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State of
Department of
professional and financial regulation
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Bureau of Financial Institutions
36 state house station (207) 624-8570 (207) 624-8590 (FAX) Lloyd P. LaFountain III Superintendent |
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Bureau of Consumer Credit Protection
35 state house station (207) 624-8527 (207) 582-7699 (FAX) William N. Lund Superintendent |
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April
25, 2008
Joint Advisory Ruling #115
Re: Treatment
of Construction to Permanent Loans
Dear:
You
have sought guidance regarding the proper treatment of
construction-to-permanent mortgage loans in relation to the definition of a
“subprime mortgage loan” as defined in Title
9-A § 8-103 sub-§1-A(BB). Specifically,
you have asked whether a construction-to-permanent mortgage loan is a subprime
mortgage loan, given the terms which are summarized below.
The
lender holds a single closing at which the borrower agrees to the following:
·
Payment
of interest only on funds disbursed during the construction phase which phase
usually lasts no more than one year. Interest is only paid on the funds actually disbursed
during this phase;
·
At the end of the
construction phase, the borrower’s “balance owed” is rolled into the
“permanent” loan product selected by the borrower pursuant to a loan
modification agreement which is signed by the borrower at this time.
You
indicate that, for some of these loans, the terms for the construction and
permanent phases will all be agreed to at the outset, prior to
construction. In other cases, you state
that the loan will be subject to a modification agreement entered into at the
end of the construction phase, pursuant to which the terms of the permanent
phase of the loan will be agreed.
Specifically, your membership seeks clarification to determine if the construction phase of the loan makes it a subprime mortgage loan due to the fact that this phase requires the consumer to pay interest only, thereby deferring payment of principal. As you are aware, a subprime mortgage loan is defined, in part, as a “nontraditional” mortgage which allows the borrower to defer repayment of principal or interest.
Letter to
Re: Treatment of Construction to Permanent Loans
April 25, 2008
Page Two
In
your letter dated April 4th, 2008, you argue, first, that such loans
should not be considered “residential mortgage loans” based on the fact that,
under Federal Regulation Z, adopted in relevant part by the Bureaus as Regulation
Z-2, if a dwelling will become the principal dwelling upon completion of
construction, that dwelling is a “principal” dwelling, but only for specific
provisions of Regulation Z.
You
argue alternatively that, even though these loans may be residential mortgage
loans, they do not qualify as “subprime mortgage loans” because they are not
“non-traditional” loans as described in the Interagency Guidance on
Nontraditional Mortgage Product Risks, issued in 2006.
In
support of your argument, you cite various references in the Interagency
Guidance which, you assert, support your view that construction-to-permanent
mortgage loans are not contemplated as “nontraditional” loans in the
Interagency Guidance, despite their interest-only attribute.
Bureaus’ Response
(a) Are such loans residential
mortgage loans?
With
respect to your first argument that such loans are not “residential mortgage
loans” based upon your interpretation of certain provisions of Federal
Regulation Z, the Bureaus disagree. The Bureaus
are of the view that such loans are “residential mortgage loans.”
First,
it is the Bureaus’ view that it would not be in keeping with the spirit of “An
Act to Protect Maine Homeowners from Predatory Lending” to exclude such loans
from the definition of “residential mortgage loans.” The Bureaus believe that the legislative
intent behind the “primary dwelling” requirement for “residential mortgage
loans” was to exclude vacation homes and investment properties – not to exclude
primary dwellings solely because they had yet to be constructed.
Second,
it is the Bureaus’ view that construction-to-permanent mortgage loans are not
“construction loans” as that term is used in Title 9-A § 8-103 sub-§ 1-A(W)(4)
and, therefore, may be considered “residential mortgage loans.” In determining which construction loans are
properly excluded under Title 9-A § 8-103 sub-§ 1-A(W)(4), the Bureaus believe
that it is appropriate to look at 24 CFR 3500.5 (federal RESPA) for guidance,
firstly, given the importance of consistency among state and federal laws (24
CFR 3500.5 is relevant to determining whether temporary financing is a
“federally related mortgage loan under Title 9-A § 8-103 sub-§ 1-A(W).
