Howdy BOLers,

I had an interesting scenario pop-up today. On a draw-down/multiple advance loan we had a lender asking why the payment on the TIL was not correct. After explaining that TIL Appendix D allows for a half-draw scenario, we began to think.

Our promissory note states the payment as (in so many words) "monthly interest on the amount advanced".

So, given the one-half advance scenario on the TIL and the scenario based payment on the note, a fully advanced payment is not really disclosed anywhere.

1.) Do I have to use Appendix D (50% advance) on a construction only phase (we have a takeout for permanent from secondary market), or could I state a full draw scenario?

2.) If I must use Appendix D, is there any best practice to document a full draw scenario for the customer?

3.) What are you doing at your shop?

Thanks for your time. It's like chasing cats today. All over the place.

Please add a little more information:
1. Do your notes (or supplemental contract documents) set a schedule of draws (amounts and dates)?

2. Did/will the initial advance exceed 50% of the full commitment amount?

3. How is the "monthly interest on the amount advanced" calculated? (Let's say $0 is advanced when the loan closes on 3/31, $10,000 is advanced on 4/15, and nothing else is advanced before month-end. If the IR is 12%, would the first month's interest be:
a. 1% X $10,000 = $100 ?
b. 1% X $10,000 X 15 / 30 = $50 ?
c. something else?

1.)Our notes (or supplementals) do not set a draw schedule. The draws would occur as requested.

2.) No, the initial draw would not exceed 50% of the full commitment

3.) a. 1% X $10,000 = $100

So, I'm basically working off of Appendix D, Part I (A). Interest is payable only on the amount actually advanced for the time it is outstanding.

http://www.bankersonline.com/regs/226/d226.html

That's not what you described above. To get $100, you must charge $50 interest for the first 15 days of April when the outstanding balance is $0.00. In the worst case, the first draw could be outstanding for as little as 1 day--but the customer would pay a full month's interest on this amount. If this is actually how it works and your note says "monthly interest on the amount advanced", I'd get legal counsel to review this language & be sure it adequately explains your accrual/billing method.

I think I may have gotten off track with the scenario.

Interest is only charged on the amount advanced.

So, if you make an advance today, by my month end you would have 31 days worth of interest accrued on the amount advanced. Our note reads correctly, I am more concerned with the questions presented in the first post.

Unless your contract states the exact amounts and dates of advances (which you said is not the case), all construction loan disclosures are estimates. Section 1026.17(c)(1) states "the disclosures shall reflect the terms of the legal obligation between the parties...if any information necessary for an accurate disclosure is unknown to the creditor, the creditor shall make the disclosure based on the best information reasonably available at the time the disclosure is provided to the consumer, and shall state clearly that the disclosure is an estimate." Regulation Z does not require you to use Appendix D to make these estimates, but if you don't (or can't) use Appendix D as written, then you have to devise your own method to generate the estimates necessary for an acceptable TIL disclosure--and sell it to your regulator.

Until you know exactly how your contract works regarding interest accruals, then you can't estimate the interest component of the Finance Charge. In addition to the terms of the construction note, "the best information reasonably available at the time the disclosure is provided" includes the exact method your servicing system uses to calculate and bill interest. You wouldn't be the first banker to discover a disconnect between the terms of a note and the servicing system. Returning to the reason for my question, if the first draw could be outstanding for as little as 1 day--but the customer would pay a full month's interest on this amount, then you can't use Appendix D without significant modification.

Returning to your initial post, you'll have to explain what "a half-draw scenario" means. Appendix D only supports 50% utilization of proceeds, but that is an average based on 0% funding at the outset and 100% funding at maturity. This is very common--is that what your construction note allows?

Large initial advances present a hidden problem. Obviously, when more than 50% of principal is advanced at the outset of a loan, it's mathematically impossible to end up with an average of 50% utilization for the entire term of the loan. When you can't base your estimates on 50% utilization (because "the best information reasonably available at the time the disclosure is provided" says otherwise), you can't use Appendix D and are back to devising your own method and selling it to your regulator.

To tag on to this thread:

Large initial advances present a hidden problem. Obviously, when more than 50% of principal is advanced at the outset of a loan, it's mathematically impossible to end up with an average of 50% utilization for the entire term of the loan. When you can't base your estimates on 50% utilization (because "the best information reasonably available at the time the disclosure is provided" says otherwise), you can't use Appendix D and are back to devising your own method and selling it to your regulator.

This is the case with a purchase/rehab loan. I have just realized that my LOS is calculating this under appdx D which I don't believe to be at all correct!

If more than 50% is given up front...can you go with fully advanced calculations rather than 'devising your own method'?

nevermind.

https://www.bankersonline.com/forum/ubbthreads.php?ubb=showflat&Number=1883684

Also hidden is the "heads-you-win-tails-I-lose" reimbursement problem.

Unless your construction loan has $0.00 PFCs, the APR is a blend of the estimated interest and the PFC. Given the very short term of a construction loan, up-front fees will kick the APR considerably higher than the interest rate. If you estimate too little interest (by using 50% utilization instead of the higher percentage resulting from a large initial advance), you have an understated FC. If you estimate too much interest (by using 100% utilization instead of a correct valuation somewhere between 50% and 100%), you overstate the FC, BUT you also dilute the APR and can end up with a materially understated APR. The only way to avoid understatement of both the APR and the FC is to base all of your calculations on the terms of the legal obligation.

I'm so not looking forward to my LOS provider calling me back on this subject.

Does anyone know of any issues if you were to fully fund a commitment, but hold the improvement funds in some type of suspense account to be drawn based on progress and get away from the 'multiple advance' conundrum all together???

If there are issues, it would be a State law issue.

The only way you could set up something of this nature would be to spell it out in the contract documents--making the arrangement the basis for your TIL calculations and disclosures. You can style the arrangement any way you want, but if the loan proceeds are impounded and subject to disbursements you control, then I think it still looks and sounds like a duck.

Thanks, Richard. Not the answer I wanted, but I value your expertise on this subject!

So...Compliance One says that Appendix D would be the correct application for this type of transaction.

I guess they hang their hat, reputation and legal opinions on:

In addition, if either the amounts or dates of advances are unknown (even if some of them are
known), the financial institution may, at its option, use appendix D to the regulation to make
calculations and disclosures.

Unless I can be handed a citation that says otherwise, I don't believe this is a battle I feel up to fighting right now with everything else DIRT is throwing at me. I just don't have any real ammunition...the regulation seems to support them.

It does just say "some" and does not put a limit on "some".

What's the cite for this?

Sorry, that was the best laid out reasoning and it comes from the exam manual.

Exam manuals don't trump the regulation. Regulators can adopt whatever enforcement standards they wish (and later "unadopt" them) outside the formal rulemaking process. That doesn't change the regulation or your exposure to civil liability.

Sections 1026.17(c)(1) and (c)(2) are very clear--all calculations and disclosures must be based on the legal obligation between the parties and you must use "the best information reasonably available" when estimates are necessary. In a case where you advance more than half of a construction loan at settlement, there is no way to argue that the 50% utilization feature built into Part 1A of Appendix D (original recipe) is the best information reasonably available. Mathematically, it's impossible.