We have recently started offering Construction to Perm one-time close loans with interest only payments during the construction phase of 12 months and converting to a 5/1 ARM when permanent phase begins. The rate is fixed during construction and converts to an ARM at a rate based on the current index value (defined as index figure available as of 45 days before each Change Date). We are not sure which rate change notice we are required to give prior to permanent phase. Do we have to give the 210 to 240 day notice, and if so, what balance do we base our estimated payment on? Do we calculate on the full balance even if the loan has not been fully disbursed?

Here is what I found in the Commentary to TILA Appendix D #7.iii:

iii. Interest rate. If the permanent financing has an adjustable rate at consummation and separate disclosures are provided, the rate disclosed for the permanent financing is the fully-indexed rate pursuant to § 1026.37(b)(2) and its commentary. If the permanent financing has a fixed rate that will not be adjusted when the construction phase converts to the permanent phase, that fixed rate is used for disclosure purposes. If the permanent financing has a rate that may adjust when the construction phase converts to the permanent phase, the permanent financing has an adjustable rate. If the legal obligation for a loan secured by the consumer's principal dwelling provides that the permanent financing interest rate may adjust when the construction financing converts to permanent financing, and such adjustment to the interest rate results in a corresponding adjustment to the payment, the creditor provides the disclosures pursuant to § 1026.20(c), but not (d), if the interest rate for the permanent phase will be fixed after the conversion.

Do we provide (d) disclosures (210 to 240) if the interest rate for the permanent phase will be an ARM after the conversion? Trying to understand exactly what the last sentence of the commentary is telling us as to which notice is required in our scenario.

That is one of the more interesting twists to the added commentary and I think it is going to bite lenders like you that have this product. What that is saying is that if you are moving to an ARM at conversion rather than a fixed rate product that is set based on an index and margin at conversion, you need both. It also means that you need provisions in your note that allows a 45 day look back to set the initial rate on the ARM in order to deliver the 60 day notice prior to conversion. I would say that your only option is to based the notices on the legal obligation of the entire loan amount as reflected in the note.

Thank you. We do have the 45 day look back verbiage in our loans.