Consumer Purpose Loans

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., MBA
Chairman & Managing Director
Lenders Compliance Group

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[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

Living Trusts: Rescission

QUESTION
We have several loans involving living trusts. One of them came to our attention because the borrower wants to rescind the loan we made to a living trust that he set up for his nephew's benefit. We made this loan just two days ago for improvements of a large patio and other structures.

But this was a loan to our borrower, not the nephew.

So, may we refuse to rescind by claiming the loan was to a trust and, therefore, not a consumer loan?

ANSWER
This question's resolution may be found in Regulation Z, Comment 3(a)-10, which provides that credit extended for consumer purposes to certain trusts is considered to be credit extended to a natural person rather than credit extended to an organization.

Expressly noted in the section for Trusts for Tax or Estate Planning Purposes:

In some instances, a creditor may extend credit for consumer purposes to a trust that a consumer has created for tax or estate planning purposes (or both). Consumers sometimes place their assets in trust, with themselves or themselves and their families or other prospective heirs as beneficiaries, to obtain certain tax benefits and to facilitate the future administration of their estates.

During their lifetimes, however, such consumers may continue to use the assets and/or income of such trusts as their property. A creditor extending credit to finance the acquisition of, for example, a consumer’s dwelling that is held in such a trust, or to refinance existing debt secured by such a dwelling, may prepare the note, security instrument, and similar loan documents for execution by a trustee, rather than the beneficiaries of the trust.

Regardless of the capacity or capacities in which the loan documents are executed, assuming the transaction is primarily for personal, family, or household purposes, the transaction is subject to the regulation because in substance (if not form) consumer credit is being extended.

We don’t know categorically about a living trust, but it sounds as though it’s the sort of trust contemplated in Regulation Z, Comment 3(a)-10. I say this because the U.S. Court of Appeals for the 9th Circuit recently considered a similar situation.[i]

Here’s what happened.

As trustee of the Lou Ross Easter trust, Gilliam obtained a loan from Levine to finance repairs to a residential property that was the main asset of the trust. The property was the security for the loan. The borrower’s sister, Lou, had created the trust for the benefit of Lou’s daughter. After Lou died, Gilliam became the trustee. Gilliam obtained the loan to make repairs to the property, so her niece, as the sole beneficiary of the trust, could continue to reside there.

But Gilliam sued Levine for rescission and damages, alleging that Levine had violated TILA by failing to disclose the payment schedule accurately. Levine argued that the loan was not a consumer credit transaction because the trust property securing the loan was not the borrower’s primary residence, even though it was her niece's residence.

And here’s the decision, in brief: The district court dismissed the complaint, finding that the loan was not a consumer credit transaction. The district court mentioned the Regulation Z Commentary as the source for determining whether a transaction is for business purposes under RESPA, but did not mention Comment 3(a)-10.

Levine appealed, and, on appeal, Levine asserted that, as a general rule, a trust does not qualify as a natural person under TILA and cannot be a party to a consumer credit transaction, subject only to a limited exception when the loan is to finance the residence of the trustee.

Then, the 9th Circuit reversed. It held that Gilliam sufficiently alleged that the loan was obtained for a consumer purpose. It decided that Comment 3(a)-10 provides that a loan for “personal, family, or household purposes” of the beneficiary of this type of trust is a consumer credit transaction. The Comment explains that “[r]egardless of the capacity…in which the loan documents are executed,” trusts should be considered natural persons under TILA, so long as the transaction was obtained for a consumer purpose because “in substance (if not form) consumer credit is being extended.”

Thus, the lender’s argument attempted to draw an artificial distinction between a loan obtained for the benefit of the trustee alone and a loan obtained to benefit trust beneficiaries.

According to the 9th Circuit, the issue was one “of first impression under federal and state regulation of consumer credit transactions.” 

Worth mentioning is that, in addition to TILA, Gilliam included claims under California’s Rosenthal Act and RESPA. Finding the definitions of consumer credit transaction identical under TILA and the Rosenthal Act, and that RESPA’s definition required only that the transaction be for a consumer purpose, the 9th Circuit concluded that transactions such as this one should be regarded as consumer credit transactions under all three statutes. 

