Loan Made to Company for Consumer Purpose

Issue/Inquiry:

The Bank’s management loan committee wants guidance on whether a loan to a limited liability company but for the purchase of the guarantor's personal residence, is a commercial loan or a consumer loan for the purpose of the consumer protection regulations.

Response Summary:

A loan to a limited liability company to purchase a home for the guarantor is exempt from Regulation Z requirements, since the borrower is not a natural person, but would be covered by RESPA, since it is secured by residential real property and is not for a business purpose. Had the loan been for temporary financing, such as a construction loan, it would also have been exempt from RESPA. The Bank, however, should be comfortable with regards the credit underwriting aspects of the transaction, whether tax advantages are being sought through structuring the loan in this fashion, and how it will account for such an asset and liability.

RESPONSE DETAIL:

A loan to a limited liability company to purchase the guarantor’s residence is exempt from Regulation Z requirements, since the borrower is not a natural person, but would be covered by RESPA, since it is secured by residential real property and is not for a business purpose.

The term “consumer credit” means an extension of credit to a consumer for a personal, family, or househould purpose. A “consumer” is a “natural person.” A loan to a limited liability company, therefore, would not be a loan to a natural person and thus would not be consumer credit, whatever the loan proceeds was used for. 12 CFR §§1026.2(a)(11), (12).

Business purpose loans are specifically exempted from Regulation Z coverage, including extensions of credit other than to a natural person. 12 CFR §1026.3(a)(2). In this regard, the Official Interpretations provide that “the exemption for transactions in which the borrower is not a natural person applies, for example, to loans to corporations, partnerships, associations, churches, unions, and fraternal organizations. This exemption applies regardless of the purpose of the credit extension and regardless of the fact that a natural person may guarantee or provide security for the credit.” Official Interpretations, ¶1026.3(a)-9.

Since the loan is for the guarantor’s personal residence, however, it would be subject to RESPA requirements. RESPA covers all federally-related mortgage loans, which are loans made by federally-insured institutions secured by first or subordinate liens on residential real property. “Residential real property” is property on which there is located or will be constructed, using the loan proceeds, a structure or structures designed principally for occupancy of from one to four families. 12 CFR §§1024.2, 5(a).

Business purpose loans are exempted from RESPA requirements. Regulation X, giving effect to RESPA, adopts the definition of “business purpose” in section 1026.3(a)(1) of Regulation Z, which is “an extension of credit primarily for business, commercial, or agricultural purposes.” In this case, while the loan is to a business entity, it does not have a business purpose. Thus, it is not exempted from RESPA requirements. 12 CFR §1024.5(b)(2). Pointedly, Regulation X does not adopt the larger definition of “business purpose” found in section 1026.3(a)(2) of Regulation Z, which is an extension of credit to other than a a natural person. For RESPA purposes, it is the use of the loan proceeds which controls, not the nature of the borrower.

If the loan was not being made for the purchase of the house but for its construction, it would have been exempt from RESPA as well as temporary financing. This exemption would not apply, however, if the construction loan is used as or may be converted to permanent financing by the same lender, or will finance the transfer of title to the first user. 12 CFR §1024.5(b)(3).

While the Bank’s question treats the matter as being fundamentally one of the applicability of the consumer protection regulations, it should also be comfortable with regards the credit underwriting aspects of the transaction, whether tax advantages are being sought through structuring the loan in this fashion, and how it will account for such an asset and liability.

This entry was posted on Friday, July 18th, 2014 at 6:52 pm.