For years, HMDA has caused all kinds of headaches. In fact, the acronym “HMDA” itself could just as easily stand for Head Migraine Day Again. The reason for this, of course, is that HMDA is an infinitely detailed rule, but the rules don’t address every situation which often leaves those responsible stuck between a rock and a hard place, which I commonly refer to as the “gray area” of HMDA. One area that seems to be in this category relates to how an interest buyout should be reported for HMDA purposes.
Defining an Interest Buyout for HMDA
To begin, it is important to make sure we are all on the same page as to what an interest buyout is. While HMDA and other regulations don’t clearly define this term, an interest buyout is the term often used to reflect a transaction where one borrower who has a partial ownership of a dwelling is “buying out” the ownership interest of another person. Common examples of this include a divorce situation or when two siblings inherit a property and one sibling eventually “buys out” the other, giving them full ownership. The common thread in an interest buyout scenario is that the borrower of the new loan already has a partial interest in the property being financed.
Two Camps for HMDA Reporting of an Interest Buyout
The main HMDA question that many struggle with for interest buyouts is how to report the purpose of the transaction on the LAR. Generally, there are two schools of thought - or camps - as to how the purpose of an interest buyout should be reported.
The first camp chooses to report an interest buyout as a purchase while the second camp chooses to report the transaction as either a refinance or an “other” purpose loan.
Camp 1: HMDA Reporting an Interest Buyout as a Purchase
The first camp reports an interest buyout transaction as a purchase. The reasoning for this is that ownership is transferring from one person to another and, therefore, there is at least a partial purchase involved. The idea behind this is that an interest buyout results in a title change, which reflects a clear change in ownership.
Camp 2: HMDA Reporting an Interest Buyout as a Refi/Other Purpose
The second camp takes a different approach by reporting an interest buyout as either a refinance (cash-out refi or refi) or an other purpose. Basically, the thought behind this line of thinking is that the borrower already has ownership in the dwelling, so it is not possible for a person to purchase something they already own. As the reason of a purchase would not be used by this camp, the purpose would be one of the following:
A refinance - when an existing loan is satisfied and replaced with no cash-out
A cash-out refinance - when an existing loan to the same borrower is satisfied and replaced with cash out
An “other” purpose loan - such as a home that was previously free and clear or where the loan is paying off a loan to someone not on the new loan
HMDA Guidance for Interest Buyouts
The challenge in reporting the HMDA purpose for interest buyouts in the past was that HMDA guidance was completely silent. The prior rules, commentary, and Getting It Right guide did not say a thing in regards to reporting the purchase for an interest buyout. Therefore, the generally consensus was to just pick a camp (as described above) and be consistent in reporting all interest buyouts in the same way.
Fortunately for HMDA reporters, the 2015 final rule (effective 1/1/18) provided a bit of guidance on how to report an interest buyout, which I believe significantly helps give us support in choosing a camp. This guidance is found in the new commentary to Regulation C.
The commentary to a refinance specifically states: "the 'same borrower' undertakes both the existing and the new obligation(s) even if only one borrower is the same on both obligations." The example they give in the commentary to the definition of a refinance deals with two spouses divorcing where both spouses are on the prior loan and one is essentially buying out the equity of the other.
Choosing a Camp for Reporting the Purpose on an Interest Buyout
The bottom line in reporting the purpose for an interest buyout is that each financial institution is going to have to choose a “camp” on how they report these types of loans and be consistent in reporting them.
That said, I personally believe that one side holds a better argument than the other: reporting an interest buyout as a refinance or “other” purpose.
The reason I feel that the purpose of a purchase should not be used for an interest buyout is that reporting such a loan as a purchase would contradict the guidance on “the same borrower” found under the definition of a refinance. While I recognize there is nothing that clearly says "you can't report it as a purchase" or "you must report this as a purchase," it is my humble opinion that there is enough to tell us that you can't report this as a purchase because an equity buyout and a purchase are not the same thing.
Let me try to explain this in layman’s terms by breaking it down.
