QUESTION
I am a loan officer and work for a mortgage broker. I can’t figure out if a loan I’m doing is for a person or a business. My boss says that the regulations determine what is considered a consumer loan or a business loan. My borrower wants to put a mortgage on a residential property.
But my boss can’t tell me which regulations to look at; frankly, even if I did, I’m not a lawyer and would probably not get it straight. But he says I have to figure it out for myself if I am doing a consumer loan. I tried a search engine, and that only confused me. At this point, I can tell there are consumer loans and business loans.
I don’t want to look dumb to my customer, but I feel pretty stupid that I don’t really know the difference between business and consumer loans – probably because I have never had this issue before! I need to know what kind of application I’m doing. I hope you can help.
Maybe this is a dumb question, but what is a consumer?
Is there a sliding scale or some way to figure out if this is a consumer loan?
ANSWER
Thank you for your question. Your question is valuable! I think you’d be surprised how many people in the mortgage community do not know the answer to this question. In my long life, I have found that questions are not dumb, only the answers.
Let’s briefly tour the Truth-in-Lending Act (TILA) to understand how the term “consumer” has been fashioned. There is a lot of statutory and case history here, but I will try to boil it down to the basics.
TILA defines the “consumer” credit transaction as
“… one in which the party to whom credit is offered or extended is a natural person, and the money, property, or services which are the subject of the transaction are primarily for personal, family, or household purposes.”
Note the word “purposes.” This means that the purpose of the loan is an essential part of the definition. The consumer credit transaction is a consumer-purpose transaction concerning its primary use.
Regulation Z, which implements TILA, defines “consumer” as a
“… cardholder or a natural person to whom consumer credit is offered or extended.”
This definition references Regulation Z’s definition of “consumer credit,” which means
“…credit offered or extended to a consumer primarily for personal, family, or household purposes.”
For rescission,[i] the term “consumer” also includes a natural person whose security interest is or will be retained or acquired if their ownership interest in the dwelling is or will be subject to the security interest.
The regulation includes one exception to the rule that a consumer must be either a natural person (or a cardholder). Credit extended to trusts is considered consumer credit extended to a natural person if the trust has been established for tax or estate planning purposes or as a land trust.
The term “consumer” also includes a “confirmed successor in interest” with respect to Regulation Z’s provisions regarding escrow account closing notices, adjustable-rate mortgage adjustment notices, crediting of payments, late charge pyramiding, payoff statements, mortgage transfer disclosures, and periodic statements.
So, Regulation Z includes a general definition of “consumer” for most sections of the regulation and a special definition that applies to the right of rescission. (The general rule includes only natural persons or cardholders to whom consumer credit is offered or extended.) This means that persons such as endorsers, guarantors, or sureties generally are not “consumers” for purposes of the general rule.
The special rule for rescission, however, broadens the definition to include any natural person, including a guarantor, surety, or person who is not even liable on the credit transaction, when that person’s home is subject to the security interest. That person has the right to receive the “material disclosures” required by Regulation Z, including the notices of the right to cancel, and, subject to Regulation Z’s specific requirements, may rescind the transaction.
As you might expect, determining whether or not a person is a “consumer” can become more complicated than the foregoing black letter law might suggest, as often is the case with regulatory definitions.
The phrase “personal, family, or household purposes” illustrates the possible difficulties. This phrase arises in both the statutory and Regulation Z definitions of “consumer” and “consumer credit” as well as in TILA’s exemption of “credit transactions involving extensions of credit primarily for business, commercial, or agricultural purposes.”[ii]
Regulation Z specifically acknowledges this complication thus:
“Primary purpose. There is no precise test for what constitutes credit offered or extended for personal, family, or household purposes, nor for what constitutes the primary purpose.”[iii] (My emphasis.)
In effect, Regulation Z admits a case-by-case evaluation is needed to determine if a loan is consumer-purpose.[iv] Or, as your colleague told you, “figure it out” for yourself!
But there are guidelines and standards, and I will provide a few to consider.
Disclosures
When in doubt, proceed cautiously. Here’s one maxim!
For practical purposes, Regulation Z makes clear that if a creditor is uncertain whether its requirements apply, the creditor may choose to make TILA disclosures without waiving the business purpose exemption:
“Primary purposes. A creditor must determine in each case if the transaction is primarily for an exempt purpose. If some question exists as to the primary purpose for a credit extension, the creditor is, of course, free to make the disclosures, and the fact that disclosures are made under such circumstances is not controlling on the question of whether the transaction was exempt.”[v]
Sliding Scale Guidelines
You asked if there’s “a sliding scale or some way to figure out” if you’re originating a consumer loan. Regulation Z offers general factors[vi] to consider in determining whether a transaction is primarily for a consumer or business purpose, as follows:
(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; and
(5) the borrower’s statement of purpose for the loan.
Examples of business credit transactions would be a loan to expand a business, even if secured by the borrower’s residence or personal property; a loan to improve a principal residence by putting in a business office; or a business account occasionally used for consumer purposes.
Jonathan Foxx, Ph.D., MBAChairman & Managing Director
Lenders Compliance Group
[i] Regulation Z §§ 1026.15 and 1026.23
[ii] 15 USC § 1603(1)
[iii] Comment 2(a)(12)-1
[iv] Comment to § 1026.3(a)
[v] Comment 3(a)-1
[vi] Comment 3(a)-3
