HMDA: Distinction Between Consumer-Purpose and Business-Purpose Loans

Article By: Ben Giumarra, Spillane Consulting Associates, Inc.

Let’s discuss an old regulatory definition that will become more important when HMDA revisions take effect.

Distinction Gets More Important With CFPB

As far back as the Truth-in-Lending Act goes, it has only applied to “consumer-purpose” transactions. The regulations that define the distinction between consumer-purpose and business-purpose (it can only be one or the other) are unchanged. But until the Dodd-Frank and the CFPB came around, we didn’t waste too much time or energy trying to make the distinction — it wasn’t very important partially because the stakes simply weren’t that high, and also because institutions could avoid struggling with ‘close calls’ by voluntarily complying with the extra requirements applicable to consumer-purpose loans whenever there was doubt over whether a loan was consumer or business-purpose. 

But then the CFPB came around. By incorporating this long-standing regulatory principle into new regulations, it thrust this into the spotlight. Even though the industry never really paid much attention to it before, it was hard for industry advocates to use this as part of its “too much, too fast, too unclear” argument against the CFPB’s new regulations: This wasn’t a new regulatory twist – it was the same as it had always been. 

Now all of a sudden the ability to identify when a loan is, or is not “consumer-purpose” became more important: those loans would be exempt (or not) from ability-to-repay requirements, from loan originator compensation limitations, from TILA-RESPA integrated disclosure rules, and on and on. So the stakes were generally higher(and that’s even before we start talking about million dollar TILA fines and other new penalties).

New HMDA Requirements Require Greater Accuracy

But even still – institutions still had the option of “playing it safe.” If in doubt of whether a loan was “consumer-purpose,” an institution retained the ability to voluntarily comply with the CFPB’s new regulatory requirements. This changes now with the last major Dodd-Frank regulatory reform. I’m talking about HMDA. And specifically I’m referring to the additional data field where institutions must accurately report on whether a loan is “made primarily for a business or commercial purpose.” If you’re puzzled – this is the opposite of consumer-purpose. As in, if a loan is consumer-purpose, it cannot be business-purpose (we use business and commercial interchangeably).

So now there’s really no option of playing it safe – it’s time to get it right. For some institutions, this might prompt a healthy response and kick a habit of over-complying with requirements unnecessarily on loans that are really simple exempt as business-purpose (again, same as saying “not consumer-purpose).

Citation: 12 CFR 1003.4(a)(38)

Refresher on Definition: “Consumer-Purpose”

So given that background, I think it’s time to update ourselves on how to distinguish between consumer- and business-purpose loans. Remember – this is the same rule that’s been in place for decades.

Primary Purpose. To classify a loan as either consumer- or business-purpose we must ascertain what the primary purpose of that loan is. It must be one of two choices:

  1. Is the loan “made primarily for a business or commercial purpose”?, or

  2. Is the loan made primarily for “personal, family, or household purposes”?  

Factors. Borrowers often have multiple reasons for getting a loans – no different than we have multiple reasons behind anything we do. In order to determine the primary purpose, you balance the following 5 factors:

  1. The relationship of the borrower’s primary occupation to the asset purchased. The more closely related, the more likely it is to be business purpose.

  2. The degree to which the borrower will personally manage the asset purchased. The more personal involvement there is, the more likely it is to be business purpose.

  3. 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.

  4. The size of the transaction. The larger the transaction, the more likely it is to be business purpose.

  5. The borrower’s statement of purpose for the loan. Note that this is only one of 5 factors- you can’t rely on what the borrower says alone!

Example: Let’s see how we do this applies with a simple example. Assume a borrower comes in to refinance his family home to buy a bulldozer for his construction business.  

Question = Is the primary purpose here business or consumer?

Analysis – Go through the factors to decide:

  • Number One: Is the borrower a construction worker? Or is he a stockbroker with a small construction company as a “hobby”? If he’s a stockbroker, this is more likely to be a consumer loan.

  • Number Two: N/A.

  • Number Three: Are we talking about a small, second-hand bulldozer that the stockbroker’s monthly salary could easily cover? Or is it an industrial bulldozer that the construction worker is really extending himself on? (more likely to be business if the latter)

  • Number Four: N/A

  • Number Five: Does the stockbroker say he wants the bulldozer mostly for landscaping in his own backyard? Or does the construction worker plan to use it in a couple of jobs he’s working for the county?

