When we originate a residential construction loan, the loan is structured as an open-end line of credit, typically for a term of six to twelve months, with a fixed interest rate. The borrower makes monthly interest-only payments based on the drawn balance, with a balloon payment due at maturity. When the construction phase is complete, the borrower applies separately for permanent financing. Our loan origination system (LOS) generates our construction loan documents. On the closing disclosure for a construction loan, the field for “Monthly Principal & Interest” automatically fills “NO” in response to the question, “Can this amount increase after closing?” We are concerned this is inaccurate given that the monthly interest payment may vary based on the amount drawn on the loan, even though the interest rate is fixed. We are unable to change the answer to “YES.” Can you provide any insight or guidance on this matter?

As a preliminary matter, you should confirm that your construction loans are “open-end” transactions under Regulation Z, as the TRID Closing Disclosure is not required for open-end transactions.

The requirement to provide a borrower with a Closing Disclosure applies only to loans that are “closed-end consumer credit transaction[s] secured by real property or a cooperative unit, other than a reverse mortgage.” If your LOS is generating closing disclosures for your open-end construction loans, some settings may need to be changed to reflect that these loans are not closed-end.

Under Regulation Z, “[o]pen-end credit means consumer credit extended by a creditor under a plan in which: (i) The creditor reasonably contemplates repeated transactions; (ii) The creditor may impose a finance charge from time to time on an outstanding unpaid balance; and (iii) The amount of credit that may be extended to the consumer during the term of the plan (up to any limit set by the creditor) is generally made available to the extent that any outstanding balance is repaid.” If the line of credit is truly a revolving line that meets all three prongs of this definition, it is not subject to the TRID rule.

If these loans are instead closed-end lines of credit (lines that allow for multiple advances but are not revolving — i.e., the customer cannot redraw up to the maximum amount after repaying the balance), then the TRID requirements do apply.

In that case, your LOS should be aware that the CFPB has issued a final rule, effective October 1, 2018, which modified the disclosure requirements for closed-end construction loans where the actual schedule of advances is unknown (among other changes). For a fixed-rate construction-only loan where the monthly interest-only payments will be based on the amount of the loan advanced, appendix D of Regulation Z allows a creditor to estimate the monthly interest payments based on a 50% draw of the total loan amount.

Prior to this final rule, a creditor using appendix D to estimate monthly interest payments for construction loan disclosures was required to answer the question of whether the amount of principal and interest payments could change after closing as “NO.” Under the final rule, the official interpretations for this provision now indicate that creditors using the methods in appendix D to calculate monthly interest payments should instead answer this question as “YES.”

The final rule recognized that vendors and creditors would need time to integrate the new disclosure rules into their systems and processes. As such, the compliance period for the final rule was extended for applications received before October 1, 2018 (in other words, it applies to applications received on or after October 1, 2018). This could explain why your LOS is still answering the question of whether monthly principal and interest payments can increase after closing with “NO.”

If you are unable to change the settings for your LOS to reflect the CFPB’s modified requirements for construction loans, we recommend notifying your vendor that your system needs to be updated to reflect the CFPB’s new disclosure rules.

For resources related to our guidance, please see:

Regulation Z, 12 CFR 1026.2(a)(20) (“Open-end credit means consumer credit extended by a creditor under a plan in which: (i) The creditor reasonably contemplates repeated transactions; (ii) The creditor may impose a finance charge from time to time on an outstanding unpaid balance; and (iii) The amount of credit that may be extended to the consumer during the term of the plan (up to any limit set by the creditor) is generally made available to the extent that any outstanding balance is repaid.”)

Regulation Z, Official Interpretation, Paragraph 2(a)(2), Comment 1 (“This definition describes the characteristics of open-end credit (for which the applicable disclosure and other rules are contained in Subpart B), as distinct from closed-end credit. Open-end credit is consumer credit that is extended under a plan and meets all 3 criteria set forth in the definition.”)

