This MLO Mentor guide helps you quickly identify when a loan falls under Section 32 requirements. Enroll in firsttuesday’s 8-Hour NMLS CE to renew your California mortgage loan originator license and learn more about Section 32 loans in your practice.

The Home Ownership and Equity Protection Act (HOEPA) was amended to the Truth in Lending Act (TILA) in 1994 to protect homeowners from predatory lending practices related to high-cost home loans.

High-cost loans, better known as Section 32 loans (in reference to Section 32 of Regulation Z which governs them), carry higher risk and therefore come with a higher rate and cost to homeowners. As a mortgage loan originator (MLO), it’s imperative you provide the required timely disclosures, loan terms and restrictions to such loans.

The high-cost provisions required by HOEPA apply to a loan when either the interest rate or costs exceed a certain level, or trigger point, as they are more commonly referred to. The interest rate in question is that of the Annual Percentage Rate (APR) and not the interest rate shown on the promissory note. And the costs, or fees, refer to those the borrower(s) pay at or before closing. Here, we expand on the coverage tests an MLO uses to measure a loan against these trigger points so they may then assess your loan accordingly.

The annual percentage rate coverage test

A loan becomes subject to Section 32 requirements through the APR test if the APR on the total loan amount exceeds the Average Prime Offer Rate (APOR) for a comparable transaction on the same date by more than:

  • 5 percentage points for first lien transactions;
  • 5 percentage points for first lien transactions if the residence is personal property and the transaction is for less than $50,000; or
  • 5 percentage points for junior lien transactions. [12 CFR §1026.32(a)(1)(i)]

The APR is measured on the date the interest rate for the transaction is set.

The interest rate used to calculate the APR is:

  • the rate in effect on the date the interest rate is set (whether the rate is locked, or at loan closing) for a fixed-rate loan;
  • the greater of the introductory interest rate or the fully indexed rate for a loan with a varying interest rate based on an index; or
  • the maximum rate allowed to be charged during the term of the loan for any other transaction in which the interest rate may vary. [12 CFR §1026.32(a)(3)]

Note that this calculation is different from general Reg Z APR calculations.

The APR thresholds will be compared against the APOR for a comparable transaction on the same date. The APOR is published on the website of the Federal Financial Institutions Examinations Council.

The APOR currently only covers closed-end transactions. Thus, a HELOC’s APR is to be compared to the APOR for the most closely comparable closed-end transaction.

To do this, first, identify whether the HELOC is a fixed or variable rate. If a HELOC has a variable rate, but an optional fixed-rate feature, assume the HELOC is a variable rate transaction for purposes of the Section 32 threshold test.

Compare the APR for a variable rate HELOC with the APOR for a variable rate closed-end transaction with a fixed-rate period comparable to the introductory period on the HELOC. If the HELOC has no initial fixed rate, assume an initial fixed-rate period of one year.

Compare the APR for a fixed rate HELOC with the APOR for a fixed rate closed-end transaction with the same loan term in years as the HELOC maturity term. If the HELOC has no definite maturity term, assume a 30-year term. [Official Interpretation of 12 CFR §1026.32(a)(1)(i)-2]

APR Testing

Testing an APR for Section 32 designation involves three steps:

  • determining which APR threshold applies to the transaction;
  • calculating the APR for the transaction according to the rules above; and
  • comparing the transaction’s APR to the APOR for a comparable transaction.

For these examples, assume other factors (points and fees and prepayments) do not alone make the loan a Section 32 loan.

Example 1

Consider a second-lien transaction of $10,000 secured by a primary residence. The APR on the loan is 6%. The APOR for a comparable transaction is 4%. Is this transaction a Section 32 loan?

No! Since the transaction involves a junior lien, the 8.5 percentage point threshold applies. The difference between the APR and the APOR is only 2%. Thus, the loan is not a Section 32 loan.

Example 2

Consider a first-lien transaction of $45,000, secured by an RV used as a primary residence. The APR on the loan is 15%. The APOR for a comparable transaction is 8%. Is this transaction a Section 32 loan?

No! Since the transaction involves a first-lien secured by personal property and is less than $50,000, the 8.5 percentage point threshold applies. The difference between the APR and the APOR is 7%. Thus, the loan is not a Section 32 loan.

Example 3

Consider a first-lien transaction of $150,000, secured by second home. The APR on the loan is 6.5%. The APOR for a comparable transaction is 6.0%. Is this transaction a Section 32 loan?

No! Since the transaction involves a first-lien secured by real property, the APR has to exceed the APOR by 6.5 or more percentage points. In this scenario, the APR is actually less than the APOR on a comparable transaction. Thus, the loan is not a Section 32 loan under the APR test.

The points and fees coverage test

A loan becomes subject to Section 32 requirements under the points and fees test if the points and fees payable by the borrower at or before closing exceed:

  • 5% of the total loan amount for a loan of $22,969 (in 2022) or more; or
  • the lesser of 8% or $1,148 for a loan of less than $22,969 (in 2022). [12 CFR §1026.32(a)(1)(ii)]

These figures are adjusted annually for inflation. [12 CFR §1026.32(a)(1)(ii)]

The calculation of points and fees differs depending on whether the loan is closed-end or open-end.

