the borrowed funds will be used to clear credit card balances inflated by a family medical emergency and to payoff remaining medical bills. [See first tuesday Form 203-3]

Based on the broker’s cursory analysis of the risks presented by the loan, he informs the homeowner:

  • his lender will probably demand around 12% interest;
  • his brokerage fee for arranging the loan will be 10%; and
  • the borrower pays all charges for processing and originating the loan.

The broker is aware the interest rate on five-year treasury notes on the 15th of last month was 3%.

The homeowner indicates he only needs the loan for 24 months and would prefer no monthly payments, with the principal and interest due in a lump sum payment.

Does this loan, as discussed with the homeowner, cross either of the two Regulation Z (Reg. Z) thresholds for high rates and fees and become a Section 32 loan?

Yes! This is a Reg. Z loan which is classified as a Section 32 loan. The Section 32 Reg. Z APR for the loan will exceed the interest rate threshold test. Further, the loan related fees will also exceed the points and fees threshold test. As a result, the broker advises the homeowner the loan must be fully amortized by equal, regular monthly payments over the term of a loan if it is to be paid off within five years. Even payments of interest-only are not available for a loan due in less than five years.

Added calculations and disclosures

A Reg. Z Section 32 loan is a personal-use loan of the type which further encumbers a homeowner’s principal residence, called a home equity loan. However, it is arranged at interest rates or related loan fees which exceed threshold amounts set by state and federal mortgage laws. Thus, as an equity loan (or refinance) secured by a one-to-four unit residential property which is occupied by the borrower as his principal residence, this Reg. Z loan with rates or fees exceeding either threshold test falls under Section 32 of Regulation Z which implements the federal Truth in lending Act (TILA).

Section 32 never includes:

  • purchase-assist loans made to individuals to acquire a principal residence;
  • a personal-use loan made to an individual and secured by any type of property other than the principal residence of the borrower (one-to-four units); or
  • a loan which funds an individual’s business, investment or agricultural operation even if secured by the individual’s principal residence.

As a Reg. Z loan which further encumbers a principal residence as an equity loan or refinance, the homeowner must be given:

  • a good faith estimate of costs he will incur related to the arranging and making of the loan; [See first tuesday Form 204]
  • a Truth in Lending, Reg. Z disclosure of the loan’s APR based on the amount financed, along with other financial information on loan conditions; [See first tuesday Form 221] and
  • a three-day notice of right of rescission. [See first tuesday Form 222]

When a Reg. Z loan is further classified as a Section 32 loan due to an interest rate or fees charged exceeding threshold tests:

  • supplemental Truth in Lending disclosure must be given to the borrower containing a Section 32 notice, recalculated APR and schedule of payments; [See first tuesday Form 223] and
  • limitations are placed on repayment provisions, such as amortization schedules and balloon payment dates.

Before the threshold tests can be run (or discussed) the total loan amount financed must be calculated by a Section 32 formula. The Section 32 total loan amount is the basis for setting the Section 32 APR for treasury rate comparison and calculating the percentage represented by points and fees.

The imposing repayment limitations

But it is only the limitations placed on the note’s repayment provisions which interfere with arranging a Section 32 loan, not the Reg. Z and Section 32 disclosures. The total loan amount and the Section 32 APR disclosed must be calculated, but that only entails the use of worksheets and computer programs.

Before the terms of repayment for a Section 32 loan can be negotiated, and thus the note provisions agreed to, the loan broker must know what limitations are placed on the note terms, and then anticipate their application.

Other than disclosures and amortization/due date schedules, a Section 32 loan is just a high cost loan arranged by a real estate broker or his agent and made by a private lender.

Nothing except reasonableness, which is construed very liberally in favor of the lender, and the competitiveness of the marketplace, interferes with the private lender’s and loan broker’s right and ability to charge high rates and fees when making or arranging home equity loans or refinancing an existing loan on the borrower’s residence.

However, only when either the recalculated APR for Section 32 analysis or the points and fees charged exceed the Section 32 thresholds do the supplemental notice and disclosure of the recalculated APR and periodic payment limitations of Section 32 kick in, in addition to regular Reg. Z disclosures. [See first tuesday Form 223]

The total loan amount for Section 32

Before a loan broker arranging a loan with a private lender applies the two Section 32 threshold tests to determine whether an equity loan or refinance secured by the borrower’s principal residence (one to four units) is a Section 32 loan, the total loan amount under Section 32 must first be calculated.

The mathematical abstraction called total loan amount is an attempt by federal regulators to arrive at a dollar figure which best represents the beneficial proceeds generated by a high rate, high fees type of personal-use loan secured by the borrower’s principal residence.

