This is a question that comes up frequently. Lenders and brokers are sometimes
shocked that the answer is yes, so long as the proceeds of the loan will
be used for a business purpose. Generally speaking, a business purpose
loan is a loan in which the loan funds are used for a purpose
other than a personal, family or household purpose. This applies even if the borrower
lives in the property that is securing the loan.
The distinction between a business purpose and consumer purpose loan is
important as business purpose loans are explicitly exempt from the burdensome
regulations imposed by the federal Truth in Lending Act (“TILA”)
and Real Estate Settlement Procedures Act (“RESPA”). Consumer
loans are subject to enhanced licensing requirements, additional disclosure
requirements, in addition to cumbersome substantive protections. For example,
in California, to make a consumer purpose loan, a lender must be licensed
by the Bureau of Real Estate (“BRE”) or by the Department
of Business oversight (“DBO”), and also have a Nationwide
Mortgage Licensing System (“NMLS”) endorsement. However, to
make a business purpose loan, a license from the BRE or DBO is required,
but the NMLS endorsement is not.
Business Purpose loans are subject to fewer regulations, as they are specifically
exempt from TILA and RESPA. To figure out if a loan is a business purpose
loan, ask the following question at the time of originating the loan: “what is the primary
purpose of the loan?” The good news is that TILA provides some guidelines for determining
if a loan is business purpose: (1) the more closely related the borrower’s
primary occupation is to the acquisition, the more likely it is to be
business purpose; (2) the more personal involvement there is in managing
the acquisition, the more likely it is to be business purpose; and (3)
the higher the ratio of income from the acquisition to borrower’s
income, the more likely it is to be business purpose; and, (4) the borrower's
statement of purpose for the loan, in which the borrower describes the
intended use of the loan funds.
Moreover, TILA provides explicit examples of business purpose loans, and
actually uses owner-occupied properties in its examples. A business purpose
loan could be a loan to expand an existing business, even if it is secured
by the borrower’s primary residence. It could even be a loan in
which the borrower is using the loan proceeds to build a home office and
is securing the loan with his principal residence. So long as the loan
funds are used for a business need, and not for a personal, family or
household use, then it is still considered a business purpose loan that
is exempt from TILA and RESPA even though the borrower resides in the property.
A multi-unit owner-occupied rental property can also be considered a business
purpose loan under certain circumstances. If the purpose of the loan is to
acquire the rental property and it contains
more than 2 housing units, then it is considered a business purpose loan. If the
purpose of the loan is to
improve or maintain the rental property and it contains
more than 4 housing units, then it can be categorized as a business purpose loan.
For example, if a borrower was purchasing a duplex to live in one unit,
and rent out the other unit, it would not be considered business purpose,
because there must be
more than two units. What if the borrower applies for a loan to remodel the kitchens
in all the units, and he lives in one of the units? So long as there are
at least five units, it would be considered a business purpose loan.
There are also instances in which a loan has both a consumer purpose and
a business purpose. In these circumstances, the deciding factor is the
primary purpose of the loan funds. Generally if more than half of the funds are
used for a business purpose, with the remainder used for a consumer purpose,
the loan will be considered a business purpose loan and will be exempt
from TILA and RESPA, subject to the four factors identified above.
It is possible to make a business purpose loan that is owner-occupied so
long as the proceeds are to be used for a purpose
other than a personal, family or household purpose. As discussed above, TILA even
provides examples of business purpose loans in which the borrower lives
in the subject property. The correct question to ask is what the funds
are to be used for. If after asking this question, the answer is definitively
yes, and if the property is also owner occupied, then there are safeguards
that the lender can take to protect itself. The lender should obtain a
handwritten, signed and dated statement from the borrower at time of application
in which the borrower explains the purpose of the loan funds. At loan
closing, the lender should also include a Business Purpose of Loan form
in the loan document package, which includes blank lines the borrower
fills in stating the purposes of the loan proceeds and the amount allocated
to each purpose which is signed under penalty of perjury. Additionally,
if possible, the loan proceeds should be disbursed to the borrower’s
business account at closing, rather than to a personal account. Taking
these measures and correctly documenting the business purpose of the loan
could ultimately protect the lender should the borrower file suit later
down the line and claim that the loan was for a consumer purpose.
Geraci Law Firm is dedicated to the representation of lenders, brokers
and other real estate professionals. The firm has fourteen attorneys with
experts in securities, lending compliance, document preparation, litigation
and secured creditors’ rights.
 This article addresses only the federal regulations, TILA and RESPA. Some
states may have additional licensing requirements and substantive regulations
for loans that are owner-occupied regardless of the purpose of the loan.
If you would like more information on this topic, or would like to set
up a free consultation, please call the main office line at (949) 298-8050 or
email Jaspreet Kaur, Esq.