Regulation Z, 12 CFR 1026.2(a)(10) (“Closed-end credit means consumer credit other than ‘open-end credit’ as defined in this section.”)

Regulation Z, Official Interpretation, Paragraph 2(a)(1), Comment 1 (“The coverage of this term is defined by exclusion. That is, it includes any credit arrangement that does not fall within the definition of open-end credit. Subpart C contains the disclosure rules for closed-end credit when the obligation is subject to a finance charge or is payable by written agreement in more than four installments.”)

Regulation Z, 12 CFR 1026.19(f)(1)(i) (“In a transaction subject to paragraph (e)(1)(i) of this section, the creditor shall provide the consumer with the disclosures required under § 1026.38 reflecting the actual terms of the transaction.’”)

Regulation Z, Official Interpretation, Paragraph 19(f)(1)(i), Comment 1 (“Section 1026.19(f)(1)(i) requires disclosure of the actual terms of the credit transaction, and the actual costs associated with the settlement of that transaction, for closed-end credit transactions that are secured by real property or a cooperative unit, other than reverse mortgages subject to § 1026.33.”)

Regulation Z, Appendix D to Part 1026, Part 1(A) (“If interest is payable only on the amount actually advanced for the time it is outstanding: . . . Assume that one-half of the commitment amount is outstanding at the contract interest rate for the entire construction period.”)

Regulation Z, Official Interpretations, Appendix D to Part 1026, Comment 7(iv) (“Creditors may use, at their option, the following methods to estimate and disclose the terms of multiple-advance construction loans pursuant to §§ 1026.37 and 1026.38. . . . If the amounts or timing of advances is unknown at or before consummation and the appendix D assumption that applies if interest is payable only on the amount advanced for the time it is outstanding is used to calculate the periodic payment: A creditor discloses ‘YES’ as the answer to ‘Can this amount increase after closing?’ pursuant to § 1026.37(b)(6)(iii) whether the creditor provides separate construction disclosures or combined construction-permanent disclosures, even though calculation of the construction financing periodic payments using the assumptions in appendix D produces interest-only periodic payments that are equal in amount.”)

Final Rule, 82 Fed. Reg. 37656 (August 11, 2017) (“The option to disclose an answer of either ‘YES’ or ‘NO’ to the question ‘Can this amount increase after closing?’ under comment app. D-7.v.A is not adopted under this final rule. Only a disclosure of ‘YES’ would be provided as the § 1026.37(b)(6) response to whether there will be an increase in the periodic payment when the amounts or timing of advances is unknown at or before consummation and the appendix D assumption that applies if interest is payable only on the amount advanced for the time it is outstanding is used to calculate the periodic payment. This change will address the concerns of creditors and others that the disclosure should reflect the fact that the payments actually increase over the term of the construction financing, even though the amount of such increases is not known at or before consummation.”)

Final Rule, 82 Fed. Reg. 37656 (August 11, 2017) (“However, during the optional compliance period before October 1, 2018, and after the optional compliance period with respect to transactions for which a creditor or mortgage broker received an application during the optional compliance period, disclosures may continue to be made in the manner explained by the informal guidance provided by the Bureau. . . . This takes into account the concerns of vendors, creditors, and others for sufficient time to reprogram systems and train staff to integrate the disclosures finalized here into their systems and processes.”)

Finastra Market Commentary, Building a Better Construction Loan Disclosure — Construction Only Loans under TRID 2.0 (“Under the pre-amendment TRID rule, because Appendix D I.A.1. allows for the assumption that half of the commitment amount is outstanding for the entire construction period, for a fixed-rate construction-only loan, this question relating to the periodic payment amount would have been answered with a ‘NO’ as reflected below in Figure 1. . . . Although a lender will continue to be able to rely on this assumption for the purpose of estimating the initial periodic payment and the periodic payments for the Projected Payments table, TRID 2.0 provides that when disclosing payment adjustments in the Loan Terms and the Adjustable Payments table, the lender must disclose that ‘YES’ the payment could change.”)