TRID Purpose on Construction Loans

This free TRID training Compliance Clip reviews how to disclose the loan purpose for construction loans. This is a topic we continue to see issues on as it is actually a bit more complex than it needs to be. Adam breaks down examples of construction loans that are listed under TRID as a purchase, refinance, and construction loan.

The following is a transcript of this video:

This Compliance Clip focuses on disclosing the TRID purpose on construction loans.

This is a topic that has continued to give people a hard time. I've seen a number of continued errors from both mortgage processors and loan officers in regards to the loan purpose on construction loans, so that's why we are discussing this topic. The underlying reason for our choice of this topic and all the confusion on this topic is that guidance from the CFPB has not always been as clear as it could have been. In fact, before the implementation of TRID 1.0, there really wasn't any guidance for us in the original rule except for appendix D of Regulation Z, but that left a lot of questions unanswered.

Now, fast-forwarding a bit, before the implementation of TRID 2.0, the CFPB had a webinar in March of 2016 that outlined several things for construction loans.  Over time, those elements that were discussed in that March 2016 webinar have actually now been incorporated into TRID 2.0 both in the text and the commentary. In addition to this, the CFPB small entity compliance guide has been updated to reflect all of these changes.  So, all of the guidance I have listed so far is all of the guidance we have on completing TRID for construction loans.

Now, that is all of the guidance we have for construction loans under TRID, and specifically, that is all of the guidance we have for disclosing the purpose for construction loans.

First of all, to answer our question on how we disclose a purpose on construction loans, we need to recognize there are two disclosure options when you have a construction-permanent loan. You can either disclose that loan as a single, combined disclosure  - which includes both the construction phase and the permanent phase - or you can disclose it as two separate disclosures. In fact, how we disclose this, either as one or two transactions, could have an impact on your loan purpose to some degree.

Let's take a look at the loan purposes under TRID.

For all loans, not just construction loans but all loans, there is what we call a “waterfall.” The waterfall is basically a hierarchy on what purpose takes precedence over other purposes. Who is King on the waterfall? Who is on top of the pole? A purchase is on top. A purchase always trumps everything else. So if you have multiple purposes, where a loan is both a purchase and refinance and maybe even a home equity loan, the purchase is always going to take precedence over the other purposes.  We always start at the top of the waterfall - which is a purchase.

The way the purpose order works is that, after a purchase, we have a refinance, then a construction purpose and after that, of course, is the purpose of home equity.

Now for those of you who are HMDA reporters, I am sorry. It is terrible for you because the purposes under HMDA are completely different than that of TRID. So you need to forget HMDA for a minute because we are talking about TRID. For those of you who are not HMDA reporters, you have lucked out.

Moving on.  Let's talk about how purposes apply to construction loans.

For a purchase, when you have a purpose of a purchase on a construction loan, this is going to be when you have a consumer who intends to use the loan proceeds to also purchase property (i.e land) that is going to secure the loan.

For example, let's say my wife and I are in the market for a home. We did this several years ago in Fort Wayne, Indiana when we were looking at new subdivisions and we're looking to buy a plot of land from a builder who owned all of the plots in the subdivision we were interested in. Basically, there were a couple of different builders in Fort Wayne who tried to sell you a house - they owned all of the Lots, had done the development, and then we're selling the lots that were exclusive to their homes. In this case, if we were to purchase a home from one of these builders, then the loan would have been a purchase because we would have had a loan to buy both the lot and the construction process.

When we look at the refinance purpose, it gets a little more confusing because what we would have here is, say my wife and I were shopping and today we decided to buy a plot of land on a lake, but are not ready to build yet. We buy this plot of land with the intentions to eventually build, maybe in 15 or 20 years. Down the road when we go to build a new home - such as building in five years because we originally had a 20-year term loan on that land - what we are going to have to do is to pay off that land loan. So our new loan would pay off an existing loan and also give us money back to build our house and to do the construction. In that case, we would call the loan purpose a refinance because we would have both satisfied and replaced an existing loan on the land to the same borrower. That is an example of a refinance. When a consumer obtains a loan to refinance a property that they already own.

To clarify, if you are a bank that provides two separate disclosures, your initial disclosure -  it could be a refinance if you are refinancing land - your Loan Estimate for the end loan is always going to be a refinance because an end loan is going to be paying off the construction loan. Now I guess if there is a purchase involved in there for some reason, it would be a purchase. Otherwise it would always be a refinance because you are paying off that original loan.  That is the refinance purpose on construction loans. Basically, the permanent loan is almost always going to be a refinance.

Now for the construction purpose.

You're only going to have a construction purpose when it is not either a purchase or a refinance. This would be when a consumer owns the land free and clear. In that example I gave of my wife and I buying a lake property, let's say we did buy it, but we paid cash for the land. Then 5 years down the road, we own the home free and clear and we decide to build. At that point, and that point only - when the land is owned free and clear - the loan would be called a construction loan under TRID purposes.  We can only use the purpose of a construction loan under TRID when the home is owned free and clear.

The final purpose in the waterfall is home equity, but that is not going to really apply to construction loans because the purpose of construction will always trump the purpose of home equity, so we don't need to spend any time on it today.