Section 32 of Regulation Z — the rule the industry calls HOEPA — reshapes how a seller-carried note works when the property is the borrower’s primary residence. A carry on an investor-owned rental sits outside the rule. A carry on the borrower’s home runs through coverage tests on the average prime offer rate spread and on the points-and-fees ratio, and a covered loan carries a distinct disclosure timeline, restrictions on balloon payments and prepayment penalties, and an ability-to-repay analysis tied to §1026.32 and §1026.34. The Dodd-Frank seller-financer exclusion under the SAFE Act removes the loan originator licensing question on a small number of carries each year, but it does not remove Regulation Z. This guide walks the coverage tests, the disclosures, the loan-feature limits, and the structural choices that keep a carry outside Section 32. Consult qualified legal counsel on whether a specific carry falls in or out of scope.

What is Section 32, and which seller carries fall in scope?

Section 32 of Regulation Z, 12 CFR §1026.32, sets the rules for a high-cost mortgage — a closed-end, consumer-purpose, dwelling-secured loan whose pricing crosses one of two coverage thresholds. A seller-carried note falls in scope when three conditions line up: the borrower occupies the property as a primary residence, the proceeds serve a consumer purpose rather than a business one, and the loan pricing crosses the APR spread test or the points-and-fees test. A carry on a rental house held for investment is outside Regulation Z because the loan is business-purpose. A carry on the borrower’s home is inside Regulation Z, and a carry inside Regulation Z that crosses either coverage threshold is a Section 32 loan.

Why does owner-occupied versus investor matter for the seller carry?

The owner-occupied versus investor distinction is the first gate the seller-carry holder walks through. A loan to an investor purchasing a rental or to a buyer purchasing a property for resale serves a business purpose under Regulation Z §1026.3(a), and Regulation Z does not apply — no Section 32 analysis, no truth-in-lending disclosures, no ability-to-repay file. A loan to a buyer purchasing the property to live in serves a consumer purpose, and Regulation Z applies in full. The occupancy status at origination is the record the seller files in the loan jacket — a signed occupancy affidavit, the buyer’s identification showing the subject-property address, and the homestead or owner-occupied hazard insurance binder. A seller who marks the loan as investor-purpose without the records to back the designation has a Regulation Z exposure that runs the full life of the note.

How do the Section 32 coverage tests work?

Section 32 applies one of two coverage tests, and crossing either one brings the loan in scope. The first test is the APR spread test: the loan’s annual percentage rate exceeds the average prime offer rate for a comparable transaction by more than the threshold in §1026.32(a)(1)(i). The threshold is higher for a first-lien loan above a statutory size, lower for a first-lien loan below that size, and lower still for a subordinate-lien loan. The second test is the points-and-fees test: the points and fees payable in connection with the loan exceed the threshold in §1026.32(a)(1)(ii), expressed as a share of the total loan amount for loans above a statutory size and as a dollar threshold for loans below it. The calculation of points and fees runs under §1026.32(b)(1) and covers most upfront charges the borrower pays at closing. A seller-carry that crosses either test is a Section 32 loan.

Expert Take

“Every seller carry on an owner-occupied home runs through the coverage tests in §1026.32 — that is not optional. The sellers I see in trouble are the ones who decided the rule did not apply to a private deal between two people. Section 32 does not draw a line between a bank loan and a private loan. It draws a line on pricing, and a private loan with a high rate is exactly the loan the rule was written for.” — Thomas Standen, President, Note Servicing Center

What disclosures does Section 32 require on a covered seller carry?

A covered Section 32 seller carry triggers a distinct disclosure package under §1026.32(c). The seller delivers the high-cost mortgage disclosure to the borrower at least three business days before closing, identifying that the loan is a high-cost mortgage, the APR, the regular monthly payment, the maximum monthly payment if the loan has a variable feature, the total loan amount, and the consequences of default. The disclosure form is separate from the truth-in-lending disclosures the loan also carries under §1026.18. The three-business-day window is a hard wait — the seller cannot close earlier than that, and rushing the closing voids the disclosure timeline. The signed disclosure goes into the loan file with a written record of the delivery date.

What loan-feature restrictions apply on a Section 32 seller carry?

Section 32 restricts the loan terms a seller-carry note carries on a covered loan. Balloon payments are prohibited under §1026.32(d)(1), with narrow exceptions for certain short-term bridge loans and certain seasonal-income loans — most seller-carries do not fit either exception. Prepayment penalties are prohibited under §1026.32(d)(6). Negative amortization is prohibited under §1026.32(d)(2). Advance payments financed by the loan proceeds are prohibited under §1026.32(d)(3). Acceleration of the debt at the lender’s sole discretion is restricted under §1026.32(d)(8). The combination of these restrictions removes the most common structural features sellers use to control risk on a private note — and a seller who closes a Section 32 carry without rewriting the note terms has a loan that violates the rule on day one.

What is the Dodd-Frank seller-financer exclusion, and where does it stop?

