Recently, we have seen an uptick in inquiries from some of our clients, colleagues, and requests from media, regarding disclosures for construction to permanent loans. In the inquiries, the specific facts dictated our responses. However, we can point out that Regulation Z permits a creditor to disclose the construction phase and permanent phase of a residential construction loan either as one transaction or as separate transactions. This aspect of the disclosure process seems to cause some confusion, so I would like to dispel with some of the more salient concerns expressed by lenders involved in originating these loan products.
What is the basic structure of construction to permanent mortgage loan transactions?
For the most part, they have two distinct phases that make them similar to two separate transactions. First, the construction period usually involves several disbursements of funds, at times and in amounts often unknown at the beginning of the period. The consumer generally pays only accrued interest until construction is completed. Second, unless the obligation is paid at the time the construction is completed, the loan converts to permanent financing in which the loan amount is amortized just as in a standard mortgage transaction.
So far, so good!
But on July 7, 2017, the CFPB amended Regulation Z to clarify that, for construction-permanent financing transactions, the creditor is required to disclose a Loan Estimate only for the transaction for which it received an application. So, for instance, if the creditor receives an application for construction financing only, the creditor is only required to provide a Loan Estimate for the construction transaction. If the creditor receives applications for separate construction and permanent financing transactions at the same time, then the creditor must provide the Loan Estimate disclosures as either a combined disclosure or separately for each phase of the transaction.
Therefore, the special disclosure rule permits the creditor to give either (A) one combined disclosure for both the construction financing and the permanent financing or (B) a separate set of disclosures for the two phases. The rule is applicable whether the consumer was initially obligated to accept construction only or for both construction and permanent financing. But, if the consumer is obligated on both phases and the creditor chooses to give two sets of disclosures, both sets must be given to the consumer initially, because both transactions would be consummated at that time.
Another issue that seems to perplex construction-permanent loan originators is the allocation of fees.
The following outline may help to clarify the fee allocation structure involved in this loan product. When using this special disclosure rule to disclose as multiple transactions, must allocate fees and charges between the construction and permanent phases of the transaction.
Here is a set of basic fee allocation structures:
- If a creditor discloses a construction-permanent loan as multiple transactions, the creditor must allocate to the construction transaction finance charges and points and fees that would not be imposed but for the construction financing. An example would be where a creditor must include inspection and handling fees for the staged disbursement of construction loan proceeds in the disclosures for the construction phase (viz., not in the disclosures for the permanent phase).
- If a creditor charges separate amounts for finance charges and points and fees for the construction phase and the permanent phase, the creditor must allocate the amounts to the phase for which they are charged.
- If a creditor charges an origination fee for construction financing only but charges a higher origination fee for construction-permanent financing, the creditor must allocate the difference between the two to the permanent phase.
- The creditor must allocate to the permanent financing all other finance charges and points and fees.
- The creditor may allocate in any manner it chooses any fees and charges not used to compute the finance charge or points and fees. Thus, a creditor may allocate in any manner it chooses a reasonable appraisal fee paid to an independent, third-party appraiser.
There is also this important nuance: if the construction phase consists of a series of advances under an agreement to extend credit up to a certain amount, Regulation Z provides some disclosure flexibility. In this particular case, the creditor may disclose the construction phase as one or more than one transaction – so, it may disclose each advance as a separate transaction or all of the advances as one transaction – and also disclose the permanent financing as a separate transaction.
Preparing these disclosures is a complicated task, suitable only for compliance professionals. If you need assistance regarding construction to permanent finance transactions, with respect to reviewing your policies, procedures, disclosures, and loan flow process, please contact or email us. There is no initial consultation fee. We're glad to help!