Private Money Expert Witness / Direct Lender
What is the business purpose exemption?
The business purpose exemption, (“BPE”) applies to real estate loans that are for business purposes, as opposed to loans that are for consumer purposes, possibly making them exempt from certain laws, regulations, and practices.
To whom is this important?
Private money lenders (hard money lenders) may not impose the difficult qualifying standards that institutional lenders/investors, such as Federally Insured Banks, Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association, (FNMA) or other institutional lenders, investors, or mortgage insurers impose when making loans.
Laws, regulations, and practices may require that lenders making consumer purpose loans (loans primarily for personal, family, or household use) concern themselves with the borrower’s ability to repay. If a lender can rely on the Business Purpose Exemption, they may be able to avoid some concerns as to how they considered the borrower’s ability to repay.
Private money loans, also referred to as “hard money loans,” are real estate loans that are made by private or semi-private investors, as mentioned before, with often less-stringent qualifying or underwriting requirements as compared to institutional lenders.
What loans are affected?
1-4 family residences, the largest percentage of loans relying on the BPE, have risen in value greatly, providing large protective equities to secure loans. These properties are generally saleable in the event the lender becomes the property owner. They are often the easiest collateral to evaluate and for lender/investors to understand.
When owners or buyers of these properties can’t or don’t have time to meet the standards and documentation of institutional lenders, they may be excellent prospects for mortgage loan brokers who are making or arranging private money loans and corresponding trust deed investments.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) imposed qualifying requirements largely related to a borrower’s ability to repay the loan, that apply to consumer-purpose loans secured by 1-4 family residences. Therefore, most of the loans relying on the business purpose exemption would be loans on 1-4’s. With consumer-purpose loans secured by properties other than a 1-4 family dwelling, borrower qualification issues may not be required, but if the loan is made to a consumer for consumer purposes, compliance with applicable portions of Regulation Z (TILA) may still be necessary.
“Properties other than 1-4” refers to properties consisting of 5 or more residential units, retail, office, warehouse, or other non-residential properties.
Why do lenders want the exemption?
The Home Ownership and Equity Protection Act, (“Section 32”) enacted in the 1994, placed restrictions on making consumer purpose loans to owner occupants and in some cases, required consideration of the borrower’s ability to repay. Since “Section 32,” continuing through to Dodd-Frank and then to the present, there have been consistent efforts to pass laws restricting lending to consumers when loans were secured by a 1-4 family properties. While the majority of these laws apply to any consumer-purpose loan secured by a 1-4 family dwelling, California’s Financial Code 4970 and certain other laws apply only to loans on owner-occupied dwellings.
Private money lenders often loan to individuals who would not have qualified for institutional or traditional loan underwriting. If lenders were to make consumer-purpose loans, they could be in the position of processing and underwriting the borrower’s financial information and determining if they had adequately documented the borrower’s ability to repay. They may also be required to service the loan or have the loan serviced in compliance with the January, 2014 and subsequent loan servicing requirements imposed by the Consumer Financial Protection Bureau. (“CFPB”)
What about loans to entities, like LLC’s, or Corporations. Aren’t those exempt?
A consumer purpose loan can only be made to a consumer, which is a natural person or a natural person’s personal or family trust. Since LLC’s or Corporations can’t be a consumer, loans made to these entities would generally be exempt, unless the entity was determined as having been established or used for the purpose of circumventing applicable laws.
“OK, but this loan isn’t owner-occupied, so what am I worried about?”
That’s a great question and relates to a common misunderstanding. Many confuse “owner occupancy” with whether or not a loan is covered by TILA, (the Truth in Lending Act) RESPA, (the Real Estate Settlement Procedures Act) Dodd-Frank, and other requirements. Loans don’t have to be owner-occupied to fall under the “ability to repay” requirements and other issues raised here. Consult with qualified counsel to determine what applies to your loan(s).
Beware that there are a lot of unqualified answers to this being circulated around. With all due respect to those involved, the vast majority of the real estate lending and legal community does not understand the significance of owner-occupancy as it relates or doesn’t relate to coverage under some of these laws.
“All our loans go through escrow and title. They handle the paperwork, so that’s all covered.”
