The Section 32 coverage test determines whether a seller-carry note on an owner-occupied home falls inside the high-cost mortgage rules of §1026.32. Run the test before closing, document every step on a written workpaper, and file that workpaper in the loan jacket. A seller who skips the analysis carries the legal exposure of an undisclosed covered loan.

Step 1 — Confirm the loan is consumer-purpose

Pull the buyer’s identification, the occupancy affidavit, the insurance binder, and the deed application. A consumer-purpose loan on a dwelling triggers Regulation Z under §1026.3; a business-purpose loan to an investor purchasing a rental falls outside Regulation Z and outside Section 32. Document business purpose with a lease plan, rental history, or a separate primary-residence record when the borrower is an investor — the documentation protects the seller from a later claim that the exemption was improperly applied.

Step 2 — Pull the average prime offer rate

Visit ffiec.gov and pull the average prime offer rate (APOR) for the week the rate on the seller-carry note is set. Match the loan type — fixed-rate term for a fixed note, adjustable-rate index for an ARM. Record the rate, the publication date, and the matching loan category on the workpaper. The APOR table updates weekly; use the row that corresponds to the loan’s lock or set date, not the closing date.

Step 3 — Calculate the loan APR under §1026.22

The annual percentage rate under §1026.22 equals the note rate plus the cost of credit prepaid at closing, expressed as an annualized rate. Where the seller-carry carries upfront fees paid by the borrower at or before closing, the §1026.22 APR will exceed the note rate. The spread test uses the §1026.22 APR — not the note rate. Document the inputs and the resulting APR on the workpaper so any note buyer or state examiner can replicate the calculation.

Step 4 — Run the APR spread test

Subtract the APOR from the loan APR. The §1026.32(a)(1)(i) threshold differs by lien position and by whether the loan amount falls above or below the statutory loan-size cutoff: a first-lien loan above the cutoff carries one threshold, a first-lien loan below the cutoff carries a higher threshold, and a subordinate-lien loan carries a different threshold. Identify the applicable threshold, perform the subtraction, and record the spread and the outcome on the workpaper. A spread that exceeds the applicable threshold means the loan crosses the APR test.

Step 5 — Build the points-and-fees worksheet

List every charge the borrower pays at or before closing that §1026.32(b)(1) sweeps into the points-and-fees calculation. The enumerated items include origination fees, borrower-paid discount points, and most third-party fees the seller selects. The rule also identifies specific carve-out items that are excluded from the calculation. Work from the rule’s text — not from the closing statement format — and record each included item and each excluded item with the statutory basis for the treatment.

Step 6 — Run the points-and-fees test

Compare the total points and fees to the §1026.32(a)(1)(ii) threshold. The threshold is expressed as a percentage of the total loan amount for loans above the statutory size cutoff and as a fixed floor for loans below it. The total loan amount runs under §1026.32(b)(4). Record the total points and fees, the applicable threshold, and the coverage outcome on the workpaper. A total that exceeds the threshold means the loan crosses the points-and-fees test regardless of where the APR spread fell.

Step 7 — Document the coverage outcome

Record the complete analysis on the workpaper: the §1026.22 APR, the APOR, the spread, the applicable APR threshold, the total points and fees, the total loan amount, the points-and-fees threshold as a percentage and as a calculated figure, and the final coverage outcome. A loan that crosses either test is a Section 32 loan. A loan that crosses neither test is outside Section 32 — and the workpaper is the evidence that the analysis was actually performed.

Expert Take

Sellers who run the coverage test after the fact rather than before closing face a materially different legal position. The §1026.32(c) disclosure timeline runs from the analysis to closing — once closing occurs without the disclosure, no post-closing workpaper cures the violation. The loan file should show the analysis date, the APOR pull date, and the disclosure delivery date as a sequenced timeline, not three undated documents assembled after the fact.

