This article covers provisions which are restricted or prohibited in a note documenting a Section 32 mortgage origination. Read about Section 32 restrictions following origination: Section 32 disbursements, servicing and modification restrictions.
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Restricted Section 32 provisions
Several repayment provisions in the note documenting a Section 32 mortgage origination are restricted in their scope or outright prohibited, including:
- balloon payments;
- negative amortization;
- advance payments;
- increased interest rate on default;
- rebates;
- prepayment penalties; and
- acceleration.
Balloon payments
Balloon payments are prohibited — with exceptions. They are note provisions calling for payments equal to more than twice the amount of the average scheduled payments on the mortgage. [12 Code of Federal Regulations §1026.32(d)(1)(i)]
While balloon payments are generally prohibited on Section 32 mortgages, exceptions exist, including:
- a mortgage transaction with a payment schedule structured for ability to pay compliance which conforms to the seasonal or irregular income of the borrower [12 CFR §1026.32(d)(1)(ii)(A)];
- short-term bridge loans of 12 months or less which fund the borrower’s purchase of a new home when the borrower is selling their existing home [12 CFR §1026.32(d)(1)(ii)(B)]; and
- balloon mortgages made by small lenders, provided the mortgage meets the ability-to-repay rules. [12 CFR §1026.32(d)(1)(ii)(C); 12 CFR §1026.43(f)]
Negative amortization
Section 32 mortgage note provisions may not have a potential for mathematically increasing the principle balance of the debt, called negative amortization. However, any increase in principal balance due to allowed charges unrelated to the payment provisions is permitted, such as property insurance premiums and other advances to protect the mortgage holder’s security interest in the home. [12 CFR §1026.32(d)(2)]
Advance payments
Section 32 mortgages may not call for the prepayment on closing of more than two periodic payments when they are funded by mortgage proceeds, called advance payments. [12 CFR §1026.32(d)(3)]
Increased interest rate on default
In the foreseeable event a borrower may default, a Section 32 mortgage may not call for an increased rate of interest on the principal whether its due on the delinquent payment or due on the principal balance of the mortgage. However, this rule does not affect the periodic interest rate adjustments scheduled for a variable interest rate mortgage (ARM). [Official Interpretation of 12 CFR §1026.32(d)(4)]
Rebates
When a mortgage balance is called due by acceleration on the borrower’s default, any calculation of rebates of interest which are less favorable to the borrower than the actuarial method of calculation is prohibited. [12 CFR §1026.32(d)(5)]
Prepayment penalties
Prepayment penalties are prohibited when a consumer mortgage is classified as a Section 32 mortgage. [12 CFR §1026.32(d)(6)]
When a lender originates a consumer mortgage which initially is not a Section 32 mortgage and thus not subject to the prepayment penalty prohibitions of Section 32, they are permitted to have a prepayment penalty provision in the note. However, when the prepayment penalty period extends beyond 36 months or is an amount greater than 2% of the prepaid amount, that mortgage becomes a Section 32 mortgage. Then, as a Section 32 controlled mortgage, the lender is prohibited from charging any prepayment penalty. [Official Interpretation of 12 CFR §1026.32(a)(1)(iii)]
Acceleration or due-on clause
Additionally, a due-on-demand clause permitting the mortgage holder to accelerate payment in full of the remaining principal balance is prohibited on Section 32 mortgages, unless:
- the borrower has committed fraud or material representation in connection with the origination of the mortgage;
- the borrower fails to repay the mortgage as agreed or cure delinquent payments as permitted by local law; or
- the borrower’s actions or neglect adversely impact the property securing the mortgage, such creating waste or a nuisance. [12 CFR §1026.32(d)(8)]
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