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, former chief compliance officer for two of the country’s top publicly-traded residential mortgage loan originators, is the president and managing director of Lenders Compliance Group, a mortgage risk management firm devoted to providing regulatory compliance advice and counsel to the mortgage industry. He may be contacted at (516) 442-3456 or by e-mail at [email protected]