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Thursday, October 19, 2017

Construction-Permanent Loan – Disclosing Increase in Payment

QUESTION
With respect to a construction-permanent loan, with respect to the Loan Estimate and Closing Disclosure, under “Loan Terms”, with respect to the monthly principal and interest payment, how should a creditor respond to the statement “Can this amount increase after closing"? 

ANSWER
If, during the construction period, interest is payable only on the amount advanced for the time it is outstanding, the creditor should disclose “YES” in response to the question “Can this amount increase after closing?”  

Discussion
Effective October 10, 2017, the Bureau adopted Amendment to Federal Mortgage Disclosure Requirements Under the Truth in Lending Act (the “Final Rule”).  [82 Fed Reg 37656]   A creditor may use the methods set forth in Regulation Z, Appendix D to estimate interest and make disclosures for construction loans if the actual schedule of advances is not known.   

The proposed rule initially addressed the “Can this amount increase after closing” disclosure in the context of a separately disclosed fixed rate construction loan. In the Section by Section analysis, the Bureau acknowledges that using those methods for the calculation of the periodic payments in a fixed-rate construction loan results in interest-only periodic payments that are equal in amount. 

The preamble of the proposed rule explained that “although the actual interest-only payments will increase over the term of the construction financing as the amounts advanced increase, because the methods provided by appendix D to estimate interest may be used to make disclosures, a technically correct and compliant answer to “Can this amount increase after closing?” is “NO.” 

The periodic payments for fixed-rate construction financing, as calculated under appendix D, do not increase but are equal.” The Bureau discussed creditor’s concerns over providing a “NO” answer as the disclosure may not reflect the actual increase in payments that will occur during the construction financing.  

Thus, the Bureau initially proposed adopting a comment to Appendix D which gave the creditor an option of answering “YES”, although a technically correct answer is “NO” and stated that the “proposed comment is consistent with informal guidance provided by the Bureau”.

Ultimately, the Bureau declined to adopt the proposed rule giving the creditor an option to answer either “YES” or “NO” to the question “Can this amount increase after closing?”. Rather, the Final Rule only permits a disclosure of “YES” in response to the question “Can this amount increase after closing?” in instances where there will be an increase in the periodic payment when the amounts or timing of advances is unknown at or before consummation and the Appendix D assumption that applies if interest is payable only on the amount advanced for the time it is outstanding is used to calculate the periodic payment.  The Bureau noted that this change addresses the concern that the disclosure should reflect the fact that the payments actually increase over the term of the construction financing, even though the amount of such increase is not known at or before consummation. 

With respect to separate disclosures for fixed rate construction loans, the Bureau stated that during the optional compliance period before October 1, 2018, a creditor may continue to disclose “NO” based on the informal guidance by the Bureau discussed above.

In an effort to provide further clarify and simplify the disclosures and their implementation, the Bureau stated that the scope of the new comments to Appendix D, is not limited to circumstances when separate disclosures are provided for fixed rate construction financing as they were in the proposed rule. 

The Bureau stated, “as a practical matter, if “YES” is the answer to “Can this amount increase after closing?” when separate disclosures are provided for either fixed-rate or adjustable-rate construction financing, “YES” will necessarily be the answer when a combined disclosure for that financing is provided.  This is generally the result whenever a combined disclosure is used because the interest-only payment of the construction financing increases to the principle and interest payment of the permanent financing. Comment app. D-7.v therefore applies to both separate construction disclosures and combined construction-permanent disclosures because, in either case, the § 1026.37(b)(6) disclosures would reflect the construction phase during which there may be an increase in the periodic payment.”
[Emphasis added.]

For Section by Section analysis, see 82 Fed. Reg. 37758-37760. The Amendment to Appendix D-7 is set forth below.

Amendment to Appendix D-7
iv. Increase in periodic payment. If the amounts or timing of advances is unknown at or before consummation and the appendix D assumption that applies if interest is payable only on the amount advanced for the time it is outstanding is used to calculate the periodic payment: 
A. A creditor discloses “YES” as the answer to “Can this amount increase after closing?” pursuant to § 1026.37(b)(6)(iii) whether the creditor provides separate construction disclosures or combined construction-permanent disclosures, even though calculation of the construction financing periodic payments using the assumptions in appendix D produces interest-only periodic payments that are equal in amount.
B. A creditor that discloses “YES” as the answer to “Can this amount increase after closing?” pursuant to § 1026.37(b)(6)(iii) may use months or years for the § 1026.37(b)(6)(iii) disclosures, consistent with comment 37(b)(6)-1.  For example, for a 10-month construction loan, the first § 1026.37(b)(6)(iii) disclosure bullet may disclose, “Adjusts every mo. starting in mo. 1” and the second § 1026.37(b)(6)(iii) disclosure bullet may disclose, “Can go as high as $[insert maximum possible periodic principal and interest payment] in year 1”.  The calculation of the maximum possible periodic principal and interest payment disclosed is based on the maximum principal balance that could be outstanding during the construction phase.  As part of the “First Change/Amount” disclosure in the “Adjustable Payment (AP) Table” pursuant to § 1026.37(i)(5)(i), the creditor may omit and leave blank the amount or range corresponding to the first periodic principal and interest payment that may change.  In such cases, the creditor must still disclose the timing of the first change, which is the number of the earliest possible payment (e.g., 1st payment) that may change under the terms of the legal obligation.  
C. When separate construction disclosures or the combined construction-permanent disclosures are provided for adjustable-rate construction financing, a creditor provides the § 1026.37(b)(6)(iii) disclosures reflecting changes that are due to changes in the interest rate and changes that are due to changes in the total amount advanced.  Such a creditor discloses “YES” as the answer to “Can this amount increase after closing?” pursuant  to § 1026.37(b)(6), because the initial periodic payment may increase based upon an increase in the interest rate in addition to a change based on the total amount advanced.  Such a creditor also discloses a reference to the adjustable payment table required by § 1026.37(i), disclosed as provided in comment app. D7.iv.B, because that disclosure reflects both a change due to a change in the total amount advanced, which is a change to the periodic principal and interest payment that is not based on an adjustment to the interest rate, as well as the fact that there are interest-only payments.  Such a creditor also includes a reference to the adjustable interest rate table required by § 1026.37(j) because that disclosure reflects a change due to a change in the interest rate.

Joyce Wilkins Pollison, Esq.
Director/Legal & Regulatory Compliance
Lenders Compliance Group