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director

Lenders Compliance Group

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[i] References: Gilliam v. Levine, 955 F.3d 1117 (9th Cir. Apr. 14, 2020)

Consumer Loans and TILA

QUESTION

I am the Associate General Counsel for a bank. Recently, the attorney for one of our credit card borrowers wanted to claim TILA protections. This request has come up several times. I wonder if you would provide some insight into this issue. 

My question, therefore, is do commercial borrowers have access to TILA protections?

ANSWER

I will tell you that this particular request is going to continue to come up no matter what you do. It is one of those questions that never seems to age with time!

Many lawyers know that the Truth-in-Lending Act (TILA) generally does not apply to loans primarily for business, commercial, or agricultural purposes. Portions of Regulation Z governing the issuance of credit cards and the liability for their unauthorized use apply to all credit cards, even if the credit cards are issued for use in connection with extensions of credit that otherwise are exempt

Regulation Z Comment 3(a)-2, which was added in December 2008, explains that if a business purpose credit card is issued to a person, the provisions of the regulation do not apply, other than as provided in §§ 1026.12(a) and (b) (viz., the provisions that govern card issuance and liability for unauthorized use), even if extensions of credit for consumer purposes are occasionally made using that business purpose card.

For instance, the billing error provisions of § 1026.13 do not apply to consumer purpose extensions of credit using a business purpose credit card. The comment also looks at the converse situation, and explains that if a consumer purpose credit card is issued to a person, the provisions of the regulation apply, even to occasional extensions of credit for business purposes made using that consumer purpose credit card. As an example, a consumer may assert a billing error with respect to any extension of credit using a consumer purpose card, even if the specific extension of credit on the credit card or open-end credit plan that is the subject of the dispute was made for business purposes.

Some bank lawyers have wondered whether a commercial borrower might become entitled to TILA protections if their bank funnels a commercial transaction into the consumer loan pipeline, whether intentionally or not. For example, a bank might find it convenient to handle certain types of loans, such as a loan to finance the purchase of a motor vehicle, under the same policies and procedures it applies to a consumer’s purchase of a car. Does the bank’s provision of TILA and other consumer disclosures bind the bank to TILA compliance for that loan?

I think you may want to look at a recent case for some guidance. A federal district court in Florida (in dicta) recently rejected a business borrower’s argument that the bank’s provision of TILA disclosures had bound the bank to TILA’s regulatory requirements. However, the court did not disavow the possibility of a breach of contract claim. [Penton v. Centennial Bank, 2019 U.S. Dist. (N.D. Fla. Nov. 22, 2019)].

Penton obtained a loan from Centennial Bank to purchase real estate. The loan documentation indicated the loan purpose was to “purchase investment home.”

Penton sued the bank and other defendants, alleging, among other things, that the bank had violated TILA by failing to disclose a kickback scheme among the bank and insurance providers to give the insurance providers the exclusive right to monitor the bank’s mortgage portfolio and force-place insurance.

However, the court dismissed the complaint because TILA exempts credit transactions primarily for business, commercial, or agricultural purposes.

The court rejected Penton’s argument that the promissory notes referenced TILA and therefore indicated that the parties intended to be bound by TILA. Alternatively, the court held that even if the parties had intended for TILA to govern their relationship, the bank’s failure to live up to TILA’s terms would constitute a breach of contract rather than a TILA violation.

So, the court highlighted a claim Penton should have made, but apparently did not make. He should have sued for breach of contract! If he could show that the promissory notes had incorporated the provisions of TILA – or perhaps better yet for Penton, the Real Estate Settlement Procedures Act (RESPA) – into the terms of the business loan transaction, then the lender’s failure to comply with TILA (or RESPA) would constitute a breach of contract.

Maybe you should explore that angle!

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
Lenders Compliance Group

Procedures for Fraud and Active Duty Alerts

QUESTION

Does a consumer reporting agency have any obligations regarding fraud and active duty alerts? Also, as a lender, what procedures do we have to follow if the credit bureau notifies us of existing fraud or an active duty alert?