The total loan amount is, in practical terms, the result of a deduction from the face amount of the note for any up-front disbursements or charges. These up-front amounts include all earnings received by the lender on closing (points, discounts, prepaid interest, a broker fee), and any advances included in the face amount which were paid to the lender or a lender controlled business, advances called lender connected and financed. [See first tuesday Form 223-1 §§7 to 10]

The total loan amount which forms the basis for Section 32 threshold tests is calculated as follows: Enter

  • the amount borrowed under the loan application


  • any other amount advanced by the lender and added to the amount borrowed to establish the face amount of the note, such as other debt owed the private lender on a refinance or advances for appraisal, home inspection, etc., made on behalf of the borrower, called items financed;


  • prepaid earnings received by the lender, called finance charges, such as discount points, loan acquisition fees and add-on amounts (which when all preceding figures are subtotalled represents the Reg. Z amount financed as disclosed on the truth-in-lending disclosure); [12 CFR §§226.4(a), 226.4(b)]


  • amounts paid to either the private lender or a business controlled by the lender and added to the amount borrowed, amounts called lender connected and financed; [12 CFR §§226.4(a), 226.4(b)]


  • the total loan amount for Section 32 APR and threshold calculations. [See first tuesday Form 223-1 §§7 to 12]

As noted above, lender connected and financed fees advanced by the lender reduce the Reg. Z amount financed for the sole purpose of setting the Section 32 total amount financed. Further, all amounts paid the lender for services rendered or obtained by the lender or paid to a business controlled by the lender are deducted, which might include:

  • title insurance premium, property survey, appraisal, home inspection report, structural pest control reports, and similar costs;
  • fees for preparing deeds, reconveyances, settlement statements, notary and related escrow charges and fees;
  • broker fees;
  • credit reporting charges and credit workup fees;
  • PMI premiums paid before closing, called, credit insurance. [12 CFR §§226.32(a)(1)(ii), 226.32(b)(1)(iii), 226.32(b)(iv), 226.4(c)(7)(v)]

The APR threshold and treasury rates

Consider the private lender who will fund a $45,000 personal use loan — to fund a borrower’s purchase of a second home in Mexico. The loan is to be fully amortized over 24 months and secured by a second trust deed on a one-to-four unit residential property occupied by the borrower as his principal residence.

The Section 32 APR on the loan is 11%. The treasury securities rate for two year notes is 2.5%. [See first tuesday journal online rate page]

Is the loan a Section 32 loan subject to Reg. Z requirements?

Yes! The APR threshold test for determining whether a Reg. Z loan is further classified as a Section 32 loan indicates the Section 32 APR exceeds by more than eight percentage points the rate on treasury securities with a similar term as of the fifteenth of the month prior to the month the lender received the loan application. [Fin C §4970(b)(1)]

On the fifteenth of the preceding month, the treasury rate on two- year treasuries was 2.5%, the applicable rate for analyzing this loan. Here, the treasury yield of 2.5% plus the margin of eight percentage points equals 10.5%, the Section 32 threshold rate for testing this loan. In comparing, the 11% APR for this loan exceeds the threshold rate placing this loan within the Section 32 repayment limitations and supplemental disclosures.

The month the loan application is considered received is instructive since the security rates from the 15th of the prior month must be used in the APR threshold test.

A loan application is received when it first reaches the private lender. Further, an application is considered received even though the private lender may not consider the application to be complete or the loan amount is changed. [12 CFR §226.32(a)(1)(i)(1)]

Further, the applicable treasury rate is taken from the treasury security with the same or similar due date.

Treasury securities come with maturities of 1, 2, 3, 5, 7, 10, 20 and 30 years.

If the loan’s due date is not the same length as the maturity of a treasury, such as 42 months, the applicable rate selected to add with the ten-percentage-point margin for comparison to the loan APR is the rate from the treasury security with the nearest due date. Thus, for a 42-month loan, the rate on the three-year treasury bill would apply.

However, if the loan’s payoff date is four years, which falls halfway between the three year and five year treasury maturity periods, the private lender uses the treasury security with the lowest rate of the two to add to the eight-percentage-point margin to set the Section 32 threshold for his loan’s interest rate. [12 CFR §226.32(a)(1)(i)(4)]

Threshold for points and fees test

If the Section 32 APR threshold test for a loan does not place the loan within Section 32, the points and fees test may. A loan is also subject to Section 32 disclosure and repayment limitations if the points and fees charged on the loan exceed a 6% points and fees threshold test. [Fin C §4970(b)(2)]

To conduct the points and fees test, the broker or lender merely compiles figures, all of which are already stated in the good-faith estimate delivered to the borrower within three days of taking the application. While all costs and fees to be incurred in the loan transaction are in the cost estimate, only those up-front fees paid to the lender or a controlled company are included in the points and fees test, with the inclusion of PMI and broker fees. [See first tuesday Form 223-1 §§1 to 6]

A personal-use installment loan secured by the equity in the borrower’s principal residence, be it in a single family residential (SFR) property or two to four residential units, is controlled by Section 32 if, separately from the APR test, the total of all points and fees paid exceed 6% of the total loan amount. [Fin C §4970(b)(2)]

The items considered points and fees include:

  • finance charges paid to the private lender, such as discounts, points, loan fees, origination fee and other similar charges; [See first tuesday Form 223-1 §1]
  • loan fees, such as amounts paid to the lender or lender controlled business for services related to the loan; [See first tuesday Form 223-1 §2]
  • fees charged by mortgage brokers and finders; [See first tuesday Form 223-1 §3] and
  • premiums and charges for private mortgage insurance (PMI), or any guarantee or mortgage insurance protecting the creditor against default or loan loss; [See first tuesday Form 223-1 §4; 12 CFR §§226.32(b)(1), 226.4(b)]

Payment of loan broker fees, etc.