The Dodd-Frank Act amended the SAFE Act to exclude certain natural-person seller financers from the loan originator definition. Under the exclusion, an individual who finances the sale of a small number of properties in a calendar year — subject to conditions on the loan structure and on the individual’s relationship to the property — is not a loan originator for SAFE Act licensing purposes. The exclusion addresses one regulatory regime: the federal licensing requirement for mortgage loan originators. The exclusion does not address Regulation Z. A seller who falls inside the exclusion still owes the borrower the Regulation Z disclosures on a consumer-purpose dwelling-secured loan, still runs the Section 32 coverage tests if the loan is on an owner-occupied home, and still complies with §1026.32 and §1026.34 if the coverage tests pass. The exclusion is a licensing carve-out, not a Regulation Z carve-out.

How does a seller structure a carry to stay outside Section 32?

A seller carry stays outside Section 32 when at least one of the three coverage conditions does not line up. Three structural paths stand out. The first path is to carry only on investor-purpose loans — a rental purchase, a fix-and-flip purchase, a commercial-purpose dwelling — where the loan is business-purpose and Regulation Z does not apply. The second path is to price the carry below the APR spread threshold and below the points-and-fees threshold in §1026.32(a)(1) — a rate that tracks the average prime offer rate and an origination fee structure that stays inside the points-and-fees cap keeps the loan out of scope. The third path is to engage a licensed mortgage originator and a licensed servicer on the carry, run the loan as a fully disclosed consumer-purpose loan, and comply with §1026.32 in full. The first path is the cleanest for a seller who wants to avoid the rule; the third path is the cleanest for a seller who wants to carry the loan and comply.

Expert Take

“The sellers who do this well decide before the closing whether the carry is going to be inside Regulation Z or outside it, and they build the file around that decision. The sellers who do this badly close the loan first and ask the regulatory question second. By then the loan terms are set, the disclosures either ran or did not run, and the file either has the records or does not. The structural choice is made at the closing table, not in the loan servicing cycle.” — Thomas Standen, President, Note Servicing Center

What handoff points to a licensed servicer matter for Section 32 risk?

The handoff to a licensed servicer matters at four points on a Section 32 carry. The closing-table handoff transfers the disclosure timeline to a servicer that runs the three-business-day wait and delivers the Section 32 disclosure on the form Regulation Z requires. The boarding handoff transfers the ability-to-repay file under §1026.43 to a servicer that holds the underwriting records — the income documentation, the credit report, the debt-to-income calculation — for the life of the loan. The reporting handoff transfers the annual escrow analysis under §1024.17 and the periodic statements under §1026.41 to a servicer that produces the records on the schedule the rule requires. The examination handoff transfers the production-on-demand record set to a servicer that responds to a regulator within the window the rule sets. A seller who self-services a Section 32 carry takes on the full disclosure, the full underwriting file, the full annual reporting, and the full examination response — every duty Regulation Z places on a high-cost mortgage holder.

Frequently Asked Questions

Does Section 32 apply to a seller carry on an investor-owned rental?

No. Regulation Z applies to consumer-purpose loans secured by a dwelling. A loan to an investor purchasing a rental for business purposes is outside Regulation Z under §1026.3(a), and no Section 32 analysis applies. The seller documents the business-purpose nature of the loan in the loan file with the investor’s occupancy affidavit, the lease or rental plan, and the buyer’s identification showing a separate primary residence.

What is the average prime offer rate, and where is it published?

The average prime offer rate is the rate the Federal Financial Institutions Examination Council publishes weekly for a survey of prime-quality loans. The rate sits at ffiec.gov on the Average Prime Offer Rate page, with separate rates for fixed and adjustable loans across loan terms. The APR on a seller-carry loan compares against the rate for a comparable transaction at the date the rate is set under §1026.32(a)(3).

Can a seller-financed note include a balloon under Section 32?

Section 32 prohibits balloons on covered loans under §1026.32(d)(1) with narrow exceptions. A seller-carried note that is a covered Section 32 loan cannot include a balloon payment, in most cases. A seller who wants a balloon on a carry on an owner-occupied home structures the loan to stay outside Section 32 — or carries the loan on investor-purpose property where the rule does not apply.

Does the seller-financer exclusion remove the Section 32 obligation?

No. The seller-financer exclusion under the SAFE Act addresses federal mortgage loan originator licensing. It does not remove the Regulation Z disclosure obligations or the Section 32 coverage tests. A seller inside the exclusion still runs the Section 32 analysis on an owner-occupied carry and still complies with §1026.32 if the loan is covered.

What records do Section 32 examiners ask for?

The signed Section 32 disclosure with the delivery date, the truth-in-lending disclosure under §1026.18, the loan documents showing the rate and the payment schedule, the points-and-fees calculation under §1026.32(b)(1), the ability-to-repay file under §1026.43 with the income documentation, the annual escrow analyses under §1024.17, the periodic statements under §1026.41, and the borrower sub-ledger showing every payment posted over the life of the note. A loan file that produces this record set on demand is the file that survives an examination.

Does the seller need a federal mortgage originator license to carry a Section 32 loan?

The federal mortgage loan originator licensing question runs under the SAFE Act and depends on whether the seller falls inside the Dodd-Frank seller-financer exclusion. A seller who does not fall inside the exclusion is a loan originator under the federal definition and faces the SAFE Act licensing question regardless of Section 32. State licensing layers on top of the federal question and varies by state. Consult qualified legal counsel on the licensing analysis that applies in the seller’s state.

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