Consumer Loan for Purchase of Multi-Use Building

Inquiry/Issue

The Bank is making a $325,000 loan to two individuals for the purchase of a three-story multi-use property. The ground floor is a commercial retail space rented to a church and the two upper floors are apartment units which will be occupied by the owners. Is this a consumer loan?

Response Summary

Regulation Z exempts extensions of credit used primarily for a business purpose. Under the regulation’s rules of interpretation, however, this loan appears to be a consumer loan in that a majority of the units are being used by the borrowers as their residences, the Bank is looking primarily to the non-rental income of the borrowers to service the loan, and the management or ownership of the building is not related to the borrowers’ primary occupations.

Response Detail

The loan contemplated by the Bank appears to be a consumer loan for which Truth-in-Lending and other appropriate consumer protection disclosures should be made.

Regulation Z exempts extensions of credit primarily for a business, commercial, organizational, or agricultural purpose. 12 CFR §1026.3(a). Whether the loan in question qualifies for this exemption depends on the primary use of the property being purchased.

In the case of an owner-occupied rental property, the Official Interpretations of Regulation Z say that if there are more than two housing units, the loan is considered to be a business loan. Official Interpretations, ¶3(a)-5. The assumption is that there will be three or more residential units, with the owner occupying one and renting out the others. The rule does not squarely apply to this case, in that here there is one commercial unit and two residential units. It suggests, however, that this would be a consumer loan in that there are not more than two residential units, the residential units are owner-occupied, and the owner-occupied units make up a majority of the use of the building, while the rule contemplates the rental units making up a majority of the use of the building.

In a related rule regarding acquisitions, the Official Interpretations offer a number of other factors to be considered in determining whether a loan is primarily for a business or commercial purpose, including the following:

• The relationship of the borrower’s primary occupation to the acquisition, in that the more closely related they are, the more likely it is a business purpose
• The degree to which the borrower will manage the acquisition, in that the more  personal the involvement, the more likely it is to be a business purpose
• The ratio of income from the acquisition to the total income from the borrower, in that the higher the ratio, the more likely it is to be for a business purpose
• The size of the loan, in that the bigger the loan, the more likely it will be for a business purpose. Official Interpretations, ¶3(a)-2

Examining the Bank’s Approval Request Summary, it appears that it is looking primarily to the non-rental income of the owners to service the debt:

1st floor rental income	$20,604
2013 AGI – Owner 1	43,494
2013 AGI – Owner 2	7, 148

For the purposes of the analysis, the Bank reduced the adjusted gross income of Owner 1 and Owner 2 by 40 percent.

In evaluating the Rent Roll, the Bank also accords the majority of the “income” to the owner-occupied residential units:

1st floor	$1,717
2nd floor	1,200
3rd floor	1,717

Whether the bank is considering the income of the property and the owners or the relative value of the rentals, the greater weight is with the owners as consumers rather than the building as a business.  On this basis, then, the loan should be considered a consumer loan.

Owner 2 will manage the building. Since she is retired, her primary occupation, to the extent she has an occupation, will be the management of the building. With nothing else to consider, this would be a business purpose. However, Owner 1’s regular occupation is that of a pressman and it is his income as a pressman that is being used to qualify for the loan. Given that his income is twice as great as the rental income, even as adjusted, the management or ownership of the building is not related to the owner’s primary occupation, when the owners are considered together.

The amount of the loan is $325,000, a modest investment in real estate, given the size of the building and its use. On this point as well, their loan is more likely to be considered a consumer loan.

This entry was posted on Friday, August 22nd, 2014 at 3:55 pm.