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Thursday, August 13, 2015

Business or Commercial Purpose

QUESTION
It is our understanding that TILA exempts extensions of credit primarily for a business, commercial or agricultural purpose. What is a business or commercial purpose loan? Are there any factors that we can use to determine if the loan is for a business or commercial purpose?

ANSWER
Regulation Z does not expressly define what an extension of credit for a business or commercial purpose is, though applicable Commentary does offer some guidance with respect to what is credit for a business or commercial purpose that is exempt from TILA and what is consumer credit that is subject to TILA.

In order to be exempt from TILA, the primary purpose of a credit transaction must be for a business or commercial purpose. Generally, there are determinative factors. As it pertains to residential mortgage lenders, these factors bifurcate into two types of credit extensions and special rules, one applying to non-owner occupied rental property and the other applying to owner-occupied rental property.

Certain factors must be considered in determining whether a credit transaction is for a business purpose or a consumer purpose. These are:
  1. The relationship of the borrower’s primary occupation to the acquisition. That is, 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 Supp. I to Part 226, Official Staff Commentary § 226.3(a)-3.i]
Examples of business purpose credit are:
  1. Loans 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 building into it a business office.
  3. A business account used occasionally for consumer purposes. [12 CFR Supp. I to Part 226, Official Staff Commentary § 226.3(a)-3.i]
Examples of consumer purpose credit are:
  1. Credit extensions by a company to employees 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. [12 CFR Supp. I to Part 226, Official Staff Commentary § 226.3(a)-3.ii]
Consider also the special rules. Credit extended to acquire, improve, or maintain rental property that is not owner-occupied is deemed to be for a 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 and the special rule would not apply. [12 CFR Supp. I to Part 226, Official Staff Commentary § 226.3(a)-4]

Furthermore, credit extended to acquire owner-occupied rental property is deemed to be for a business purpose if it contains more than two housing units; and credit extended to improve or maintain owner-occupied rental property is deemed to be for a business purpose if it contains more than four housing units. [12 CFR Supp. I to Part 226, Official Staff Commentary § 226.3(a)-5]

Finally, a credit transaction involving real property that includes a dwelling, such as a farm with a homestead, is exempt from TILA if the transaction is primarily for agricultural purposes. [12 CFR Supp. I to Part 226, Official Staff Commentary § 226.3(a)-8]

Jonathan Foxx
President & Managing Director
Lenders Compliance Group