VIDEO: TRID Purpose for Construction Loans
In this Compliance Clip (video), Adam talks about the loan purpose on construction loans and how it is treated on the Loan Estimate and the Closing Disclosure. Construction loans seem to be a challenge especially when it comes to loan purpose but it shouldn't be that difficult. Watch as Adam explains the TRID purpose “waterfall”.
Video Transcript
The following is a transcript of this video:
TRID Purpose for Construction Loans
This Compliance Clip is going to talk about the TRID purpose for construction loans. Construction loans seem to be a challenge especially when it comes to loan purpose. Construction loans are a challenge all around. There's just so much to them. They can be complicated. There's unique things that happen, but when it comes to the loan purpose, it shouldn't be that difficult. I have seen recently where there has been some confusion still related to the loan purpose on construction loans. So I wanted to do a short Compliance Clip to talk about that.
Of course, our Compliance Clips, we release about one a week, I like to call it our weekly medicine for compliance. A little tidbit of information to keep us apprised of what's going on in compliance and refreshing our memories. Let's dive into this Compliance Clip.
If we're going to look at the loan purpose, there's some guidance we have to look at, specifically we're going to look at a number of things. Let's look at appendix D of Regulation Z. We can look at the March 2016 CFPB webinar on construction loans. We can look at TRID 2.0, the texts and the commentary. Quite a few things that we can look at. What I'm going to do is just summarize this for you, kind of give you an overview of how this works. Of course, there's information in the Small Entity Compliance Guide as well.
Disclosure Options
There are two disclosure options for construction/permanent loans. You can either do a single disclosure or two different disclosures for the construction phase and the permanent phase. Generally, I'm going to assume in this video, we're just doing a single combined disclosure. You'll see at one point where I talk about if you do two disclosures, if you’re a bank that does two disclosures, then there's something that you can pay attention to down the road, and I'll point that out when we get to it.
Those are the two options. The purpose may vary based on whether the disclosures are combined or separate, but again, for the most part, let's focus on just being a single disclosure.
TRID Purpose “Waterfall”
The TRID purpose waterfall is this. It starts with a purchase. This is the hierarchy. If you have any of these things, the top one overrides everything else. First we have a purchase, then we have a refinance, a construction, and then home equity. So that's our waterfall for our TRID purpose. If you had both a purchase and refinance, we're going to call it a purchase on the loan estimate and the closing disclosure. If we have purchase, refinance and construction loan, we still call it a purchase. But if we don't have a purchase, we just have a refinance and construction loan, refinance trumps everything else. So that's how the waterfall works is you start from the highest top and work your way down. That's what they're talking about there.
Of course, for those of you who are HMDA banks, it's very important to understand there is a difference on this loan purpose hierarchy when it comes to TRID and the loan estimate and the closing disclosure, because when we look at HMDA, the purposes are completely different. This is very confusing and complicated for lenders and I completely understand that. But what we're talking about in this video is the waterfall for your loan estimate and your closing disclosure and how you identify what the loan purposes on the LE and on the CD. For HMDA, the reporting may and probably will be different. That's completely different, and if you’re a HMDA bank, you just have to understand there's a difference in the loan purposes and that's just what we have to do when we're HMDA reporters. If you're not under HMDA reporter, you can just say, hallelujah, praise the Lord, whatever you want to and say, this is wonderful, we get to avoid HMDA as it is a pain in the whatever. Just keep in mind, what we’re talking about here is the TRID purpose for your loan estimate and your closing disclosure.
Purchase Purpose
The purchase purpose, this is when a consumer intends to use a loan and the loan proceeds to purchase property. In other words, the land that's going to secure the loan in addition to financing the construction loan. So if they're going to be purchasing the land and building the loan, all in one loan, that's what they're using the funds for, purchasing the land and building the house, then that's going to be considered a purchase. They’re purchasing the land. That's kind of the key in all of this.
Refinance Purpose
As far as a refinance, when a consumer intends to use a loan to refinance property, otherwise the land that they already own, therefore this would be considered a refinance. Of course, in order to be a refinance, the new loan must satisfy and replace an existing loan secured by the real property. What we have is maybe we have an instance where a customer has purchased land with an initial loan then waited a couple of years to build, get their ducks in a row, whatever the case is. Then now they're doing a construction loan to build their home. What they're doing is paying off that original land only loan.So they're paying off that loan, which is really a refinance to now build their home. What happens in this situation is you have a refinance because we're satisfying and replacing that existing loan to the same borrower that's secured by the same property. That would be considered a refinance. They're not purchasing the property, they already own it through a loan. They already have it, so now it's not a purchase. It falls down the waterfall to a refinance. That's the next part.
If you have two separate disclosures, keep in mind that the permanent phase, your permanent phase disclosures, you're going to call that a refinance because you had your initial phase, so you would call that a refinance in the permanent phase as well.
Construction Purpose
Moving on to the construction purpose, that's the third one. We have purchase, refinance and now construction. This is when a consumer intends to use a loan to finance construction on land they already own free and clear. Instead of refinancing land that they had through a loan, maybe what they did is they purchased land through cash, or they had a loan that they paid off, but now it's owned free and clear. They're not purchasing land and they're not refinancing because there's no loan to pay off. So they own the land free and clear. We don't have a purchase. We don't have a refinance. What we have on the waterfall is a construction loan. That's the next line down. So if the land is owned free and clear, we're going to call this a construction purpose. That's what this would be.
If it does not meet the definition of a purchase or refinance, it does of course, fall into construction.
CFPB’s March 2016 Webinar
To explain this a little bit in a different way, let's look at the transcript from the CFPB’s March 2016 webinar where they talked about construction loans and loan purposes for construction loans. Here's what they say, “To illustrate the use of the waterfall, if the loan meets the definition of purchase because the consumer intends to use the credit to purchase the property that will secure the loan, the creditor must disclose the purpose as purchase even if the loan also meets any other definitions appearing later in the waterfall.” So they're saying start from the top down. If it's a purchase and a refinance and a construction, you call it a purchase because that's at the top of the waterfall. That's what they're saying there.
They go on and say this about a refinance. They say, “A creditor must disclose the purpose as refinance if the consumer intends to use the credit to construct a dwelling on real property that the consumer already owns and to satisfy an existing loan secured by that real property.” So they bought that property with a loan. You're now doing a new loan to build a home, but you're paying off satisfying and replacing that initial loan. You're rolling that into the new loan because the initial loan was a land only loan. Now we have a construction loan so now we have to refinance a construction and this is considered a refinance. It's what they're saying there.
Finally, they go on and give us an example of construction. They say, “If the credit will be used to finance the initial construction of a dwelling on the property and will not be used for any purchase or refinance purpose, the creditor must disclose the purpose as construction. This is the case where they own that land free and clear. There's no purchase because they already own the land. There's no refinance because there's no loan on the initial land that we're rolling into the new loan. Therefore the purpose would be construction. That is the construction loan purpose and how we treat this in the loan estimate and the closing disclosure.
That's all I have for you in this Compliance Clip.