HMDA – The Temporary Financing Exclusion

Among the various alphabet soup of state and federal laws and regulations relating to mortgage origination and loan servicing, one that had previously escaped the notice of many California private lenders is the Home Mortgage Disclosure Act, or HMDA. In effect since 1975, HMDA requires decisionmakers on residential loan applications to report a variety of application, loan and
borrower data annually to the federal government. Due to the rules relating to ‘covered’ lenders, most private lenders have
not been covered under the law. However, major changes to HMDA, initiated under the Dodd-Frank Act and further expanded
on by the Consumer Financial Protection Bureau (CFPB) under its rule-making authority, will be in effect beginning in 2018, and these changes will have a significant impact on private lenders across the country. Thresholds for covered lenders have been lowered and many smaller lenders, who previously were not covered under HMDA, now will be.

In recognition of this major change to private lenders, CMA presented two programs on HMDA, the first at our Winter 2017 Seminar, and a follow-up at our Spring 2017 Seminar. Some questions arose at the Spring Seminar as to what constitutes ‘temporary’ financing under HMDA. Addressing this issue is important, as applications and loans for temporary
financing may be excluded from HMDA reporting requirements. As most private lenders make short-term loans to their
borrowers, having a clear definition of temporary financing will help our members better understand and prepare for these regulatory changes.

Before delving into this particular issue, a brief overview of the new HMDA requirements is warranted.1 The original
purpose of HMDA was to a) assist regulators in determining if financial institutions were serving the housing and credit access
needs of their communities; b) assist in the distribution of public and private sector investments in communities where it’s
most needed; and c) provide useful data to the public in understanding the scope of mortgage lending across the nation. Over time, both the scope and purpose of HMDA have grown. In addition to its original purposes, today HMDA data provides both federal and state regulators, as well as community groups, with detailed information about the types of applications taken and loans made by lenders, the racial and ethnic make-up of applicants, and the eventual disposition of the loan application. The CFPB, in particular, uses HMDA data to search for possible Fair Lending violations by lenders. Community groups often use the data to support claims of lender discrimination in various minority and economically disadvantaged communities.
Although somewhat benign at its inception, HMDA has become an important tool for government regulators and community groups to identify potential ‘bad actors’ in the mortgage lending community.

Who Must Report?
Under the new regulation, HMDA reporters are ‘for profit ’ lending institutions (including individuals) who make a credit
decision and who

  • Have a home or branch office in a Metropolitan Statistical Area (MSA), and
  • Meet at least one of the following criteria:
    º In both of the two preceding calendar years, originated at least 25 closed-end mortgage loans, or
    º In both of the two preceding calendar years, originated at least
    100 open-end lines of credit

Examples of private lending ‘financial institutions’ are:

  • Mortgage brokers (who make the
    credit decision)
  • Mortgage lenders
  • Mortgage pools funding the loan
  • Mortgage investors (who make the credit decision)

Making The Credit Decision
A thorough discussion of who does or doesn’t make the credit decision is beyond both the scope and space requirements of
this article. Some mention of this is useful, however as it can represent perhaps an important exemption under HMDA for
a small number of private lenders. An excellent reference source for more detail on this part of HMDA are the materials
provided at the two CMA seminars mentioned above.

The person or institution which makes the credit decision on an application is the party responsible for reporting under HMDA. For some private lenders, this is easy to ascertain, and for others it can be more difficult. Who makes the credit decision can vary depending upon the private lender’s business model. Those making loans using their own finds, through a line of credit or through a broker-managed fund can most likely be characterized as having made the credit decision. Those who broker loans to individual investors may or may not be the party who makes the decision. Some brokers send loans to their private investors to make the credit decision. Other brokers who fund using private investors, however, make the
credit decision themselves. A broker may consider several points in resolving the credit decision issue. Consider if the broker
does any of the following:

• Negotiates the terms of the loan before presenting it to the investor
• Approves a loan request before offering it to any investors
• Denies a loan request without offering it to any investors
• Advertises as a lender
• Issues loan approvals or credit denials
• Discloses the loan with the broker’s name as the lender
• Funds a portion of the loan
• Communicates a positive or negative credit decision before sending the loan to the investor

It may be necessary for the broker to consult legal counsel knowledgeable in HMDA before coming to a final conclusion on this point.

