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Owner-Occupied Balloon Renewal/Dodd-Frank

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Question: 
For owner-occupied loans that are up for balloon renewal (mostly 5 year balloons), are they grandfathered into the Dodd-Frank regs? We are a small creditor and are coming up against some of our renewals not meeting our internal d/i limits since we do not have to meet the 43% rule. Are we still able to make these renewals, or should we have the borrowers move the loan?
Answer: 

That depends on whether you are refinancing (satisfying and replacing) or modifying the existing obligation. A refinancing would require new disclosures, new underwriting, and adherence to ATR/QM requirements, but a modification would not.

We need to look to Regulation Z section 1026.20(a) and the related commentary for a discussion of "refinancing." A refinancing occurs when the existing obligation is satisfied and replaced by a new obligation undertaken by the same consumer. That section then goes on to provide five exceptions that, even though they may be accomplished by replacing the existing obligation with a new one, still would not be considered a "refinancing." Chief among those exceptions is what is generally referred to as the "workout" exception. As long as the rate is not increased, or the new amount does not exceed the total of the unpaid balance, earned finance charge and certain insurance premiums, then a new note to replace an existing note for a borrower who is delinquent or in default is not considered a refinancing. But what about borrowers that are in good standing but just coming to maturity? That's where it starts getting a little gray. But as long as you are careful to not set off any of the tripwires in 1026.20(a), I think you can do a modification without triggering a requirement to do new underwriting and meet ATR requirements.

You may need to get legal counsel involved in structuring the document language, but clearly the modification should spell out that it does not replace the existing obligation. In addition, I would avoid any rate increases as that could be argued as both a replacement of the existing obligation as well as a potentially abusive practice for a borrower that you know or suspect may not meet ATR requirements already. Also any change from a fixed to variable rate would not be appropriate. But if all you are doing is changing the maturity date and nothing else, I think you are OK with a clearly defined modification agreement to not be required to re-underwrite and re-disclose.

There are also some other factors to consider including whether the modification would be considered a troubled debt restructuring. In cases where you know or suspect the borrower would not meet QM nor ATR requirements, simply extending the maturity may push the debt into collateral-dependent status even though it doesn't trigger new disclosures and new underwriting. That would be something you should discuss with your loan accounting experts.

First published on 05/19/2014

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