Loan Purpose – Consumer vs Business
Do you remember a l950’s television series called “Dragnet”, reenacting the cases of a dedicated Los Angeles police detective, Sergeant Joe Friday? Sergeant Friday would demand from suspects and witnesses “Just the facts, ma’am, just the facts.”
In today’s real estate lending environment, the Mortgage Broker and the loan underwriter need to identify “just the facts, ma’am, just the facts.” When the intended security property is a one to-four residential unit, the presumption is the loan transaction is a “consumer loan” and the facts will determine whether the loan is a “consumer loan” or a “business purpose loan.”
The Secured and Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act) is applicable requiring registration under the NMLS, as defined: “Mortgage loan originator”. An (MLO) means an individual who takes a residential mortgage loan application or offers or negotiates terms of a residential mortgage loan for compensation or gain.”
Depending on whether the security property is owner-occupied, the Truth and Lending Act (TIL) will be applicable and the Real Estate Settlement Procedures Act (RESPA) will apply whether the security property is owner or non-owner occupied. Consumer loans by definition are “federally related residential mortgage loans in which the primary use of the loan proceeds are for personal, family, or household purposes regardless of whether the security property is owner or non-owner occupied.” A consumer loan is also referred to, as noted above, “a residential mortgage loan.”
The burden of proof is on the lender and broker to establish a commercial-business purpose loan and, thus avoid the extensive body of Federal and State regulations which are intended to protect borrowers in consumer loan transactions and to limit the loan terms available to the lender. As well as control how the lender processes, documents, and underwrites the loan. I have a phrase that should be memorized by every practitioner,
“Document your file if the loan is intended for a business purpose.”
A common conclusion of practitioners who are considering a loan request is: “This is not the borrower’s primary residence; therefore, it is not a consumer loan.” An inappropriate conclusion based on insufficient facts. This limited evidence will not result in either the broker or lender having carried the burden of proof that the use of the loan proceeds are for commercial-business purposes.
It is the purpose and use of the loan proceeds and neither the collateral nor the occupancy as a primary residence which establishes whether the transaction falls under extensive and controlling Federal and State consumer laws.
Consumer lending laws will apply if the purpose and use of the loan is primarily for personal, family, or household purposes (even when the intended security property is other than a one-to four residential unit). For example, a gas station owner/operator who wants to re-finance his commercial property to consolidate personal debt such as credit cards, pay for his children’s college, purchase a car or pay for vacation, each fall under “consumer purpose”.
If the loan is to truly be for commercial-business purposes then the loan documents should contain evidence supporting this conclusion, including a hand-written Purpose and Use of Loan Proceeds declaration from the borrower. Other evidence may include:
- Evidence that the borrower is actively participating in the business for which the loan proceeds are intended;
- Confirmation letter from borrower’s attorney;
- Business financials and tax returns;
- Evidence that a substantial majority of the loan funds are being used for business purposes;
- Demands for payment of debts to be discharged from the loan proceeds addressed to borrower’s business;
- Business purpose projections resulting from the new loan proceeds;
- Borrower’s evidence of other loans and/or credit card debt to be paid off as part of a business purpose loan;
- Internet based research to verify the existence of the business entity.
Warning: the difficulty will come when the lender and broker are sued by the borrower claiming each knew the real purpose and use of the loan proceeds were for “consumer purposes.”
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