Consumer vs. Business Purpose Lending Dark Liability Clouds Arrive Over California’s One-Party Rule, By Dan Harkey
Origin of Applicable laws:
Prohibitions in consumer-purpose lending on single-family 1-4 residential properties originated in 1968 federal regulations, Regulation Z, Truth-in-Lending.
Regulation Z was the Federal Reserve Board regulation implementing the Truth-in-Lending Act (TILA) of 1968. It was part of the Consumer Credit Protection Act of 1968.
California has significantly increased its oversight, particularly with the passage of AB 3108. This regulation casts a shadow over mortgage brokers involved in consumer and business-purpose lending to natural persons, and now non-natural persons, on single-family 1-4 and consumer-purpose borrowing on other types of properties. The new law underscores our responsibility to adhere to these regulations, proving our commitment to the lending industry.
What is a consumer-purpose real estate loan?
Consumer purpose loans are loans made to natural persons on 1 to 4 residential units of real property, where the loan proceeds are used primarily for consumer purposes- personal, family, and household.
On the other hand, a business-purpose loan is a loan where the proceeds are used primarily for business purposes.
When borrowers seek a loan, they may find a lender(s) who only offers business-purpose loans. In such cases, borrowers often construct a narrative to make their loan “business-purpose.” Whether the narrative is legitimate or not, proper documentation ensures a secure and transparent lending process and instills confidence.
If the borrower defaults, memory may be fuzzy about the purpose of the loan. Yesterday’s business purpose borrower may suddenly become a meek, vulnerable, and confused consumer who was taken advantage of by the big-bad-wolf mortgage broker. If the borrower’s narrative is considered illegitimate, it could lead to severe legal and financial consequences for both the borrower and the lender. Proper documentation and the storage of the same becomes critical.
The history of conversations may quickly turn from “I want a business purpose loan” to “You knew all along that I was going to use all the proceeds personally, and you told me to do it this way.” “You also knew that I could not afford the payments.” A defaulting borrower may conveniently turn on the broker/lender and blame them as “they told me to do it. Blaming others for bad decisions seems to have become the American way. ?
The greater the percentage of loan proceeds used for business, the safer for the lender and procuring loan broker in the event of default. What I mean by “safer” is whether the lender or procuring loan broker could become entangled in the borrower’s accusation that the loan was a disguised consumer loan.
Industry participants often refer to the ‘business purpose exemption’ when discussing lending regulations. While there is no explicit ‘exemption’ in the Truth-in-Lending regulations, particular loans are ‘not covered’ under these consumer laws. This distinction effectively exempts these loans from the stringent requirements of consumer laws, a concept that is crucial to understand in the lending industry.
Most private money lenders and mortgage brokers have abandoned consumer-purpose lending only for business purposes. Many mortgage brokers have found that consumer-related lending is not worth the risk of legal liability if something goes wrong. Judges and courts are tremendously biased toward the “perceived less than sophisticated consumer/homeowner parties,” which refers to consumers who may not fully understand the terms and conditions of their loans.
Businesspersons in U.S. law courts, especially in California, suspected of wrongdoing are assumed “guilty until proven innocent.” Proving innocence can be aggravated by the ideological leanings of the parties. The court system has leftist-leaning, bureaucratic labor union public employees, judges, and judge assistants. Most highly experienced practitioners will agree!
Any accusation of a perceived infraction of violating Truth-in-lending or other state and federal law, even with little legal basis, could cost a mortgage broker a ton of money for discovery, court costs, and lawyer fees. Their entire career and real estate lending license loss could be on the line with every consumer loan transaction.
Here are a few recommendations under the category of best practices:
·????? Build your defense file up front for peace of mind.
·????? All borrowers should sign a handwritten statement outlining the source and use of funds.
·????? Consider a Zoom Lock Recording or video signup for safekeeping and backing up in the cloud.
·????? A broker should require an escrow at closing to deposit the proceeds of the business purpose into a business account.?
·????? The net proceeds are net after the cost and fees.
·????? Does the borrower have bank accounts in the business name with debits and credits and running balances that are a business operation?
·????? A website or online evidence of a company presence or a bonified business may be helpful.
