Mortgage Concepts: Is it a Section 32 loan?

high-endrolex.com
The Home Ownership and Equity Protection Act (HOEPA) was passed in 1994 as an amendment to the Truth in Lending Act (TILA). As its title implies, HOEPA’s purpose is to protect homeowners from predatory lending practices such as short-term balloon loans and prepayment penalties. Where TILA functions as a broad shield for homeowners, HOEPA more narrowly addresses high-cost home loans. These loans are discussed in Section 1026.32 of Title 12 of the Code of Federal Regulations. Thus, these high-cost loans are known as Section 32 loans.

Section 32 loans require additional disclosures by lenders before loan closing.

In practice today, Section 32 loans are few and far between. Restrictions on Section 32 loan terms, the additional disclosures required and heavy penalties for violations make these loans unattractive to investors. Thus, they are largely shunned by lenders and originators. However, knowing what constitutes a high-cost loan is part of how loan originators, brokers and lenders avoid making such loans.

Section 32 loan designation applies to personal-use loans secured by one-to-four unit residential property (or personal property) which is used as the borrower’s principal residence.

For instance, a loan secured by a houseboat used as a principal residence may be designated a Section 32 loan. In contrast, a loan secured by a single family residence used as the borrower’s second home may not be designated a Section 32 loan. [12 CFR §1026.32(a)(1)]

The following loans are exempt from Section 32 designation:

• reverse mortgages;
• construction loans financing the initial construction of a new dwelling;
• loans originated and financed by a Housing Finance Agency; and
• U.S. Department of Agriculture Rural Development Section 502 direct loans. [12 CFR §1026.32(a)(2)]

Thus, purchase-money loans, home improvement or remodel loans and home equity lines of credit (HELOCs) are subject to Section 32 thresholds. [12 CFR §1026.32(a)]

To determine whether a loan is a Section 32 loan, three different coverage tests apply, based on:

• the loan’s annual percentage rate (APR);
• the points and fees paid in connection with the loan; and
• the prepayment penalties charged under the loan or credit agreement.

It’s important to note that if a loan exceeds thresholds set by any one of these criteria, the loan is considered a Section 32 high-cost loan. [12 CFR §1026.32(a)(1)]

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:

•  6.5 percentage points for first lien transactions;
•  8.5 percentage points for first lien transactions if the residence is personal property and the transaction is for less than $50,000; or
•  8.5 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 website, http://www.ffiec.gov/ratespread.

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]

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 $22,052 (in 2021) or more; or
• the lesser of 8% or $1,103 for a loan of less than $22,052 (in 2021). [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, 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)]

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)]

Additionally, points and fees 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)]

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)]

So you’ve got a Section 32 loan

A loan classified as a Section 32 loan under Reg Z mandates the loan originator to:

• make Section 32 specific disclosures, in addition to the standard Reg Z disclosures [12 CFR §1026.32(c)];
• restrict certain transaction terms, fees and practices [12 CFR §1026.32(d)];
• consider ability-to-repay requirements specific to high-cost loans [12 CFR §1026.34(a)(4)]; and
• require the borrower to complete pre-loan counseling. [12 CFR §1026.34(a)(5)]

Section 32 disclosures

Section 32 disclosures are to contain:

• the following statement: “You are not required to complete this agreement merely because you have received these disclosures or have signed a loan application. If you obtain this loan, the lender will have a mortgage on your home. You could lose your home, and any money you have put into it, if you do not meet your obligations under the loan.”;
• the APR based on the total loan amount financed under Section 32, as well as the total points and fees;
• the amount of the periodic payments and any final/balloon payment, if balloon payments are allowed, on a closed-end loan;
• on variable rate transactions, a statement disclosing that the interest rate and monthly payment may increase, the amount of the maximum possible monthly payment and interest rate;
• on a closed-end loan, the amount borrowed, including a disclosure about and charges for optional credit or debt cancellation insurance coverage;
• an example of repayment under an open-end Section 32 loan; and
• for an open-end loan, the credit limit for the plan as the amount borrowed. [12 CFR §1026.32(c)]

The example of repayment for open-end loans is to show the first minimum periodic payment for the draw period, the first minimum periodic payment for the repayment period, and the balance outstanding at the beginning of any repayment period. The example is to be based on the following facts:

• the borrower draws the full amount of the credit line at account opening;
• the borrower makes only minimum periodic payments during the draw and repay period; and
• the APR remains the same during the draw and repayment period. [12 CFR §1026.32(c)(3)(ii)(A)]

The statements are to inform the borrower that the examples show the first minimum periodic payments at the current APR if the borrower draws the full amount at the account opening. It is to further clarify that the example does not obtain any additional extensions of credit. The statement is also to identify the example as an example, and disclose that the borrower’s actual payments will be based on the amount of the borrower’s credit line, the amount drawn, the interest rate in effect at the time, and whether the borrower pays more than the minimum amount due. [12 CFR §1026.32(c)(3)(ii)(C)-(D)]

On all loan applications, this Section 32 disclosure is to be made in writing, and in a form the borrower may keep. Disclosures must be clear and conspicuous, but are not required to be contained in the note or loan documents, or provided to the borrower in any specific typeface or font size. [12 CFR §1026.31(b)]

The regular Reg Z disclosures must always be made on a personal-use loan, whether or not it was also classified as a Section 32 loan.

On all loan documents, a loan originator must include their name and Nationwide Mortgage Licensing System and Registry (NMLSR) ID. [12 CFR §1026.36(g)]

All Reg Z disclosures on a loan classified as a Section 32 loan must be handed to and acknowledged by the borrower at least three business days before closing. [12 CFR §1026.31(c)(1)]

No particular method for delivering the Section 32 disclosure is mandated. The only delivery requirement states the borrower must receive the disclosure at least three business days before closing the loan, regardless of the method of delivery. [12 CFR §1026.31(c)(1)]

Faced with an urgency which necessitates immediate release of funds by closing the loan escrow, a borrower may occasionally present the lender with a bona fide personal financial emergency. Here, the three-business-day waiting period may be modified or waived by the borrower after they receive the disclosures. [12 CFR §1026.31(c)(1)(iii)]

Note that the three-business-day requirement allows for the loan to close on the third business day after the disclosure is received by the borrower. Unlike the rescission period, the Section 32 disclosure period does not require the entire third business day to run before the loan closes. For example, if the borrower receives the Section 32 disclosures on Friday, June 1, the loan may close any time on Tuesday, June 5. [Official Interpretation of 12 CFR §1026.31(c)(1)-1