Covered Loans and Applications
Loan applications covered under this regulation are for closed-end loans or open-end lines of credit secured by a lien on a ‘dwelling.’ Under 12 CFR 1003.2 &3, a dwelling is a residential structure, whether or not attached to real property. The term
includes, but is not limited to

• A detached home
• An individual condominium or cooperative unit
• A manufactured or factory-built home
• A multifamily residential structure or community
• A mixed-use property where 50% or more of the structure is residential

Most consumer and business purpose loans are covered under HMDA. There is a very narrow definition of business purpose
loans which are exempt from HMDA reporting requirements. This exemption will be discussed later. The three primary
loan purposes which are covered under HMDA are home purchase loans, home improvement loans and refinancings.

Home Purchase Loan
Any open-end line of credit or closed-end loan application for the purchase of a dwelling. The purchase application is covered regardless of whether the loan will be for a consumer or nonconsumer purpose, or whether the property will be a primary residence or for investment purposes. An application is considered to be for a home purchase even if the property to be secured by the loan is not the property being acquired. In other words, if a borrower requests a cash out refinance on Property A in order to purchase Property B, the loan request on Property A is considered to be for a home purchase.

Home Improvement Loan
A home improvement loan is one where the loan proceeds, in whole or in part, will be used to repair, rehabilitate, remodel or
improve a dwelling, or the real property on which the dwelling is located. As with the home purchase loan, the home improvement application is reportable under HMDA regardless of whether the loan will be for a consumer or nonconsumer
purpose, or whether the property will be a primary residence or for investment purposes.

Refinancing
A refinancing is a loan application in which a new dwelling-secured obligation replaces an existing dwelling-secured obligation
by the same borrower. In other words, a refinancing is a loan where a new loan will pay off an existing loan on the property.
Conversely, a cash out loan which does not pay off existing debt on the property is not a refinancing. Such a cash out loan
may still be reportable under HMDA as either a home purchase loan or a home improvement loan, depending upon the loan purpose. However, if the loan proceeds will be used for a purpose other than a home purchase, home improvement or for the repayment of debt on the property, then the application would not be reportable under HMDA rules.

Exemptions from HMDA
Certain loans are expressly exempt from HMDA:

• Business purpose loans –
But only those loans that are for a purpose other than the purchase, refinancing or improvement of a dwelling. In other words, if the loan is to provide funds for the borrower’s widget manufacturing business, then it would be excluded from HMDA
reporting requirements. But a loan to acquire, refinance or improve a dwelling, even if for a business purpose or profit motive, is covered under HMDA and must be reported

Additional exemptions under HMDA include

• Loans not secured by real estate
• Loans secured by unimproved land
• Temporary financing (discussed further below)
• Purchase of an interest in a pool of mortgages
• Purchase solely of the right to service loans
• Purchase of loans as part of a merger or acquisition
• Applications for less than $500
• Purchase of a partial interest in a loan
• Loans primarily for agricultural purposes

Temporary Financing
Turning to the topic of temporary financing, there has been some confusion pertaining to this issue. To provide additional insight into the temporary financing question, among other things, the CFPB issued a clarification document in April, 2017 containing the following:

Paragraph 3(c)(3).
1. Temporary financing. Section 1003.3(c) (3) provides that closed-end mortgage loans or open-end lines of credit obtained
for temporary financing are excluded transactions. Except as provided in comment 3(c)(3)-2, a loan or line of credit is considered temporary financing and excluded under § 1003.3(c)(3) if the loan or line of credit is designed to be replaced by separate permanent financing extended to the same borrower at a later time. [emphasis added]

Essentially, under the rule, a temporary financing is one that is intended to be replaced by permanent financing. Unfortunately, this explanation can still be a bit murky to lenders. To further clarify its meaning, the CFPB has provided the following examples related to temporary financing:

Example 1 – Fix and Flip Loan:
(from page 709 of the original October 2015 rule)
Lender A originates a loan with a nine-month term to enable an investor to purchase a home, renovate it, and resell
it before the term expires. Under § 1003.3(c)(3), the loan is not designed to be replaced by permanent financing and therefore the temporary financing exclusion does not apply. Such a transaction is not temporary financing under § 1003.3(c)(3) merely because its term is short.

