While the revised HMDA rules have been in place for just over a year now, we are finding that a number of financial institutions are still struggling with a few of the quirks of the new rules. Specifically, one question we have seen a few times in recent months is this:
Is a spec home HMDA reportable?
Background on HMDA Spec Loan Requirements
To fully understand the answer to this question, we need to first discuss how the changes to the 2018 HMDA rules relate to this topic. You see, under the old HMDA rules, spec homes were excluded from HMDA reporting under the “temporary financing” exemption. Temporary financing, in the past, automatically excluded construction and bridge loans by definition. In other words, the way the temporary financing exception was written, construction and bridge loans were included in the definition of temporary financing, and thus exempt.
HMDA Reporting Changes Affecting Spec Loans
Confusion came with the new rules as the 2018 version of HMDA included a change of language in the definition of “temporary financing.” Basically, the 2018 version of HMDA initially said that, in order to be temporary financing (and thus exempt from HMDA reporting), a loan had to be designed to be replaced by additional financing at a later time. In other words, the language that was found in the old rule that specifically excluded construction and bridge loans was removed from the new definition of temporary financing.
This change ultimately meant that, since a loan to construct a dwelling for sale (spec home) was designed to be paid off from sale proceeds rather than by additional financing to the same borrower (which is the new definition of temporary financing), then the loan would be HMDA reportable. This change was interesting, as loans to construct a dwelling for sale were not previously HMDA reportable and did not appear to have a benefit to HMDA data as these loans don’t really help to serve the housing needs of the community, which is the underlying purpose of HMDA reporting.
Fortunately, the CFPB realized this unintended change to HMDA reporting and made a change to the rules with the 2017 amendments. Specifically, the CFPB added a new comment to the commentary (comment 2 to 1003.3(c)(3) to explain that loans to construct a dwelling for sale are included in the temporary financing exemption, and thus, are not HMDA reportable.
From the commentary:
“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.”
Confusion on HMDA Applicability for Spec Loans
While new comment 2 may seem simple on the surface, it has caused confusion for some as not all builder loans are included in the temporary financing exemption. For example, comment 1003.3(c)(3)(1)(v) states that short term investor loans that are used to renovate a home for sale are, in fact, HMDA reportable.
“v. Lender A originates a loan with a nine-month term to enable an investor to purchase a home, renovate it, and re-sell it before the term expires. 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. Such a transaction is not temporary financing under § 1003.3(c)(3) merely because its term is short.
The difference between 1003.3(c)(3)(1)(v) and 1003.3(c)(3)(2) can be confusing as both examples are business purpose loans to contractors/builders. That said, it is important to understand we have to distinguish between 1) "short term" loans (which are reportable) and 2) loans "exclusively to construct a dwelling for sale" (which are not reportable) as two different situations.
To explain, the example in 3(c)(3)(1)(v) provides an illustration of a loan that may have a "short term", but is not considered temporary financing because the example explains that the purpose is to “renovate” a home rather than to “construct a dwelling for sale. In other words, the key difference between comment 3(c)(3)(1)(v) (which is reportable) is that the example is to “renovate” an existing home while comment 3(c)(3)(2) provides an example to “construct” a (new) home for sale.
The CBPB actually explained this in the 2017 proposed rule:
"The Bureau believes that construction-only loans or lines of credit extended to a person exclusively to construct a dwelling for sale are distinguishable from short-term transactions that provide valuable HMDA data and are not excluded as temporary financing under § 1003.3(c)(3). The Bureau recognizes that in the Final Rule, it explained that the temporary financing exclusion does not depend on the loan purpose, but rather turns on whether the loan is or is not designed to be replaced by longer-term financing at a later time. The Bureau did not intend to expand Regulation C's transactional coverage to include construction-only loans or lines of credit to a person exclusively to construct a dwelling for sale, and expressly stated in the Final Rule that the commentary to § 1003.3(c)(3) “will help to ensure reporting of short-term transactions that function as permanent financing (e.g., a loan with a nine-month term to enable an investor to purchase a home, renovate, and re-sell it before the term expires).” The Bureau also explained in the Final Rule that it is important for HMDA purposes to know how often and under what circumstances financing is granted to investors to purchase a dwelling and sell it for occupancy before the term of the loan expires.
In contrast to construction-only loans or lines of credit to construct a dwelling for sale, the Bureau believes these short-term home improvement or home purchase loans may pose particular risks to communities and to consumers. The Bureau believes that reporting such loans will provide information to help public officials and public interest organizations identify risks to consumers and to local markets and enable them to target programs to assist vulnerable consumers. For example, with the information reported from these loans, public officials may identify the property value relied on for a loan to an investor to purchase a home, renovate it, and re-sell it as compared to the property value relied on for a buyer's permanent financing obtained to purchase that home. The Bureau believes such information would provide significant value for HMDA's purposes. Accordingly, the Bureau continues to believe that the guidance provided in comment 3(c)(3)-1, taken together with the proposed clarifications, will effectively serve HMDA's purposes. At the same time, for the reasons explained above, the Bureau believes it is appropriate to clarify its intent to classify construction-only loans or lines of credit to a person exclusively to construct a dwelling for sale as temporary financing, even where such loans or lines of credit are not designed to be replaced by separate permanent financing to the same borrower."
The bottom line is that not all builder loan are exempt from HMDA reporting. While a loan to construct a new dwelling for sale is exempt, a loan to “renovate” an existing dwelling for sale would be HMDA reportable.
The April 2017 HMDA proposal can be found here.