Loan broker fees paid by the lender with no charge to the borrower (other than the rate of interest charged) are not considered when calculating the points and fees for the 6% threshold test. [12 CFR §226.32(b)(ii)]

However, all brokerage fees paid by the borrower, either directly or through the lender, must be included. This inclusion is consistent with RESPA — which requires brokerage fees charged the borrower to be disclosed on the settlement statement. [12 CFR §226.32(b)(ii)]

Thus, a broker who charges a fee exceeding the 6% threshold when arranging or making a personal-use installment loan to be secured by the borrower’s current principal residence (one to four units) alone triggers the Section 32 limitations and disclosure requirements.

Loan processing charges paid by the borrower to the private lender or to a controlled business of the lender are included as points and fees. For example, escrow or appraisal fees paid by the borrower to a company controlled by the private lender are included as points and fees. [12 CFR §226.32(b)(1)(iii)]

Charges paid by the borrower which are not considered points and fees include:

  • application fees charged to all loan applicants, regardless of whether a loan is made;
  • late payment charges on a default or delinquency in payment of a loan; and
  • hazard (fire) insurance premiums if the borrower is not required by the private lender to use a particular insurer. [12 CFR §226.4(c),(d)]

Low rates, high fees combination

Consider a real estate broker who is working with a private lender to arrange a $90,000 loan payable in installments on a 30-year amortization, due in three years. The loan will fund a personal use and be secured by a second trust deed on the borrower’s current principal residence (one to four units).

The APR on the loan is less than the interest rate threshold for Section 32 loans, the applicable treasury security rate plus eight percentage points. The private lender deposits funds for the full amount of the note into a loan escrow account.

The private lender receives no prepaid earnings, such as a discount, bonus, loan origination fee, advance payment of regular monthly installments, add-on interest or prepaid interest. The borrower pays all brokerage fees, escrow charges, title insurance and other closing costs, either out-of-pocket or from the proceeds of the loan. Further, the lender does not require the borrower to purchase private mortgage insurance (PMI).

None of the loan fees or escrow charges are paid to the lender or businesses under the control of the private lender. Thus, no amount of fees are included in the Section 32 calculations for the points and fees threshold test. [See first tuesday Form 223-1 §§1 to 6]

As a result, the face amount of the note received by the private lender is $90,000 — the Section 32 total amount financed which serves as the basis for calculating the 6% points and fees test.

However, if the broker charges more than $5,400 in brokerage fees for arranging the $90,000 loan, the loan will be a Section 32 loan. Brokerage fees are included in the amount of points and fees which would make them greater then 6% of the total amount financed. [12 CFR §226.32(a)(1)(ii)]

Broker judgment and conduct

California places further restrictions on borrower qualification and brokering of Section 32 loans. For example, a broker must reasonably believe that the borrower of a Section 32 loan is capable of making the scheduled payments based on the note’s interest rate, and if the loan is an adjustable rate loan, not the initial qualifying rate. [Fin C §4973(f)]

The borrower is automatically considered able to make payments if they constitute no more than 55% of his monthly gross income. However, even if more than 55% of the borrower’s monthly income comprises the borrower’s monthly payments, the broker may still qualify the borrower for the loan if the broker has good reason to believe that the payments would not over encumber the borrower financially. [Fin C §4973(f)]

Further, the loan can only be arranged if it provides the borrower with a financial benefit based on his purpose for seeking the loan. The lender with whom the broker arranges the loan must not charge higher than market rates which would be charged to cover the risk of default presented by the borrower, called the borrower’s risk grade. [Fin C §§4973(j ), 4973(l)]

California’s Section 32 law requires brokers to be judicious in matching borrowers with suitable loans — after all, the broker now is at all times always the agent of the borrower. Thus, the loan broker must make decisions which are in the borrower’s best interests. [Fin C §4979.5]

For this reason, California prohibits brokers of Section 32 loans from:

  • releasing loan funds intended for home improvement directly to a contractor, releasing funds only through a builder’s control upon progress of construction [Fin C §4973(g)];
  • adding points and fees in excess to $1,000 or 6% of principal balance (minus points and fees) to the loan amount [Fin C §4979.6]; and
  • adding to the loan amount at closing or within 30 days after closing, the premiums for life, disability, property or unemployment insurance or any debt cancellation or suspension agreement (except for private mortgage insurance) — premiums which must be paid on a monthly bases and cannot be added to the loan amount. [Fin C §4979.7]