“Private lenders, and the originators
they work with, must exercise an ounce of
prevention on the front end of a loan deal
to ensure that a business-purpose
designation is appropriate.”
<< Probe continued from Page 58
While loans to natural persons require the private money
lender to determine at the outset whether the proposed loan
has a business or consumer purpose, a correct designation as
a business-purpose financing allows the private money lender
to originate the loan to a natural person without having to
comply with the TILA. Moreover, even loans to a natural person
that are secured by owner-occupied residential properties
may qualify as business-purpose loans.
Some examples are provided by the Consumer Financial
Protection Bureau (CFPB). Those include a loan to expand a
business, even if it is secured by the borrower’s residence or
personal property. Another is a loan to improve a principal
residence by putting in a business office. Another example
of business-purpose financing is a loan to acquire a rental
property that is or will be owner-occupied within the coming
year, if the property contains more than two housing units.
Details of the loan
Several factors must be considered when evaluating whether to
extend credit for the purchase of owner-occupied properties
for a business purpose. The first is what is the borrower’s
statement describing the purpose of the proposed loan.
A statement from a proposed borrower that the
proceeds of the loan will be used for a child’s school
tuition, a medical expense or to go on a family vacation,
indicates a consumer purpose. A mixed-purpose loan (part
business, part consumer), may still result in a lender properly
designating a loan as having a business purpose.
If a borrower is a licensed contractor who is going to use
some of the proceeds of a loan to buy a truck to use for work
and for personal purposes, for example, this could still qualify
as a business-purpose loan. An originator working with a lender,
however, must look deeper into the proposed loan before
making the business-purpose determination. This would include
determining, among other things, if the proposed borrower has
any other vehicles that are used for personal purposes.
Originators also should determine if there’s correlation
between the borrower’s occupation and the use of the
loan proceeds. If a dentist, for example, proposes to use the
loan proceeds to expand a dental practice or to modernize
equipment, such as to purchase chairs and X-ray machines, this
would have a greater likelihood of being for a business purpose.
Whether the borrower will personally manage the assets
purchased with the loan proceeds is another factor to consider.
To qualify as a business purpose, a borrower who will use
the loan proceeds to buy an asset, enterprise, or to make an
investment, must have a high degree of personal involvement
in the asset’s management. If a borrower plans to use loan
proceeds to purchase stock in a real estate holding company
where the borrower doesn’t work, for example, that likely
would be deemed a personal investment and a consumer-purpose loan, not a business-purpose loan.
In addition, the larger the size of the transaction, the
more likely it is that the loan being used to fund it will be
deemed to have a business purpose. The CFPB tends to take
the view that individuals are less likely to need large loans for
Finally, the amount of income derived from the property
acquired by the loan proceeds also is a factor in determining
whether it has a consumer or business purpose. The less
income derived from the acquired property or asset, the more
likely the loan will be deemed to have a consumer purpose.
The CFPB is usually inclined to presume that the acquisition of
an asset that is income-producing is more likely than not to be
for a business purpose.
To the extent that there is one type of loan for which
the CFPB does not see a “twilight zone” gray area between
a business or consumer purpose, it is a loan secured by a
nonowner-occupied rental property. Credit extended to
acquire, improve or maintain a rental property (regardless of
the number of housing units) that is not owner-occupied is
deemed to be for business purposes.
n n n
Business-purpose loans are the lifeblood of the private money
lending industry. To keep that lifeblood pumping, private
money lenders, and the originators they work with, must
exercise an ounce of prevention on the front end of a loan deal
to ensure that a business-purpose designation is appropriate.
This due diligence will go a long way in preventing the
private money lender from unwittingly making
a consumer-purpose loan and potentially
suffering a big hit to the bottom line later on
as a consequence of that mistake. n