Step 8 — Deliver the §1026.32(c) disclosure if the loan is covered

A covered loan requires the §1026.32(c) disclosure delivered to the borrower at least three business days before closing. Adjust the closing date where the analysis runs close to the scheduled close, and document disclosure delivery with a signed receipt filed in the loan jacket. Closing inside the three-business-day window violates the rule regardless of the borrower’s acknowledgment at the closing table.

Step 9 — Restructure the note where required

A covered Section 32 loan cannot carry a balloon payment under §1026.32(d)(1), a prepayment penalty under §1026.32(d)(6), or negative amortization under §1026.32(d)(2). Where the note draft includes a prohibited feature, the seller restructures the note as a fully amortizing instrument without the prohibited term — or restructures the transaction to bring the loan outside Section 32. To illustrate the amortization mechanics: a seller-carry note at a fixed rate on a 30-year schedule produces a level monthly payment of principal and interest from month one through month 360, with no balloon and no interest-only period, satisfying the §1026.32(d)(1) prohibition.

Step 10 — Assemble and file the complete loan jacket

File the following records together in the loan jacket: the coverage workpaper, the APOR pull printout with date, the §1026.22 APR calculation with inputs, the points-and-fees worksheet with statutory citations for included and excluded items, the occupancy and consumer-purpose documentation, the signed §1026.32(c) disclosure with delivery receipt if the loan is covered, and the truth-in-lending disclosure under §1026.18. A complete, sequenced file is what a state examiner requests at examination and what a note buyer’s due-diligence review requires before funding a purchase.

For a broader view of the disclosure obligations that sit alongside the Section 32 analysis, see 7 Costly TILA/RESPA Misconceptions Every Seller Financier Must Avoid and 7 Mandatory Disclosures for Private Mortgage Lenders. For the record-keeping requirements that support the completed loan file, see 10 Record-Keeping Requirements for Private Mortgage Note Servicers.

Frequently Asked Questions

What is the difference between the §1026.32 APR and the note rate?

The §1026.32 APR is the §1026.22 annual percentage rate — the note rate plus the cost of credit prepaid at closing, expressed as an annualized rate. The note rate is the contractual interest rate on the promissory note. The two figures diverge when the loan carries upfront fees the borrower pays at or before closing; the §1026.22 APR is always the correct input for the spread test.

Does the points-and-fees test include third-party closing costs?

The §1026.32(b)(1) calculation sweeps in most fees the borrower pays at closing where the seller selects the third party and the fee is not a §1026.32(b)(1) carve-out item. The rule enumerates both the items that are included and the items that are excluded — the calculation follows the statutory text, not the formatting of the closing disclosure or settlement statement.

What if the coverage analysis is run after closing?

A post-closing analysis that identifies the loan as covered does not cure the §1026.32(c) disclosure timeline. The disclosure had to be delivered before closing, and the closing occurred inside the prohibited window. The seller consults qualified legal counsel on the §1026.32(a)(3) rescission rights the borrower holds and on the cure path, if any, available under the facts.

Does Section 32 apply to every seller-carry note?

Section 32 applies only to consumer-purpose loans secured by the borrower’s principal dwelling that cross either the APR spread threshold or the points-and-fees threshold. A seller-carry on an investment property, a commercial property, or a property the buyer does not occupy as a primary residence falls outside the rule. Document the consumer-purpose determination at origination — not at the time of a later question.

What loan features are prohibited in a covered Section 32 loan?

A covered §1026.32 loan cannot include a balloon payment (§1026.32(d)(1)), negative amortization (§1026.32(d)(2)), or a prepayment penalty (§1026.32(d)(6)). Seller-carry notes that cross the coverage threshold must be structured as fully amortizing instruments without these features. Restructure the note or restructure the transaction before closing — not after.

Sources

• Truth in Lending Act (TILA), 15 U.S.C. §1601 et seq. Cornell Legal Information Institute.
• Regulation Z, 12 C.F.R. §§1026.22, 1026.32, 1026.34. Consumer Financial Protection Bureau.
• Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203. U.S. Government Publishing Office.
• Federal Financial Institutions Examination Council — Average Prime Offer Rate. FFIEC.