As is the case with new regulations, we are often left scratching our heads as to why a rule is done the way it is. For those of you that are HMDA reporters, I’m sure you can relate with the 2018 changes that are now upon us. In particular, one HMDA head scratcher is the new HMDA hierarchy for reporting the loan purpose.
Understanding the HMDA Hierarchy
In prior HMDA rules, the order for reporting the purpose of a loan – when you had multiple purposes – was first a purchase, then a home improvement loan, and finally a refinance. This hierarchy has been around for decades and the old rules made a big deal out of home improvement loan, even requiring the reporting of classified home improvement loans that were not secured by a dwelling. Yet today, the 2018 HMDA rules have an entirely new hierarchy as follows:
- Refi/cash-out refinance
- Home improvement
This new hierarchy is explained in the commentary to 1003.4(a)(3) as follows:
“Section 1003.4(a)(3) requires a financial institution to report the purpose of a covered loan or application. If a covered loan is a home purchase loan as well as a home improvement loan, a refinancing, or a cash-out refinancing, an institution complies with § 1003.4(a)(3) by reporting the loan as a home purchase loan. If a covered loan is a home improvement loan as well as a refinancing or cash-out refinancing, but the covered loan is not a home purchase loan, an institution complies with § 1003.4(a)(3) by reporting the covered loan as a refinancing or a cash-out refinancing, as appropriate. If a covered loan is a refinancing or cash-out refinancing as well as for another purpose, such as for the purpose of paying educational expenses, but the covered loan is not a home purchase loan, an institution complies with § 1003.4(a)(3) by reporting the covered loan as a refinancing or a cash-out refinancing, as appropriate. See comment 4(a)(3)-2. If a covered loan is a home improvement loan as well as for another purpose, but the covered loan is not a home purchase loan, a refinancing, or cash-out refinancing, an institution complies with § 1003.4(a)(3) by reporting the covered loan as a home improvement loan. See comment 2(i)-1.”
Why does a Refinance/Cash-Out Refinance Trump a Home Improvement Loan?
Now, with all of the prior emphasis on reporting home improvement loans, you might be scratching your head as to why the CFPB no longer seems to care about home improvement loans as they are placing a greater emphasis on refinancing/cash-out refinancings. Well, this wasn’t just an arbitrary decision.
The main reason for this change seems to be that the CFPB believes that knowing whether the loan was a refi or cash-out refi is more valuable than a purpose of home improvement. As credit offerings have evolved, over the years, the CFPB believes that data regarding home improvement loans is no longer as valuable as it was in the 1970’s when HMDA rules were first implements.
The CFPB explains this in the pre-amble to the final rule:
"The Bureau believes that this will make the cash-out refinancing and refinancing reporting categories more valuable by clearly identifying loans that are considered cash-out refinancings or refinancings whether or not they are for home improvement."
While this fairly general statement doesn’t seem to give us much insight on this decision, we can learn even more regarding this decision if we go back to the pre-amble to the 2014 HMDA proposal:
"The Bureau has received feedback indicating that the current requirement to identify whether a loan or application is for home improvement purposes is a substantial compliance burden. As discussed in part II.A above, the inability to obtain credit to repair and maintain homes was one of the major factors driving urban deterioration in the 1970s. As a result, Congress was particularly concerned about access to home improvement credit when HMDA was enacted. Home improvement loans were traditionally used for older properties, and community groups and public officials needed data on a neighborhood's ability to maintain the quality of existing housing stock. Issues in this subset of the market have remained over time, as some studies suggest that home improvement lending practices may be a concern in certain neighborhoods and for certain borrowers.
Although home improvement data was a central concern when HMDA was originally enacted, it may be the case that these data are no longer useful. While consumers routinely resorted to local banks for home improvement loans in the 1970s, after the widespread adoption of credit cards began in the 1980s consumers had alternative means of obtaining credit to repair or improve their homes. This trend may have accelerated during the 1980s and early 1990s, when home-equity lines of credit became an increasingly popular form of credit. In today's market, statistics suggest that HMDA provides the public with relatively little data about home improvement loans. For example, in 2012 home improvement loans comprised only approximately 4.4 percent of all HMDA records. Testimony provided during the Board HMDA Hearings supports the argument that home improvement loan data are of limited value. Thus, the consumer financial market may have evolved to the point where relatively few consumers use secured home improvement loans to repair, renovate, or otherwise improve their homes, and the data provided through HMDA may no longer be useful. The Bureau is concerned about this potential reduction in usefulness, considering that financial institutions frequently state that home improvement reporting is a substantial burden."
The 2014 pre-amble even expands on why cash-out refinancing data is valuable:
"The Bureau has received feedback indicating that requiring financial institutions to identify whether a loan or application is for a cash-out refinancing would improve the usefulness of the reported data. Several participants during the 2010 Board Hearings argued that cash-out refinancings should be separately identified in the HMDA data. Studies suggest that cash-out refinancings were commonly offered in the subprime market which, as discussed in part II.A above, was and remains a particular area of concern for many communities. Furthermore, public officials may find information on cash-out refinancings useful for developing programs intended to promote stable homeownership. Thus, requiring financial institutions to identify cash-out refinancings may make the HMDA data more useful.
New Times and a New HMDA Hierarchy
So, I guess that the bottom line here is that there really was a method to the madness. I understand that this change will be difficult for HMDA reporters to get over at first as the old hierarchy (where a home improvement loan trumped a refinance) was a pure to HMDA as anything was. But times have changed and so have the HMDA reporting requirements.
Good luck, and happy HMDA reporting.