For closed-end loans, points and fees calculations will fall in line with the ability-to-repay rule calculation of points and fees.

Mortgage insurance premiums & bona fide discount points excluded

Mortgage insurance premiums, whether government or private, are not considered in the points and fees calculations on closed-end loans. [12 CFR §1026.32(b)(1)(i)(B)-(C)]

A bona fide discount point is a discount point paid by the borrower in order to reduce the interest rate or time-price differential applicable to the mortgage. The interest rate reduction must be reasonable and consistent with industry norms. Bona fide discount points, up to the limits discussed below, are now excluded from points and fees calculations. [12 CFR §1026.32(b)(1)(i)(E)-(F)]

There are limits to how many bona fide discount points may be excluded from the points and fees calculation. These limits change depending on the loan’s interest rate. The closer the interest rate is to the APOR, the higher the threshold for excluding discount points. This is another way in which regulators are preventing lenders from overcharging borrowers.

Up to two bona fide discount points may be excluded if the interest rate before the discount is one percentage point or less below the APOR. However, only up to one bona fide discount point may be excluded if the interest rate exceeds the APOR by one to two percentage points.

No bona fide discount points may be excluded if the pre-discount interest rate exceeds the APOR by more than two percentage points. [12 CFR §1026.32(b)(1)(i)(F)]

Some loan originator compensation excluded

Compensation paid to loan originators is excluded from points and fees calculations if it:

  • has already been accounted for in the finance charge;
  • is paid by the loan originator’s employing mortgage broker;
  • is paid by the lender who employs the loan originator; or
  • paid by a retailer of manufactured homes to its employees. [12 CFR §1026.32(b)(1)(ii)]

This tightens up rules existing prior to January 10, 2014, which simply required the inclusion of all fees paid to mortgage brokers, regardless of whether they had already been accounted for. It also clarifies that this applies to fees paid to a “loan originator,” which includes mortgage brokers, their employees and loan officers employed by lenders.

Note that the compensation to be included in the points and fees calculation is to be attributable to the transaction. This is differentiated from compensation that is dependent on other factors (such as the long-term performance of a loan originator’s loans), or salary paid by the employer of the loan originator, which is excluded. A creditor shall maintain records sufficient to evidence all compensation it pays to a loan originator and the compensation agreement that governs those payments for three years after the date of payment. [12 CFR § 1026.25(c)(2)(i)]

Points and fees also include:

  • the maximum prepayment fees and penalties that may be charged under the terms of the credit transaction [12 CFR §1026.32(b)(1)(v)]; and
  • any prepayment fees or penalties incurred by the borrower if the loan refinances an existing loan made or held by the same lender. [12 CFR §1026.32(b)(1)(vi)]

In addition to the fees which are collected under a closed-end loan, open-end loans also take into account:

  • participation fees payable at or before account opening [12 CFR §1026.32(b)(2)(vii)]; and
  • transaction fees, including minimum fees or per-transaction fees, charged on a draw on the credit line. [12 CFR §1026.32(b)(2)(viii)]

The prepayment coverage test

A third coverage test applies: the prepayment coverage test. A loan is designated a Section 32 high-cost loan if the prepayment penalty charged:

  • more than 36 months after the loan transaction is consummated on a closed-end loan, or account opening on an open-end loan; or
  • exceeds, in aggregate, more than 2% of the prepaid amount. [12 CFR §1026.32(a)(1)(iii)]

For a closed-end loan, a prepayment penalty is any charge imposed for paying all or part of the transaction’s principal before the due date. [12 CFR §1026.32(b)(6)(i)] For an open-end loan, a prepayment penalty is any charge imposed for terminating the open-end credit plan before the end of its term. [12 CFR §1026.32(b)(6)(ii)]

Editor’s note — The following examples illustrate the prepayment coverage test.

Example 1

Consider a home-equity line of credit with an initial credit limit of $10,000. The HELOC requires the consumer to pay a $500 flat fee if the consumer terminates the plan less than 36 months after account opening. Is this loan a Section 32 loan?

Yes! The $500 fee constitutes a prepayment penalty under §1026.32(b)(6)(ii), and the penalty is greater than 2 percent of the $10,000 initial credit limit, which is $200.

Example 2

Consider a first-lien, closed-end mortgage secured by a borrower’s principal residence. A prepayment penalty of 2.5% of the amount prepaid applies during the first year after closing, 2% of the amount prepaid within the second year, 1.5% of the amount prepaid applies during the third year after closing and no prepayment penalty applies after the third year after closing. Is this loan a Section 32 loan?

Yes! Since the prepayment penalty in the first year exceeds the 2% threshold, the loan is considered a Section 32 loan under the prepayment penalty coverage test.

Section 32 loans are not as commonplace today as they once were. The additional disclosures required and heavy penalties for violations make them particularly unattractive to investors and therefore lenders and originators. However, knowing what constitutes a high-cost loan is part of how loan originators, brokers and lenders avoid making such loans, and why intimate knowledge and awareness of these coverage tests is prudent for your business.