HMDA Loan Purpose Hierarchy
In this extended Compliance Clip (about 8 minutes), Adam discusses the new purpose hierarchy in this HMDA video and explains why the CFPB changed the long-standing order of which purposes take priority over other purposes. This video dives into the rule, commentary, and preamble to give us a full understanding of the new HMDA hierarchy.
Video Transcript
This Compliance Clip is going to focus on the loan under the Home Mortgage Disclosure Act or HMDA. So this video does apply only to HMDA reporters.
The rule is found in 1003.4(a)(3) and discusses the loan purpose. It's pretty simple and it says to report whether the covered loan or application is a Home Purchase Loan, Home Improvement Loan, a Refinancing, a Cash Out Refinancing, or an Other Purpose. So, that is the rule and it's pretty simple, but sometimes we do get questions that need to take a deeper dive into this. So, the question that we often see is what purpose do you list if a reportable application or loan has multiple purposes?
This is known as the HMDA Hierarchy. And the commentary is our answer to this, and the commentary was specifically Comment 3 to Part 1003.4(a)(3), which is the citation to Regulation C that implements HMDA, gives us the answer. That's where we find the answer. So comment 3 talks about multiple-purpose loans. Specifically, it gives us a new HMDA hierarchy, and the old days under HMDA, the prior rules before January 1 of 2018 the hierarchy was set for years.
You had a purchase first, a home improvement loan second, followed by a refinance. That was the hierarchy. When the new rules came out, there was a change in this hierarchy. The hierarchy now is a purchase first, a refi or cash out refi second, a home improvement third, and then finally a new category of other.
The biggest change here of course was the difference between a refinance and home improvement, where under the old rules, home improvement was first and refinance was second, and many people have asked me, they said, Adam, why did they change that? Well, the reason they changed that is just to confuse you. They want to make you go crazy. They want to blow your mind. Right? No. They've got reasoning behind that, and we'll talk about that in just a second.
But this new HMDA hierarchy is actually explained pretty well in the CFPB Small Entity Compliance Guide, and you will see that really there's four categories here. I think it's important to point this out. You've got a purchase, a refi, or a cash-out refi is my second bullet point, a home improvement loan, and then other as the last point.
Now, the question I get a lot of times is why is refinance and cash-out refinance considered the same? Well, I like to look at the Small Entity Compliance Guide, so if you'll bear with me, I'll flip over here so you can actually see this. This is the CFPB's HMDA Small Entity Compliance Guide, and it basically says basically has a little battle, so to speak, for us on the different purposes on who would win in a battle. So, I like to think of this as Pokemon or something like that. My son has played those games over the years where you have cards, the most recent game he's played, the card game Magic, where one card battles another. Well, in HMDA, we get some battles. If you see here on this first point, there is a home purchase loan versus a home improvement loan. Who is going to win?
Well, of course, purchase is king, so purchase will always win that battle. Purchase also beats out a refinancing, beats out a cash out refinancing, beats out other purpose. Purchase is still king, it always has been. And always is and will be under the new rules. Purchase is king. But then, what's interesting is our next battle. If you look here, a home improvement loan versus refinancing. As you recall from what I just said, under the old rules, who would have won? This is where you answer out loud in your office by yourself. Say it louder. Right, a home improvement would have won.
But look now today, who wins? A refinancing wins. This is the change in the hierarchy. A home does beat out a cash out refinancing and it then what we look or I'm sorry a home improvement loan doesn't beat it out, a cash out refinancing of course beats out a home improvement loan.
So refinancing is the queen now under the new hierarchy. What's interesting is when you look at refinancing in other, it's of course refinancing, but cash out refinancing in other, what you don't see in here and the point I'm trying to get to, I'm going a long way around, I apologize is you don't see in these little battles over here under the multiple purposes, you never see a refinancing versus a cash out refinancing. Again, that's because cash out refinancing is just one of two types of refinancing. You have type A, which is a refinancing with no cash out, which is reported as a refinancing. Then you have type B, which is a cash out refinancing. So, that's all one type. And of course, at the bottom of the total poll, under all these types is other.
So, I hope that visual helped you understand the purposes. And back to our slide presentation here, those are the that is the new hierarchy, other is less. Last. Now, the question then is why did they change this? And again, it wasn't to blow your mind or give you a headache. The preamble explains this pretty well. This is just a fun fact to know, but the commenters in the HMDA process said that determining if a loan was for home improvement purposes was actually a “substantial compliance burden.” So that's what they said. So the CFPB evaluated this and they explained that the inability to repair and maintain homes was a major factor driving urban deterioration back in the 1970s. So when they implemented HMDA back in the 1970s, which they did temporarily for about a decade until it became final, it was a major concern for them to make sure the financial institutions were doing home improvement loans. Otherwise, there was a lot of urban deterioration. So home improvement loans were not easy to obtain back in the 70s.
Well, time has passed. We have now seen opportunities for consumers to get credit for home repairs. Other ways, such as credit cards and other unsecured loans, or securing loans by automobiles, and home improvement now is just not as relevant of a factor as it used to be. And in fact, in 2012, of all of the reportable loans, home improvement was only comprised 4%, and they found that to be a very limited value, and what they found was the better value was in whether or not a cash out refinancing was reported, because they're seeing some major concerns right now with subprime loans that are often cash out refinances. A lot of cash out refinances are subprime loans. So that's a little tidbit of as to why the rule has changed and why they changed that hierarchy.
That's all I have for today on the HMDA hierarchy. I hope this was beneficial. Hope we had a little bit of fun.