The commentary to a refinance specifically states: " the 'same borrower' undertakes both the existing and the new obligation(s) even if only one borrower is the same on both obligations." The example they give in the commentary to the definition of a refinance deals with two spouses divorcing where both spouses are on the prior loan and one is essentially buying out the equity of the other.
Now, if I was in the “purchase camp,” this commentary example would be called a purchase as ownership is changing hands - which is the main argument for calling an interest buyout a purchase. But it isn’t found under the definition of a purchase. The divorce buyout situation is found in the commentary to the definition of a refinance. In fact, the example in the commentary clearly states that it should be reported as a refinance:
“If both spouses are obligated on obligation X, but only one spouse is obligated on obligation Y, then obligation Y is a refinancing under § 1003.2(p), assuming the other requirements of § 1003.2(p) are met.”
My point here is that if the CFPB had intended for interest buyout situations to be reported as purchases, this buyout example would not be included in the commentary to a refinance because a purchase trumps a refinance in the HMDA hierarchy. In other words, we can’t report an interest buyout as a purchase because the CFPB indirectly told us it wasn’t a purchase by including the interest buyout example in the commentary to the definition of a refinance.
The way I see this working is that the HMDA purpose hierarchy keeps an interest buyout from ever being reported as a purchase. The hierarchy essentially works in a way that you can never go back up the order pole - you can only go down. You start with a purchase. If it can’t be reported as a purchase, you move on to a refi/cash-out refi. If it can’t be reported there, you move on to home improvement. If it can’t be reported there, you move all the way down to an “other” purpose.
The commentary example of a divorce buyout must follow the HMDA hierarchy. Since the CFPB stated that the divorce buyout could be reported as a refinance, they are also indirectly saying that it can’t be reported as a purchase - because if it could have been, it never would be in the refinance discussion because a purchase trumps a refinance in the hierarchy.
The bottom line in the way I see it is that an interest buyout will never be reported as a purchase as the borrower already has ownership in the dwelling. Therefore, the purpose test will start with a refinance (including cash-out) and work it’s way down the hierarchy until the purpose fits. For example, if the borrower is on an existing loan that is being paid off and is also getting cash back in the transaction to “buy out” their spouse, the loan would be reported as a cash-out refinance. If, however, the borrower’s spouse was the only one on the prior loan, this could not be considered a refinance and, therefore, would move down to the home improvement and then the “other” purpose test.
All of that said, each financial institution is going to have to choose which “camp” they are in for interest buyout situations. Once they choose a camp, they should document their reasoning and be consistent in reporting these situations on their HMDA LAR.
Regulatory Commentary for Reporting Interest Buyouts
For reference, the following commentary comes from the definition of a refinance:
“4. Same borrower. Section 1003.2(p) provides that, even if all of the other requirements of § 1003.2(p) are met, a closed-end mortgage loan or an open-end line of credit is not a refinancing unless the same borrower undertakes both the existing and the new obligation(s). Under § 1003.2(p), the “same borrower” undertakes both the existing and the new obligation(s) even if only one borrower is the same on both obligations. For example, assume that an existing closed-end mortgage loan (obligation X) is satisfied and replaced by a new closed-end mortgage loan (obligation Y). If borrowers A and B both are obligated on obligation X, and only borrower B is obligated on obligation Y, then obligation Y is a refinancing under § 1003.2(p), assuming the other requirements of § 1003.2(p) are met, because borrower B is obligated on both transactions. On the other hand, if only borrower A is obligated on obligation X, and only borrower B is obligated on obligation Y, then obligation Y is not a refinancing under Start Printed Page 66321§ 1003.2(p). For example, assume that two spouses are divorcing. If both spouses are obligated on obligation X, but only one spouse is obligated on obligation Y, then obligation Y is a refinancing under § 1003.2(p), assuming the other requirements of § 1003.2(p) are met. On the other hand, if only spouse A is obligated on obligation X, and only spouse B is obligated on obligation Y, then obligation Y is not a refinancing under § 1003.2(p). See § 1003.4(a)(3) and related commentary for guidance about how to report the loan purpose of such transactions, if they are not otherwise excluded under § 1003.3(c).”