When determining whether a transaction is exempt from Reg. Z as a business purpose loan under 1026.3(a)(1), you must look at the primary purpose of the loan. Regulation Z provides that you must determine on a case-by-case basis if the transaction falls into a primarily exempt purpose.
There are a few rules related to rental property that automatically deem the transaction to be business purpose right off the bat. First off, if the property is non-owner occupied rental property, then it will be considered a business purpose loan - ok that seems straightforward. However, keep in mind that if the borrower intends to occupy the property for more than 14 days during the coming year, then the property cannot be considered non-owner occupied. But, what happens if the property is owner occupied rental property based on the number of days the borrower intends to occupy the property? If the property is owner occupied rental property, then you have to look a bit closer to determine whether it is business or consumer purpose. If the property is being purchased and it has more than two units, it will be considered a business purpose loan. If there are less than two units, then there are a number of additional factors you will need to consider in making the determination of whether the exemption applies. We will discuss those factors below. Next, if the loan is to improve or maintain the property and there are more than four units, again it will be considered a business purpose loan. If there are less than four units, you will need to consider the factors.
According to the commentary in Reg. Z, the following factors should be used to determine whether a loan is exempt as business purpose whenever it does not meet one of the automatic rental categories above:
- The relationship of the borrower's primary occupation to the acquisition. The more closely related, the more likely it is to be business purpose;
- The degree to which the borrower will personally manage the acquisition. The more personal involvement here is, the more likely it is to be business purpose;
- 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;
- The size of the transaction. The larger the transaction, the more likely it is to be business purpose; and
- The borrower's statement of purpose for the loan.
Typically property held for "investment", where the borrower is simply banking on appreciation will not be considered business purpose, unless that is what the borrower does for a living and it comprises a substantial portion of the borrower's income.
The regulators were also kind enough to give us some examples of business purpose loans. These examples can be found in 1026.3(a) - Comment 3:
- A loan to expand a business, even if it is secured by the borrower's residence or personal property is business purpose;
- A loan to improve a principal residence by putting in a business office;
- A business account used occasionally for consumer purpose.
Alternatively, there are also a few examples of loans that are NOT business purpose:
- Credit extensions by a company to its employees or agents if the loan are used for personal purposes;
- A loan secured by a mechanic's tools to pay a child's tuition; or
- A personal account used occasionally for business purposes.
Once you have travelled the decision-making road, if you are still unsure whether the transaction is exempt as a business purpose loan, you are always free to make the consumer purpose disclosures. Doing so will not be controlling on whether the loan truly is or is not exempt as a business purpose loan in the eyes of examiners.