This example illustrates the classic ‘fix and flip’ loan and confirms that these loans do not fall under the temporary financing
exclusion and are therefore reportable under HMDA.

Example 2 – Bridge Loan:
i. Lender A extends credit in the form of a bridge or swing loan to finance a borrower’s down payment on a home purchase. The borrower pays off the bridge or swing loan with funds from the sale of his or her existing home and obtains permanent financing for his or her new home from Lender A. The bridge or swing loan is excluded as temporary financing under § 1003.3(c)(3).

Be cautious in interpreting this example.
On its face, it would seem to provide the temporary financing exclusion on bridge loans for the purchase of a new home. However, a careful reading of the example can lead to the conclusion that only bridge loans where the borrower intends to obtain permanent financing on their acquisition home after the sale of their exit home would be exempt. The example specifically mentions a loan for the down payment of the new home. It also includes the statement that permanent financing will be obtained on the new home.

There is a bridge loan situation that doesn’t fit with the facts of the example above and must be considered by all lenders making these loans. Many bridge loans are provided to borrowers who are older and wish to ‘buy down’ from their larger
family homes. These borrowers often own their homes free and clear of mortgage debt and they are buying a smaller, less
expensive replacement home. When making a bridge loan in this situation the lender needs to consider the borrower’s
financing situation when the bridge loan is paid off. If the sale of the exit home will result in the full payoff of the bridge
loan, leaving the acquisition home free and clear, then no permanent financing is anticipated to be needed. Without the
prospect of permanent financing replacing the bridge loan, the temporary financing exclusion would not apply.

The following four examples all have to do with construction loans.
Example 3 – Homeowner Construction Loan:
ii. Lender A extends credit to a borrower to finance construction of a dwelling. The borrower will obtain a new extension of
credit for permanent financing for the dwelling, either from Lender A or from another lender, and either through a refinancing of the initial construction loan or a separate loan. The initial construction loan is excluded as temporary financing under § 1003.3(c)(3).

Example 4 – Homeowner Construction Loan with Renewals:
iii. Assume the same scenario as in comment 3(c)(3)-1.ii, except that the initial construction loan is, or may be, renewed
one or more times before the separate permanent financing is obtained. The initial construction loan, including any
renewal thereof, is excluded as temporary financing under § 1003.3(c)(3).

Example 5 – Homeowner Construction to Perm Loan:
iv. Lender A extends credit to finance construction of a dwelling. The loan automatically will convert to permanent financing extended to the same borrower with Lender A once the construction phase is complete. Under § 1003.3(c)(3), the loan
is not designed to be replaced by separate permanent financing extended to the same borrower and therefore the temporary
financing exclusion does not apply. See also comment 2(j)-3.

Example 6 – Speculative Construction Loan:
2. Loan or line of credit to construct a dwelling for sale. A construction-only loan or line of credit is considered temporary financing and excluded under § 1003.3(c)(3) if the loan or line of credit is extended to a person exclusively to construct a dwelling for sale. See comment 3(c)(3)-1.ii through .iv for examples of the reporting requirement for construction loans that are not extended to a person exclusively to construct a dwelling for sale.

