What Is a Section 32 Loan and How Does It Work?

Section 32 loans are a mortgage transaction under federal consumer protection regulations. These loans are not a common product sought by consumers, but rather a designation applied to certain high-cost, high-fee home loans. Understanding this designation is important for homeowners to recognize when a loan might trigger additional protections designed to prevent predatory lending practices. The rules governing these loans aim to ensure transparency and fairness in mortgage agreements that carry higher risks for borrowers.

Understanding Section 32 Loans

A Section 32 loan refers to a mortgage classified as a “high-cost” loan under the Home Ownership and Equity Protection Act (HOEPA) of 1994. Its rules are detailed in Section 32 of Regulation Z. These regulations safeguard consumers from abusive practices in certain home equity loans and refinances. This framework applies to personal-use loans secured by a borrower’s principal residence, including one-to-four unit residential properties or personal property like a houseboat.

These mortgage products carry higher rates or fees, exposing borrowers to greater financial risk. Lenders often try to avoid the Section 32 designation due to stringent requirements and potential penalties. The law covers various types of transactions, including refinancing and home equity installment loans. However, certain loans are exempt from this designation, such as reverse mortgages, construction loans for initial dwelling construction, and some government-backed loans.

Features of Section 32 Loans

A loan is identified as a Section 32 loan if it meets one of three specific coverage tests: the Annual Percentage Rate (APR) test, the points and fees test, or the prepayment penalty test. Under the APR test, a loan is subject to Section 32 if its APR significantly exceeds the Average Prime Offer Rate (APOR) for a comparable transaction. For instance, a first-lien loan might qualify if its APR is more than 6.5 percentage points above the APOR, while junior-lien transactions or those involving personal property under $50,000 may trigger the designation if their APR is more than 8.5 percentage points above the APOR.

The points and fees test designates a loan as Section 32 if the total points and fees paid by the borrower at or before closing surpass a certain threshold. This threshold is either 5% of the total loan amount for larger loans or the lesser of 8% or a specific dollar amount for smaller loans, with these dollar figures adjusted annually for inflation. Additionally, a loan triggers Section 32 if it includes a prepayment penalty charged more than 36 months after the loan is made, or if the penalty exceeds 2% of the prepaid amount.

Once a loan is identified as a Section 32 mortgage, lenders must adhere to strict disclosure requirements and are prohibited from including certain loan terms. They must provide specific disclosures to the borrower at least three business days before closing, including a prominent warning that the borrower is not obligated to complete the agreement and could lose their home if they fail to meet their obligations. Prohibited features include balloon payments on loans with terms under five years (with limited exceptions), negative amortization where the principal balance increases, and increased interest rates upon default. Lenders also cannot require more than two periodic payments to be paid in advance from the loan proceeds.

Obtaining a Section 32 Loan

Borrowers do not typically apply for a “Section 32 loan” directly, as this designation is a regulatory classification applied to certain high-cost mortgages. Instead, a loan a consumer seeks may be identified as a Section 32 loan if its terms meet the specific APR, points and fees, or prepayment penalty thresholds. This identification triggers additional protections and requirements for the lender rather than being a product a borrower actively chooses. The primary eligibility criteria for a loan to fall under this designation are tied to its cost structure and the type of property securing it, specifically a borrower’s principal residence.

If a lender determines that a loan meets the criteria for a Section 32 designation, they are then obligated to follow a particular application process that includes enhanced disclosures and waiting periods. This mandatory waiting period allows the borrower time to review the terms and consider whether to proceed with the loan. The process emphasizes consumer awareness and provides an opportunity for the borrower to withdraw their application without penalty before finalization.