MLO Mentor is an ongoing series covering compliance best practices for Mortgage Loan Originators (MLOs). This article explains which loans fall under the high priced Section 35 mortgage guidelines.
Section 35 Designation
In 2008, HOEPA was amended to add a separate disclosure requirement for higher priced mortgages (HPML)also known as Section 35 Loans. Regulations required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) expanded the classification of all HOEPA loans, including stricter loan requirements for Section 32 loans. and 35.
Although a high cost Section 32 loan and a high cost Section 35 mortgage have similar guidelines for naming and use, they are not interchangeable and have different loan restrictions and disclosure requirements.
Like most other consumer credit transactions secured by housing, a lender granting a higher priced Section 35 mortgage must consider the borrower’s ability to repay the mortgage. . [12 CFR §1026.34(a)(4)]
A Section 35 loan is defined as a closed-end loan secured by one to four owner-occupied residential property or personal property used as a principal residence, called a dwelling, with a annual percentage rate of charge (APR) which exceeds the average prime offer rate (APOR) for a comparable transaction of more than:
- 5% for loans secured by a first lien on the home with a loan amount that meets Freddie Mac’s loan limit (i.e. conforming loans);
- 5% for loans secured by a first lien on a home where the loan amount exceeds Freddie Mac’s conforming loan limit (i.e. jumbo loans); and
- 5% for loans secured by a subordinate lien on a dwelling. [12 CFR §1026.35(a)(1)]
Impound account required
Lenders granting higher priced Section 35 mortgages are required to establish a impound account for the owner before taking out the loan. The impound account allows the owner to deposit property taxes, insurance premiums, and any other periodic payments associated with the property or loan. [12 CFR §1026.35(b)(1)]
Impound accounts can be canceled on the earliest of the following dates:
- the termination of the debt, for example, reimbursement, refinancing, cancellation or seizure; Where
- the request of the borrower, at the earliest five years after the consumption of the loan. [12 CFR §1026.35(b)(3)(i)]
However, a mandatory impound account under Section 35 cannot be undone while:
- the loan is past due; Where
- the loan-to-value ratio (LTV)based on the original value of the property at the time the loan was taken out, is 80% or more. [12 CFR §1026.35(b)(3)(ii)]
It is not necessary to set up impoundment accounts for higher priced mortgages that:
- are backed by shares in a cooperative;
- finance the initial construction of a dwelling;
- are temporary bridge loans with a term of 12 months or less; Where
- are reverse mortgages. [12 CFR §1026.35(b)(2)(i)]
Impounded accounts are also not required when the lender is designated as a small lender. A lender is considered a small lender when:
- in the past year (two years for mortgage applications received before April 1), the lender has extended at least one covered transaction secured by a first lien on a property in a rural or underserved area ;
- in the past year (two years for mortgage applications received before April 1), the lender and its affiliates initiated 2,000 transactions covered or less secured by a first lien that were sold or committed to be sold for consumption;
- at the end of the previous calendar year (the end of two years for mortgage applications received before April 1), the lender had less than statutory threshold (in 2021, the threshold is $2.230 billion); and
- the lender and its affiliates do not maintain foreclosure accounts established on higher priced mortgages (Section 35 mortgages), except:
- for Section 35 mortgage applications received between April 1, 2010 and June 17, 2021; Where
- for escrow accounts established to help distressed borrowers avoid defaults and foreclosures. [12 CFR §1026.43(e)(5)(i)(D); 12 CFR §1026.35(b)(2)(iii)]
Property subject to membership in a homeowners association (HOA) who is obliged to provide a framework insurance policy does not require the deposit of these insurance premiums in the escrow account. [12 CFR §1026.35(b)(2)(ii)]
The Lender shall pay Borrower interest in accordance with applicable federal or state law for any amount held in the Impoundment Account.
Any lender who establishes an impound account under this law must disclose the following information to the borrower at least three business days before closing the loan:
- the fact that an impound account will be opened at loan closing;
- the amount required on deposit at closing to fund the impoundment account;
- the amount, the first year after loan closing, of estimated taxes and insurance premiums to be deposited in the pound account;
- the estimated monthly amount to be paid into the pound account; and
- if the borrower chooses to terminate the impounded account, the borrower will be responsible for making all payments on taxes and insurance premiums. [15 USC §1639d(h)]
Note that lenders cannot override the rules of a Section 35 loan by structuring a closed credit transaction as an open credit transaction. [12 CFR §1026.35(d)]
In next week’s MLO Mentor, we’ll dive deeper into the assessment rules that apply to Section 35 loans.