Avoiding the CFPB's 12-month limit on construction-to-perm. lending
Don't want to limit construction phases of your construction-to-permanent loans to 12 months or less? You don't have to. Here are our thoughts on how avoiding this problem and how the CFPB comes out looking like the "good guy"
Residential construction lending is a great way for a local lender to distinguish itself from national competitors. After all, only a New England lender will know what it takes--how long and how much-- to build a house here.
How is construction lending affected by the ATR/QM regulations? Some are of the opinion that "the new CFPB rules make construction / permanent lending problematic at best, and impossible at the worst."
We here at Spillane Consulting do not share that doomsday prediction. But some adjustments may need to be made, and we wanted to share with you something to consider if your institution offers loans with construction phases greater than 12 months.
General Rule
"Construction phases of 12 months or less of a construction-to- permanent loan" are exempt from the new ATR/QM regulations.
Significance
If the construction phase is not exempt, standard 12/30 loans would automatically be non-QM because they would exceed the 30-year term limitation. Even if you reduce the permanent phase of the loan to 29 years, interest-only periods and certain charges connected to the construction phase also may nonetheless make it difficult to originate this as a QM.
Where the construction phase is exempt, the permanent portion is considered an entirely separate loan for ATR/QM purposes and much more likely to fall within the QM box.
Problem
Sometimes it takes longer than 12 months to build a house in New England.
Solution
Although construction phases must be capped at 12 months, renewals are permitted and will also be exempt even if overall the construction phases exceed 12 months.
Therefore - our interpretation of the new rules is you may exceed the 12-month limitation by simply using renewals. The renewals will also be exempt so long as they also do not exceed 12 months. If the construction schedule is 14 months, you'll have one loan that looks like this: one construction phase for 12 months, a renewal construction phase of 2 months, and a 30-year permanent portion. Here, only the permanent portion has to run the ATR/QM gauntlet...the construction phases are exempt, and the permanent portion complies with the 30-year limitation in QM.
We suggest renewals be at the borrower's option only. What borrower is going to leave for another bank at the 12-month mark when only a few months remain? By not keeping an option for itself, your institution allows LOs to market this as a guarantee of funding for the project--the borrower won't worry, "what promise do I (borrower) have that you (bank) will agree to the renewal at 12 months?"
To be perfectly clear - there is no need to try and "doctor" the construction schedule. If the schedule says it will take 18 months to build, work and underwrite the loan based on the true 18 months. The difference will simply be that you'll have a 12/6/30 loan (12- month construction phase, 6-month construction phase that was renewed at 12 months, and a 30-year permanent portion).
Explanation - "You sure that's right?"
We confirmed this over the phone with CFPB attorneys on multiple occasions, and here's an official comment to 1026.43 that supports our interpretation--
[A] construction phase of 12 months or less of a construction- to-permanent loan is exempt . . . For such a loan, the construction phase and the permanent phase may be treated as separate transactions for the purpose of compliance with §1026.43(c) through (f), and the construction phase of the loan is exempt from §1026.43(c) through (f), provided the initial term is 12 months or less. . . . Where the construction phase of a construction-to-permanent loan is renewable for a period of one year or less, the term of that construction phase does not include any additional period of time that could result from a renewal provision. For example, if the construction phase of a construction-to-permanent loan has an initial term of 12 months but is renewable for another 12-month term before permanent financing begins, the construction phase is exempt from §1026.43(c) through (f) because the initial term is 12 months. Any renewal of one year or less also qualifies for the exemption. The permanent phase of the loan is treated as a separate transaction and is not exempt under §1026.43(a)(3) (iii). It may be a qualified mortgage if it satisfies the appropriate requirements.
Why 12 months...why aren't construction phases simply exempt...why are renewals required? Great question. Doing the research and talking to CFPB attorneys led us to the background behind this seemingly useless rule. So here's what we discovered....
The Dodd Frank Act itself sets the 12-month rule. But the CFPB disagrees with this limitation, feeling it would unnecessarily chill construction lending. So the CFPB wrote the regulation intentionally to build this flexibility in. It could not deviate from the 12-month rule (required by statute) directly, but it wrote the regulation to allow renewals as a way to do essentially the same thing and get around the 12-month limit.
Here's a CFPB response during the official rulemaking process that also helps explain:
[O]ne industry commenter stated that the statutory one-year limitation would interfere with construction loans, which often require more than a year to complete. The [CFPB] understands that construction loans often go beyond a single year. . . . The [CFPB] believes that disregarding renewals would facilitate compliance and prevent unwarranted restrictions on access to construction loans.... However, the [CFPB] intends to monitor the issue through its supervision function and to revisit the issue as part of its broader review of the ability-to-repay rule[.]
With no litigation or regulatory enforcement on these brand new rules, many of these problems are arising and the solutions are a work-in-progress. But the last thing we want is for anyone to put loans on the books that are unsafe....especially when it would be easy to limit your exposure to risk. Feedback on this or a related issue is always much appreciated....gathering info. from clients is the only way we're able to work through issues ourselves and help others.
In other news:
Anybody who thinks manners also apply when driving, and commutes into Boston or has braved Cape traffic in the summer will appreciate this satisfying video
How much more important is QC under ATR/QM? Maybe a lot. Calculation mistakes and missing documentation could hurt...what were once flexible underwriting standards are now rigid regulations with strict penalties
Our President, John Spillane, is speaking on March 25 in the MassHousing/PASS symposium called "The Future of Home Ownership Lending Symposium"
Rich Jackmauh and I will be in Framingham tomorrow giving our "ATR/QM For Loan Officers" training. If interested, call the MBA's Pat Tabolsky 617.502.3814 to see if there are still openings.
Hope to see you next Thursday in Canton where I'm honored to be speaking on a panel for the Mortgage Advisory Board's"Navigating QM/ATR and Non-QM Lending" symposium
Hiring someone? Watch out if he or she is being referred from someone who has read Robert Thornton's "Lexicon of Intentionally Ambiguous Recommendations"....keep your eyes peeled for hidden meanings!
You'll be lucky to get him to work for you
We wish we had ten employees like him (unfortunately we have twenty)
Success won't go to his head (he won't have any)
I am pleased to say that this candidate is a former colleague of mine
He would like nothing better than working for you (prefers to do nothing
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**These are our opinions. We're not authorized, or willing, to express those of others.**