“They’re buying a house.”
What picture popped into your mind when you read that? Was it a couple or family standing by the curb of a suburban residential neighborhood gazing lovingly at a little cape cod? Or, was it more akin to a couple of guys in khakis and polo shirts making an assessment of the viability of rehabbing and renting a rather ramshackle house with little or no grass in the yard?
Compliance for loans can be pretty much summed up in two little words – purpose and collateral. Those two words that describe the composure of a mortgage loan drive about 99% (not scientifically derived) of the compliance requirements for the transaction. The compliance professional who is researching a regulatory requirement for a loan or application should make a stop first in the section of the regulation that describes its coverage and compare it to the loan’s purpose and collateral.
For each application, the lender must determine the purpose of the loan. “Purpose” means different things to different people, but, for mortgage lending, purpose means ‘what are the proceeds of the loan going to be used for?’
There are a number of elements to consider when determining the purpose of the loan. The first is whether the loan is primarily for a business or commercial purpose, or, if it is primarily for a consumer purpose.
Look no farther than Regulation Z – Truth in Lending Act for definitions and descriptions of consumer-purpose lending. Section 1026.2(a)(12) of Regulation Z states, “Consumer credit means credit offered or extended to a consumer primarily for personal, family, or household purposes.” Arguably, it’s impossible to just look at a person and determine whether he/she is acting in their “consumer” guise or in a capacity to conduct a business transaction. What is important about consumer credit is that it is extended to a natural person and that it meets the definition of consumer credit as defined in Regulation Z.
Regulation Z applies only to consumer credit. No definition of business or commercial purpose credit is given, and, generally, anything that is not consumer credit is considered to be business or commercial credit. Section 1026.1(c) of the regulation describes the coverage of Regulation Z (meaning its requirements) for loans:
“Coverage. (1) In general, this part applies to each individual or business that offers or extends credit … when four conditions are met:
(i) The credit is offered or extended to consumers;
(ii) The offering or extension of credit is done regularly;
(iii) The credit is subject to a finance charge or is payable by a written agreement in more than four installments; and
(iv) The credit is primarily for personal, family, or household purposes.
There are exemptions and Regulation Z §1026.3 describes transactions exempt from coverage:
“(a) Business, commercial, agricultural, or organizational credit.
(1) An extension of credit primarily for a business, commercial or agricultural purpose.
(2) An extension of credit to other than a natural person, including credit to government agencies or instrumentalities.
(b) Credit over applicable threshold amount—(1) Exemption. (i) Requirements. An extension of credit in which the amount of credit extended exceeds the applicable threshold amount [$54,600 for 2015] or in which there is an express written commitment to extend credit in excess of the applicable threshold amount, unless the extension of credit is:
(A) Secured by any real property, or by personal property used or expected to be used as the principal dwelling of the consumer; or
(B) A private education loan as defined in Regulation Z §1026.46(b)(5).
A loan may have a mixed purpose, and the creditor must determine if the primary purpose is consumer or business. The Federal Deposit Insurance Corporation (FDIC) Compliance Manual offers guidance about determining the primary purpose of the loan, including evaluation of the following:
- Any statement obtained from the consumer describing the purpose of the loan;
- The consumer’s primary occupation and how it relates to the use of the proceeds. The higher the correlation between the consumer’s occupation and the property purchased from the loan proceeds, the greater the likelihood that the loan has a business purpose.
- Personal management of the assets purchased from proceeds. The lower the degree of the borrower’s personal involvement in the management of an investment or enterprise purchased by the loan proceeds, the less likely the loan will have a business purpose.
- The size of the transaction. The larger the size of the transaction, the more likely the loan will have a business purpose. For example, if the loan is for a $5,000,000 real estate transaction, that might indicate a business purpose rather than consumer purpose.
- The amount of income derived from the property acquired by the loan proceeds relative to the borrower’s total income. The lesser the income derived from the acquired property, the more likely the loan will have a consumer purpose. For example, if the borrower has an annual salary of $100,000 and receives about $500 in annual dividends from the acquired property, that would indicate a consumer purpose.
Once the loan has been determined to be for consumer purposes, the coverage of other consumer protection regulations is revealed, such as the Real Estate Settlement Procedures Act (RESPA). The Home Mortgage Disclosure Act (HMDA) can apply to consumer-purpose and business-purpose loans, but, some different information may need to be collected, documented, and reported. Certain regulatory requirements will not be affected, for instance, the coverage of Regulation B – Equal Credit Opportunity Act. It is prohibited to discriminate against business credit applicants as well as consumer credit applicants. There may be slightly different compliance requirements, though, for business credit. Take, for example, the record retention requirements for consumer purpose loan denial files (25 months) and those for business purposes (12 months).
The next lynch pin to compliance is determining the collateral for the loan, including the proposed lien position of the collateral for the prospective lender. Is the real property improved? Are the loan applicants purchasing the real property with the proceeds of the loan, or, do they already own it and seek to refinance the the balance of a current loan with or without new money, or do they want an equity loan secured by a lien junior to the existing lien?
Improved real property is a different kettle of fish from vacant land, and different still from homes without land. A loan to purchase or refinance vacant land may be for a consumer purpose and require Regulation Z disclosures; however, vacant land will not be covered by RESPA. Similarly, the purchase of a home without land, such as a mobile home or a dwelling that is not attached to real property, might be a consumer credit transaction needing Regulation Z disclosures, but, not be covered by RESPA. Remember, “no dirt, no RESPA.”
The lien position, that is, whether the lender will have a first lien position or a junior position to another lender is a factor. Current rules for Regulation Z and RESPA allow different disclosures for loans with two parties or one party (for instance, the purchase of a primary residence is typically a two-party transaction – the seller and buyer, while an equity loan or refinancing by the property owner is a one-party transaction). The TILA-RESPA rule, effective August 1, 2015, applies to most closed-end consumer credit transactions secured by real property regardless of the lien position. However, some specific categories of loans are excluded from the rule. Specifically, the TILA-RESPA rule does not apply to home equity lines of credit (HELOCs), reverse mortgages, or mortgages secured by a mobile home or by a dwelling that is not attached to real property (i.e., land).
The fact that the property has improvements also triggers the requirement to conduct a flood hazard determination, document the results on the Standard Flood Hazard Determination Form (SFHDF), and obtain flood insurance, if applicable. Flood compliance is not limited to consumer-purpose loans. The Interagency Questions and Answers Regarding Flood Insurance is a good source of information for flood insurance issues.
In the myriad of information collected for real estate mortgage loans, two little words – purpose and collateral – carry a lot of weight. They may be few, but they can help lead you through the maze of compliance requirements.
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