Secondly, the Bureaus believe that it is appropriate to look at 24 CFR 3500.5
due to the fact that RESPA enforcement is specifically incorporated into Maine
law; see elsewhere in 9-A M.R.S.A. § 8-103, and 9-A M.R.S.A. §§ 3-316, 9-311-A
and 10-307.
Pursuant
to 24 CFR 3500.5, a “construction loan” is determined to be a type of “temporary
financing.”
Letter to
Re: Treatment of Construction to Permanent Loans
April 25, 2008
Page Three
The law states as follows:
§ 3500.5 Coverage of RESPA.
(a) Applicability. RESPA and this part apply to all
federally related mortgage loans, except for the exemptions provided in
paragraph (b) of this section.
(b) Exemptions.
. . .
(3) Temporary financing. Temporary financing, such as a
construction loan. The exemption for temporary financing does not apply to a
loan made to finance construction of 1- to 4-family residential property if the
loan is used as, or may be converted to, permanent financing by the same lender
or is used to finance transfer of title to the first user. If a lender issues a
commitment for permanent financing, with or without conditions, the loan is
covered by this part. Any construction loan for new or rehabilitated 1- to
4-family residential property, other than a loan to a bona fide builder (a
person who regularly constructs 1- to 4-family residential structures for sale
or lease), is subject to this part if its term is for two years or more. A
"bridge loan" or "swing loan" in which a lender takes a
security interest in otherwise covered 1- to 4-family residential property is
not covered by RESPA and this part.
Because
the loans that you describe are not a type of “temporary financing,” they would
accordingly not be a “construction loan” using the guidance set forth in 24 CFR
3500.5, and may thus be a “residential mortgage loan” under
(b)
Are such loans subprime mortgage loans?
With
respect to your second argument, that such loans should not be treated as
“subprime mortgage loans,” the Bureaus agree.
The Bureaus are of the view that such loans should not be treated as
“nontraditional” mortgages, and therefore should not be treated as “subprime
mortgage loans” under “An Act to Protect Maine Homeowners from Predatory
Lending.” In other words, the
interest-only attribute of the construction phase of a
construction-to-permanent loan does not cast these types of loans as
nontraditional products.
In
coming to this conclusion, the Bureaus note that any discussion of
construction-to-permanent mortgage loans is conspicuously absent from the
Interagency Guidance. In particular, the
Bureaus note that,
Letter to
Re: Treatment of Construction to Permanent Loans
April 25, 2008
Page Four
whenever examples of
“nontraditional” loans are provided in the Interagency Guidance,
construction-to-permanent mortgage loans are not mentioned. According to the Interagency Guidance,
nontraditional mortgages “include such products as ‘interest-only’ mortgages
where a borrower pays no loan principal for the first few years of the
loan…” (Underline added.) Likewise, in the Appendix to the Interagency
Guidance, an “interest-only” mortgage loan is described as “a nontraditional
mortgage on which, for a specified number of years (e.g. three or five years) the borrower is required to pay only
the interest due…” (Underline
added.) The Bureaus are therefore of the
view that the Interagency Guidance may be reasonably interpreted so as not to
include construction-to-permanent mortgage loans.
The
Bureaus recognize that such loans are typically not targeted at subprime
borrowers. Furthermore, the Bureaus are
aware that the risk of “payment shock” for such loans is significantly
diminished, because a reasonably informed borrower will understand that there
will be a payment adjustment once the “construction phase” of their loan is
completed. Finally, the Bureaus
recognize that these loans are useful lending tools for certain borrowers, play
an important part in Maine’s economy and that, if the Bureaus were to classify
them as “subprime mortgage loans,” certain lenders may be reluctant to offer
these important loan products.
In summary, the Bureaus are of the view that
construction-to-permanent mortgage loans may be residential mortgage loans but
are not subprime mortgage loans.
However, this conclusion applies only in those cases in which: (a) the
only “subprime” attribute of the “construction phase” of such loans is the
payment of interest only during this phase; and (b) there are no “subprime”
attributes to the “permanent phase” of these loans.
/s/Lloyd P. LaFountain III______________ /s/ William N. Lund________________
Lloyd
P. LaFountain III, Superintendent William N. Lund, Superintendent
Bureau of Financial Institutions Bureau of Consumer Credit Protection