Most people reading this already know what’s wrong with this statement. It’s another misunderstanding. This one is easy to resolve, simply read the escrow instructions and exceptions to the policy of title insurance. They’re not an easy read, but you’ll see that they aren’t reviewing your loans for compliance with lending laws and may in fact, specifically state that they are relying on you to ensure compliance with applicable lending laws and practices.
When loans are made based on the business-purpose exemption, can there be problems?
Yes. If borrowers are unable to repay the loans, they may later state (sometimes truthfully and sometimes not) that the loan was for consumer purpose. There are often conflicts in circumstances, facts, and documentation. Many legal disputes arise from conflicts between borrowers who state the loan was for consumer purposes and lenders who state that they thought the loan was for business purposes.
Questions you may consider if you plan to rely on the Business Purpose Exemption:
- If a loan is for busines purpose, what steps should you take?
- How solid is your knowledge, or the knowledge of the primary lending decision maker, of the underlying problems, laws, regulations, practices, and past litigation surrounding this issue?
- What is the primary “standard” for determining if a loan is for business or consumer purposes?
- Considering the question above, how does your loan or your lending/brokering/servicing meet that standard?
- How are your business purpose loans serviced?
- If you’re using a third-party loan servicer, should you consider their policies regarding servicing loans that relied on the Business Purpose Exemption? Is your servicer qualified to service the loan(s) in your interest, considering that you relied on the exemption? Are there specific instructions to give the loan servicer regarding the servicing of these loans?
- When a loan made under the Exemption goes into default, would you handle that loan differently than another loan that did not rely on the BPE?
Stop: This is everything:
Joffrey Long (author of this) is not an attorney and is not your advisor or agent. The article is provided purely to generate questions, not to provide answers. These may or may not be questions that you consider asking and may not be appropriate or necessary questions for your situation. Consult with qualified counsel and other qualified advisors to obtain necessary information for your specific business practices, investments, and intended activities.
Nothing in this article is intended as a standard of care, a suggested practice, or the “right or wrong way” to do anything in real estate lending, mortgage brokerage, or loan servicing. The questions to ask, the practices employed, and the actions taken may vary significantly from lender to lender, licensing method to licensing method, borrower to borrower, or from loan to loan.
Who is this “Joffrey Long,” anyway?
Joffrey Long is President of Southwest Bancorp, a private money direct lender/loan brokerage in Southern California that makes private (hard) money loans with its own funds, as well as arranging, servicing, and providing private trust deed investors with interests in “fractionalized loans.” (multi-lender loans) (www.FractionalizedTrustDeeds.com) Loans made by Joffrey are secured by Southern California properties including residential 1-4 unit dwellings, multiple unit (5 to 100 units) properties, small retail or mixed use, warehouse/industrial, and office buildings – if there are any tenants left.
From time to time, Joffrey serves as a Mortgage Expert Witness ( www.MortgageExpertWitness.net) providing consultation, expert witness reports, declarations, and testimony at trials and arbitrations in real estate lending and loan servicing matters. He primarily testifies as what would be referred to as a “Private Money Expert Witness” or “Hard Money Expert Witness” in matters related to the Business Purpose Exemption, among other matters concerning lending, loan servicing, and trust deed investments. He is a Past-President and Past-Education Chair of the California Mortgage Association, (“CMA”) the primary trade association for private money lenders and loan servicers. He continues to make presentations at CMA’s educational conferences, as well as participating as a presenter in a webinar series produced by the Buchalter Law Firm. (www.Buchalter.com) He is an instructor for continuing education classes required under “NMLS,” the Nationwide Multistate Licensing System for Mortgage Loan Originators. (“MLOs”)
Southwest Bancorp is a Licensed Real Estate Broker, Calif. Dept. of Real Estate, license number 00898122 and holds an endorsement from the Nationwide Multistate Licensing System, (“NMLS”) identifier number 285731. Joffrey Long is a Licensed Real Estate Broker, (since 1979) license number 00525142 and holds an endorsement # 207202 from NMLS. Southwest Bancorp does business as Southwest Mortgage.
17045 Chatsworth St, Suite 101, Granada Hills, CA 91344 Joffrey@askw.com (818)366-5200.