ANSWER

Your first question requires an extensive response. However, I think a brief statement can be helpful. The FCRA imposes various obligations on consumer reporting agencies concerning fraud and active duty alerts. The obligations include the requirement to notify prospective users of a consumer report on a consumer who has placed an alert in his or her file that the consumer does not authorize the establishment of a new credit plan or extension of credit (other than under an existing open-end credit plan), unless the user follows certain procedures set forth in the FCRA. [15 USC §§ 1681c-1, 1681c-2]

So, this leads to a brief outline of certain procedures. When a consumer report reflects an existing initial fraud alert or active duty alert, to establish a new credit plan or an extension of credit (other than under an open-end plan) in the name of the consumer, or to grant any increase in the credit limit on any existing credit account, the prospective user must: 

1. Utilize reasonable policies and procedures to form a reasonable belief that the user knows the identity of the person making the request; and

2. If the consumer requesting the alert specified a telephone number to be used for identity verification purposes, either:

a. Contact the consumer at the telephone number; or

b. Take reasonable steps to verify the consumer’s identity and confirm that the application for a new credit plan is not the result of identity theft. [15 USC § 1681c-1(h)(1)] 

To handle procedures for when a consumer report reflects an existing extended fraud alert, to establish a new credit plan or an extension of credit (other than under an open-end plan) in the name of the consumer, or to grant any increase in the credit limit on any existing credit account, the prospective user must contact the consumer in person or use the contact method designated by the consumer to confirm that the application for a new credit plan or increase in credit limit is not the result of identity theft. [15 USC § 1681c-1(h)(2)]

Jonathan Foxx, Ph.D., MBA

Managing Director

Lenders Compliance Group

Rental Property Rule

QUESTION

We hear a lot about consumer purpose versus business purpose loans. Our particular interest is in wanting to know about the “rental property rule.” So, what is the “rental property rule” and what is its effect on consumer purpose loans?

ANSWER

Use the Truth in Lending Act’s Regulation Z to determine whether a loan is for a consumer purpose or a business purpose. In making this determination, you need to be familiar with the Regulation Z commentary to 12 CFR 1026.3(a). The commentary lists a number of general factors you should use in determining whether a loan is a consumer-purpose or business-purpose loan.

In addition, the comments provide specific guidance regarding rental property.

Here are some guidelines for the rental property rule:

· If the proceeds of a loan are to be used to acquire, improve, or maintain rental property, and the borrower expects to occupy the property for 14 days or less in the coming year, the loan is considered to be for non-owner-occupied property and, therefore, is a business-purpose loan.

· If the borrower will occupy the property for more than 14 days in the coming year, the loan is considered to be for owner-occupied property, and the rental property rule would not apply. In this case, there are some additional guidelines to follow:

o   If the proceeds of a loan are to be used to acquire, improve, or maintain rental property, and the borrower expects to occupy the property for 14 days or less in the coming year, the loan is considered to be for non-owner-occupied property and, therefore, is a business-purpose loan.

o   If the purpose of the loan is to improve or maintain the property, the loan is a business-purpose loan if the property contains more than four housing units.

A property that contains fewer than the required number of units under a particular test might still be a business-purpose loan based on the general factors used to determine business purpose, which is why familiarity with the commentary is necessary. The 14-day rule is used as a general guide. However, keep in mind that other factors also may affect the determination of whether a loan is for business purposes.

Jonathan Foxx

Managing Director

Lenders Compliance Group

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

Business Purpose and Consumer Purpose Loans

QUESTION:
We need to know the difference between business purpose and consumer purpose loans. How do we distinguish between them and can you give us a few examples? Also, is a non-owner occupied rental property or an owner-occupied rental property considered business purpose?

ANSWER: 

There are at least five primary factors that must be considered in order to determine business purpose from consumer purpose. In general, these are:

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.

Admittedly, the foregoing criteria may seem somewhat subjective. Nevertheless, these are the five factors that should be applied in the loan origination process. (12 CFR Supplement I to Part 226, Official Staff Commentary 226.3(a)-3.i)

For examples of each, guidance is provided in Regulation Z, as follows:

Examples of business purpose include:

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

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

C. A business account used occasionally for consumer purposes.

Examples of consumer purpose include:

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

B. A loan secured by a mechanic's tools to pay a child's tuition.

C. A personal account used occasionally for business purposes.

(12 CFR Supplement I to Part 226, Official Staff Commentary 226.3(a)-3.i-ii)

To your question about non-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)

There are two rules involved in determining business purpose of owner-occupied rental property. Rule 1: 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. Rule 2: 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)

Jonathan Foxx
President & Managing Director
Lenders Compliance Group