·????? Obtain a borrower’s resume’ and history of business activities showing business purpose.
·????? A resume can verify the correlation between the consumer’s occupation and redundancy. For example, a rehabber may repeatedly buy.
·????? For speculative vertical construction loans, if the security property is residential property of 1 to 4, the loan file should contain a statement from the borrower stating that they intend to sell the finished property on the open market and that they do not intend to move into the home as a primary residence.
·????? Ensure the architectural drawing does not say, “Mr. and Mrs. Borrower Residence.” The statement implies “consumer dream home.”
·????? Obtain a list of items and dollars to be spent for business-related expenses contemplated by the borrower. Written estimates from vendor cost bids are helpful.
·????? Guard against making loans to failed businesses and potential bailouts in which the borrowers believe that an injection of cash will help get them back on track without changing strategy.
Adhering to a new set of underwriting standards and loan approval considerations is crucial; it’s a reassurance, especially for borrowers facing challenges during the COVID-related fiasco and the changes in actual estate-related California laws.
Borrowers may need loans secured by their real estate to catch up or strengthen the finances of their business enterprise(s), renew good credit status, and return to prompt payment habits. Property owners/borrowers may have taken advantage of payment deferrals based on the lack of tenant payments or foreclosure moratoriums from state and federal mandates. In such cases, a “fresh start loan” is not just an option; it’s a necessity.
The lenders/mortgage brokers should obtain a completed borrower’s loan application, financials, credit report, and independent third-party appraisal.
The procuring lender can verify the availability of cash flow from the borrower(s), the borrower(s) business, and the subject property for expenses and debt service. Bank statements or tax returns with a profit and loss may be helpful. Three to six months of business and personal bank statements are usually adequate for private money loans.
Conducting a compassionate circumstances analysis is essential for credit considerations and approval. This approach ensures the borrower’s ability to repay and fosters empathy and understanding in the lending process.
Many private money lenders are “equity-driven” rather than “income steam-driven.” For example, historically, many lenders assume that if a borrower has a property with a 60% loan to value and 40% as “protective equity,” the lender may not require much more than an application, independent appraisal, and a credit report. Timely payments and performance of the loan terms are assumed because any borrower who gains that much equity over time will not default.
Somewhere between “equity-driven lending vs. credit and income-driven lending” will be the answer. We may find that loan-to-values and analysis methods will change with recently passed laws and new legislation pending.
Consumer purpose laws are “purpose-driven” by borrowed funds, not property collateral-driven.
It is natural to confuse “owner occupancy” and “consumer” with whether the Federal Truth covers a loan in the Lending Act (TILA). Loans do not have to be owner-occupied under the Truth-in-lending and “ability to repay” requirements. RESPA (Real Estate Settlement Procedures Act), Dodd-Frank, and other federal and state regulatory requirements are also involved.
Suppose a gas station owner, who holds the title of trustee of the family trust and rents his property to a third party, borrows the money using the gas station as security. The loan aims to combine personal, family, and household debts and improve his owner-occupied home. In that case, it is a consumer loan.
The loan is exempt from truth-in-lending if the borrower holds title to the gas station as a corporation or limited liability company. Those entities are not considered natural persons.
Loan transactions should be closed by a licensed escrow company with a purchased title insurance policy. Escrow agents have a dual fiduciary between a buyer/seller and a borrower/lender. The lender or mortgage broker manages the regulatory compliance issues and underwriting, but escrow and title manage the escrow instructions, settlement procedures, and closing statements. Borrowers and lenders must read the title insurance policy’s narrative escrow instructions, coverages, exceptions, and exclusions. Exceptions and exclusions are things not covered by the title insurance policy.
AB 3108—The new law passed by the California Legislature and signed by Governor Newson cast extremely cloudy skies over the lending business. It creates further prohibitions, enhances liabilities, and invites borrowers to sue brokers for fraud and negligent misrepresentation.
AB 3108 codifies a new violation of the Penal Code for defined actions/conducts of real estate/mortgage brokers.?? This legislative measure “… would prohibit filing any document with the recorder of any county that the person knows to contain, instead, a material misstatement, misrepresentation, or omission. “See Financial Code Section 4973 et seq and Penal Code Section 532f; Seeley v. Seymour (1987)190 Cal App 3rd 84.
