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HELOC for Home Construction?

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Question: 
We have a customer requesting a HELOC instead of a short term construction loan in an attempt to avoid the draws. After construction is complete, a closed end mortgage would be provided. Since there is no equity in the home at this point, because it is not built, are we able to offer a HELOC for their home construction? Also, since they plan to pay off the HELOC at the end of construction, does the requirement for "repeated transactions" apply?
Answer: 

Randy Carey: IMHO - such a loan is not an open-end credit as you are missing the contemplation of repeated transactions. If you don't care about monitoring the draws, then just make him a multiple advance closed-end loan and let him draw it at will. He must qualify for unsecured credit, if you were willing to do the HELOC in that manner.

Richard Insley: I agree with Randy. You're better off using a standard credit product the way it was designed than trying to twist and distort a product that was never intended for that purpose. If there's no equity in the property, then you can hardly call it a "home equity" LOC or loan. Unless there's a significant profitability difference, I'd always go with a closed-end credit instead of a revolver. Sometimes these things are called "drawdown lines"--and that's fairly descriptive. It's always been my preference (for consumer credit) to reserve the term "line" for true revolvers, but "drawdown" clearly indicates a single use of the approved credit, not a self-replenishing evergreen LOC.

Dan Persful: Copy of memo from 2018 I sent to the Senior Management team:
This issue comes up every now and then and it has recently resurfaced with a conversation Johnny and I had a few days ago which resulted in repricing our bridge loans and a recent HELOC approved for the purpose of a bridge loan.

As Senior Management and Department Managers I am providing you the following summary of the regulatory reasons HELOCs should not be used for bridge loans or other temporary financing.

From Reg. Z 1026.2 - Definitions

(20) Open-end credit means consumer credit extended by a creditor under a plan in which:
(i) The creditor reasonably contemplates repeated transactions;

This is the regulatory (legal) definition of open-end credit which is the category HELOCs fall in. The bank knowingly making a HELOC for temporary financing purposes such as a bridge loan would have a difficult time defending their position they were reasonably expecting repeated transaction on the loan for the 6 – 12 month term of the loan.

From Reg. Z 1026.35 – Requirement for higher-priced mortgage loans

(d) Evasion; open-end credit. In connection with credit secured by a consumer's principal dwelling that does not meet the definition of open-end credit in § 1026.2(a)(20), a creditor shall not structure a home-secured loan as an open-end plan to evade the requirements of this section.

(e) Repayment ability, prepayment penalties. Except as provided in paragraph (e)(3) of this section, higher-priced mortgage loans are subject to the following restrictions:

(1) Repayment ability. A creditor shall not extend credit based on the value of the consumer's collateral without regard to the consumer's repayment ability as of consummation as provided in § 1026.34(a)(4).

The majority of these loans are going to fall within the higher-priced mortgage loan (HPML) category.

Using our revised pricing for bridge loans I ran a $100,000 sample loan for a 6 & 9 month repayment term. The 6 month term’s APR was 6.314% which is 2.654% above the Average Prime Offered Rate (APOR). The 9 month term’s APR was 6.062% which is 2.402% above the APOR. Any loan that is 1.5% or greater above the APOR is a HPML and must follow the requirements of Reg. Z 1026.35, including the ability to repay.

The most prevalent reason for doing HELOCs as a bridge loan is the loan originator is wanting to avoid charging the borrower the additional fees, the shorter processing time since HELOCs are not subject to TRID under Reg. Z 1026.19, .37 & .38 and we don’t have to follow the ability to repay requirements in 1026.35 on open-end credit. Based on this we could be cited in our compliance exam for willfully evading the required closed-end disclosures by structuring a closed-end transaction as an open-end transaction to avoid them.

Under the HMDA rules these loans are no longer exempt from reporting since they are structured to be repaid from the sale of the property. HELOCs are not subject to HMDA reporting so again we could be cited for structuring a loan to avoid necessary reporting requirements.

In a nut-shell using an open-end credit product for a loan that based on its purpose should be structured as a closed-end product can and does present numerous compliance issues and potential legal issues if the loan ends up in court.

As the compliance office, and based on regulatory reasons I have to continue advising against using HELOCs as bridge loans or for other temporary loan situations.

First published on 08/06/2020

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