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Simplifying Business Purpose Loans

I have been representing private money lenders for the better part of five years now.  One of the most frequently asked question I get is whether or not private money loans are considered business or commercial loans.  If private money loans are business or commercial neither Truth In Lending Act (“TILA”), 15 U.S.C. § 1601 et. seq. and its implementing regulation known as Regulation Z, 12 C.F.R. Part 1026 (“Regulation Z”) nor Real Estate Settlement Procedures Act (“RESPA”), 12 U.S.C. § 2601 et. seq. and its implementing regulation known as Regulation X, 12 C.F.R. Part 1024 (“Regulation X”) are applicable to the loan transaction. 

TILA and Regulation Z distinguish the “purpose” criterion from the “borrower” criterion, making it clear that that the identity of the borrower and the loan purpose are distinct, separate analysis, each on their own may exempt a credit transaction from TILA’s reach. 

In most cases, a consumer will be as defined under TILA and by Regulation Z, as "a natural person to whom consumer credit is offered or extended."  Generally speaking, the definition of "natural person" doesn't include entities  TILA and Regulation Z both clearly state that the law’s provisions do not apply to an extension of credit (i) to other than a natural person or (ii) primarily for a business or commercial purpose.  12 C.F.R. §1026.3(a)(2); 15 U.S.C. § 1603.   Specifically, 15 U.S.C. § 1603 states: 

     This subchapter does not apply to the following: 

          (1) Credit transactions involving extensions of credit primarily for business, commercial, or agricultural purposes, or to government or governmental agencies or instrumentalities, or to organizations.

Regulation Z reiterates the exception in 12 C.F.R. § 1026.3(a)(2), which states:

     This part does not apply to the following:

          (a)  Business, commercial, agricultural, or organizational credit.

Similar to TILA and Regulation Z, RESPA and Regulation X clearly state that the laws provisions to not apply to extensions of credits for business or commercial purposes. 12 U.S.C.  § 2606; 12 C.F.R. 1024.5.   12 U.S.C.  § 2606 states:

     This chapter does not apply to credit transactions involving extensions of credit –

         (1)   Primarily for business, commercial or agriculture purposes

Regulation X states an extension of an extension of credit primarily for a business, commercial, or agricultural purpose, as defined by 12 CFR 1026.3(a)(1) of Regulation Z is exempt from the provisions of RESPA.  Regulation X further states that persons may rely on Regulation Z in determining whether the exemption applies.

The Official Staff Commentary to Regulation Z provides a more in depth analysis of the business purpose exemption.  The commentary pertains to a business acquisition, but the guidance can be helpful in understanding any stated loan purpose that might fall under the exemption.

The commentary says that the following factors should be analyzed to determine business purpose of consumer purpose:

1.      The relationship of the borrower's primary occupation to the acquisition. The more closely related, the more likely it is to be business purpose.

2.      The degree to which the borrower will personally manage the acquisition. The more personal involvement there is, the more likely it is to be business purpose.

3.      The ratio of income from the acquisition to the total income of the borrower. The higher the ratio, the more likely it is to be business purpose.

4.      The size of the transaction. The larger the transaction, the more likely it is to be business purpose.

5.      The borrower's statement of purpose for the loan. (12 CFR Supplement I to Part 226, Official Staff Commentary 226.3(a)-3.i)

The above criteria are somewhat subjective, but they five factors cannot and should not be ignored during the loan origination process.  The commentary does however provide examples of business purpose loans and consumer purpose loans (12 CFR Supplement I to Part 226, Official Staff Commentary 226.3(a)-3.i-ii).

Examples of business purpose loans include:

1.       A loan to expand a business, even if it is secured by the borrower's residence or personal property.

2.      A loan to improve a principal residence by putting in a business office.

3.      A business account used occasionally for consumer purposes.

Examples of consumer purpose loans include:

1.       Credit extensions by a company to its employee or agents if the loans are used for personal purposes.

2.      A loan secured by a mechanic’s tools to pay a child’s tuition

3.      A personal account used occasionally for business purposes.

In determining the "primary purpose" of a loan (business or consumer), the focus of the inquiry is not on the nature of the property securing the loan, but rather on the borrower's motive for obtaining the loan, determining the true business purpose of a loan is the responsibility of the lender.  Thus, a loan secured by the borrower's personal residence is nevertheless deemed to have a "business purpose" if the proceeds are intended, for example, to start or improve a business (including a home business); to improve a principal residence by putting in a business office; or to pay off business-related debts.

The last important piece with respect to many private money loans is the applicability of TILA to non-owner occupied rental property and owner occupied rental property.  

  • Credit extended to acquire, improve or maintain rental property (regardless of the number of units) that is not owner-occupied is deemed to be business purpose. If the owner expects to occupy the property for more than 14 days during the coming year, the property cannot be considered non-owner occupied. (12 CFR Supplement I to Part 226, Official Staff Commentary 226.3(a)-4).
  • If credit is extended to acquire, improve, or maintain rental property that is or will be owner-occupied within the coming year, different rules apply: 
    • If credit is extended to acquire rental property that is or will be owner-occupied within the coming year, the rental property is deemed to be business purpose if it contains more than 2 housing units.
    • If credit is extended to improve or maintain rental property that is or will be owner-occupied within the coming year, the rental property is deemed to be business purpose if it contains more than 4 housing units. Neither of these rules means that an extension of credit for property containing fewer than the requisite number of units is necessarily consumer purpose. In such cases, the determination of whether it is business purpose or consumer purpose should be made by considering the five factors listed above. (12 CFR Supplement I to Part 226, Official Staff Commentary 226.3(a)-5.i-ii)

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