As demonstrated above, a construction loan may or may not be considered a temporary financing under HMDA. Construction loans that are excluded from HMDA reporting requirements are a) loans to homeowners that will be replaced with permanent financing through a refinance of the construction loan when the home is completed (Examples 3 and 4), and b) speculative construction loans that will be paid off through the sale of the property (Example 6). A construction to perm loan (Example 5) is not afforded the temporary financing exclusion and is therefore reportable. It is interesting to note that the CFPB specifically includes speculative ground up construction loans in its temporary financing exclusion, but not the similarly speculative fix and flip loan.

Next Steps
Of course, understanding a regulation and how it applies to a broker’s operation is merely the first step in the compliance
process. Moving forward a private lender may want to do the following:

• Consult competent legal counsel well versed in HMDA to discuss your business plan and lending practices. Make sure you understand who is responsible for the reporting requirement under your business model.
• Inquire about the status of HMDA compliance with your loan origination software (LOS) representative. This regulation represents a big change for most software providers who cater to  the private lending community. There are a lot of data points that will need to be added to origination software programs that were not originally designed to collect them.  Ask your LOS provider when they will be ready, and when you can demo their product. Ideally, your LOS will be ready to demo by early Fall for a January 2018 roll-out.
• Ask your LOS provider if they will offer integration with software programs that will encrypt the data and deliver it to the CFPB. Traditionally the LOS has been the mechanism for inputting the data (the data gatherer if you will), and an additional software program is needed to encrypt the data and deliver it to the appropriate regulatory agency. If the LOS can’t integrate the data with this second software program, then it won’t be possible to deliver the report to the CFPB. Expect to be charged an annual fee for the integrated software as you will be gaining access to an additional software program.
• Ask your LOS provider if they will offer integration with software programs that will encrypt the data and deliver it to the CFPB. Traditionally the LOS has been the mechanism for inputting the data (the data gatherer if you will), and an additional software program is needed to encrypt the data and deliver it to the appropriate regulatory agency. If the LOS can’t integrate the data with this second software program, then it won’t be possible to deliver the report to the CFPB. Expect to be charged an annual fee for the integrated software as you will be gaining access to an additional software program.
• Another very helpful tool within the LOS is loan level data verification. It is not unusual, and actually quite common, for there to be data errors within a file. Various fields may have been missed when keying in data. Addresses can be mistyped and zip
codes may be incorrect. The GMI (Government Monitoring Information) section, which collects borrower race, ethnicity and gender data, is one particularly prone to errors. It is far easier to check for errors at the time a loan is being processed, rather than waiting until the annual HMDA report is compiled. If errors within a loan file are not discovered until ten months after the loan closed or was denied, it can be quite cumbersome to have to retrieve the loan file and research and correct the data. An error check within the LOS will save hours of time when preparing the HMDA report at the end of the year.
• Seek out software providers who provide the encryption and delivery service independently of an LOS. Some, such as QuestSoft (www.questsoft.com) have programs that allow you to key the data directly into their system, providing an all-in-one
service without the need of an LOS. This could prove extremely useful for those who may be processing their loans manually. It can also be helpful if your LOS provider is not quite ready by January of next year. Ideally, however, programs such as those provided by QuestSoft will be available through an integration with your LOS. Integration between the two programs will avoid duplicate data entry as the data keyed into the LOS passes seamlessly into the encryption software.

One final suggestion. Take a look at your HMDA report results well before submitting them by the 2019 filing deadline. As noted in the beginning of this article, government regulators and the public at large have a keen interest in these reports. The results can appear to erroneously reflect unethical and discriminatory practices for even the most fair and unbiased of lenders. It is wise for a broker or lender to know what the data shows before the report is filed or made available to the public.

Endnotes
1 This discussion is meant only to provide a summary of the regulation, and is not intended to provide in depth analysis of the regulation or its applicability to private lenders.

Lori Randich manages the Loan Production Department as Vice President of Redwood Mortgage Corp. She is a member of the
National Association of Mortgage Brokers (“NAMB”), the California Mortgage Bankers Association (“CMBA”), the California
Association of Mortgage Professionals (“CAMP”) and the California Mortgage Association (“CMA”). Lori currently serves
on the board of directors of CMA and chairs its Education Committee.