AB? 3108 adds criminal penalties to existing administrative discipline, civil actions, and other criminal sanctions for industry violations of the California Real Estate and Securities Laws and other applicable federal and state laws. The inappropriate actions/conducts of real estate/mortgage brokers typically represent negligence, incompetence, fraud, and dishonesty.
Administrative remedies for violations of Real Estate Law and other statutes and regulations may include license discipline, revoking registrations/charters or permits, and the possibility of the licensee being subject to a “Bar Order” prohibiting engaging in Real Estate/Mortgage or Industries for a specified period.
Remedies from Civil complaints for inappropriate actions/conducts may include imposing damages for the losses incurred by the licensees’ principals in real property and real property secured transactions, including possible significant punitive damages. Material misrepresentations by licensees, including inflating broker price opinions; making false and misleading statements of material facts (e.g., promising unrealistic or unsupported returns on investments); omissions of material facts; offering half-truths as well as the failure to disclose property defects (known, or should have been known) are illustrations of inappropriate actions/conducts.
https://www.dosslaw.com/assembly-bill-3108-california-ups-the-ante-on-owner-occupied-business-loans/
Inappropriate actions/conduct and failure to perform industry standards for best practices are typically breaches of fiduciary duties owed to principals in real property or real property-secured transactions. Such licenses are performing beneath their “standard of care.”?
The concern is whether this expansion to criminalize actions/conducts of real estate/mortgage brokers under AB 3108 could criminalize individual citizens for their ideological position, if not consistent with the administrative system. The conflicts among persons or groups about political, economic, legal, and governmental standards/objectives for our nation-state underscores the need to consider (when enacting such legislation) its impact on society, historical culture and institutions, the rule of law, and the U.S. Constitution.
Various observers have expressed concern about possible runaway and expensive litigation involving licensees charged for alleged and potentially inappropriate, vague violations of AB 3108. Video and voice reproductions can memorialize the presentation and review of future written and oral communications among real estate/mortgage brokers, their clients, and customers.
California Financial Code Section 4973
Prohibits certain practices in covered loans, including:
·?????? Prepayment penalties: No prepayment fees or penalties after the first 36 months.?
·????? Payment schedules: Loans with a term of five years or less cannot have a payment schedule that doesn’t fully amortize the loan’s principal balance by the maturity date.?
·????? Negative amortization: A loan cannot have a payment schedule that increases the principal balance unless it’s a first mortgage and the lender discloses the provision to the consumer.?
·????? Consolidated payments: A loan cannot have terms that consolidate periodic payments and pay them in advance from the loan proceeds.?
·????? Interest rate increases: A loan cannot have a provision that increases the interest rate due to a default.?
·????? Loan recommendations: It’s illegal to encourage a consumer to default on an existing loan to get them to take out a covered loan that refinances the existing loan.?
·????? Refinancing: A covered loan cannot be a source to refinance another loan that doesn’t benefit the consumer.?
·????? FIN § 4973 also includes provisions for the licensing agency or Attorney General to enforce the division and recover costs.?
California Penal Code Section 532f
For the technically minded:
Regulation Z was the Federal Reserve Board regulation implementing the Truth-in-Lending Act (TILA) of 1968. Reg Z was all part of the Consumer Credit Protection Act of 1968. The act’s primary goal was to provide consumers with better information/disclosures about the actual cost of credit, including calculating the annual percentage rate (APR). An APR calculation includes all borrowing costs, with interest rates and fees. Lenders must show interest rates in writing, allow borrowers to cancel (3-day right of rescission), and provide written disclosures about the loan terms and costs.
My comments and opinions are not all-encompassing. Consumer and business purpose lending is made more complex by state and federal government regulations that sometimes conflict. Any owner/borrower or lender/mortgage broker should consult a highly competent lawyer to guide them to proper actions.
Thank You,
Dan Harkey
Educator & Private Money Lending Consultant
[email protected] ???949-533-8315
Visit www.danharkey.com
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Private Money / Hard Money Lender/Investor, Loan Servicer, and Educator
3 天前Thank you for the comprehensive article on BP lending, Dan. It was important before, now even more so.