Notes: You can see how the factor test can be TOUGH and will require training. It requires a case-by-case determination. You can’t just decide, “all loans to construction workers to purchase equipment will be business-purpose.” The reason the regulation is tough is that it requires an individualized exercise of judgment in every case.

Special Case: Rental Properties

While using the general factor test is tough due to vagueness, there are fortunately some specific rules that make our lives easier. One such case is with rental properties.

We can avoid the factor test by applying the specific rules here for rental properties:

  • Non-owner occupied rental property: This is always business-purpose loan. Note: “Owner occupied” means the borrower (or a college-age son who’s living at the beach house for the summer) lives there for 14 or more days per year.

  • Owner-occupied rental property: It depends on (a) purpose and (b) number of housing units.

So to apply the rule in the table- a loan to purchase a rental property (owner occupied) would only be “business-purpose” (and therefore exempt) if it had 3 or more housing units.

In Other News

  • In big free agency news – Peter Milewski has joined our team here at Spillane Consulting Associates. Read his company biography here. In his new role, Peter will seek to become a trusted advisor for institutions interested in help with strategic planning, marketing and advertising, portfolio risk management, and in other areas. He will help institutions develop crystal clear visions for future growth and success by sharing ideas and best practices on such topics as how to build an institution to attract millennials. We’d certainly be appreciative of anyone kind enough to help Peter as he embarks down this new path – whether it’s ideas on how he can help, specific projects you think might be successful, spreading the word around the industry that Peter’s available to help, or just sending in words of encouragement. I’m sure Peter would welcome any contact by e-mail or LinkedIn

  • Congrats to Embrace Home Loans for winning recent awards from Inc. magazine and Providence Business News.

    • “We’re honored to be recognized both locally and nationally amongst such great companies across all industries,” said Kurt Noyce, president of Embrace Home Loans. “What I am most proud of, this now being our 6th time, is how our team continues to innovate and reinvent this company to the ever-changing needs of our customers and the bank institutions we serve. Each of these awards, over our more than three decades, has represented a challenge our industry faced, in which others failed to adapt. Thanks to our teammates, we did, and each time, the professional and personal growth experienced has been evident. I am glad for our team to be recognized for such.” 

    • And don’t forget that you can contact SCA directly for more information on Embrace’s Assisted Correspondent product offeringMore information here.  . 

  • We’re still inviting friends to sign up for our second annual technology lunch (free)– coming up on October 5th and being hosted by the Bank of Canton. Click here for more information.

  • Anybody attending NEMBC this week? Catch up with John, Bill, or another one of your friends at SCA!

On My Mind …

Just like many other forms of technology, e-mail is a fantastic servant but a devastating master. E-mail management is a core skill of modern-day professionals. In his book, “The Trust Edge,” David Horsager offers some simple advice on e-mail efficiency that might just ring true for you: 

E-mail is like medication. It can cure a lot of things, but there is the potential for some serious side effects…. Before I share how to deal with e-mail every time you use it, get ready to implement the following tips:

  • Close your e-mail. With your e-mail minimized on your computer screen, you can be interrupted by pop-up notifications and chimes that may occur. That constant interruption takes you away from focusing and being productive. Consider checking all emails that collect in the inbox once in the morning, once at noon, and once late in the day. 

  • Get to 10 or fewer e-mails in your inbox. When you have 10 or fewer e-mails in your inbox, productivity goes up and you feel great. 

To get to 10 or fewer e-mails in your inbox, take a day to catch up and then do the following whenever you open your e-mail. Every message should be handled in one of four ways:

  1. Delete it.

  2. File or archive it.

  3. Deal with it now. 

  4. Flag it for follow-up

Opportunity is missed by most people because it comes dressed in overalls and looks like work.”  – Thomas Edison

Thanks so much for reading our weekly newsletters. We’re not always going to be perfect, but because we always do our best and try not to overpromise, we hope that we’re always going to be trustworthy. Your calls and e-mails are very helpful – please keep contributing.

**These are our opinions. We’re not authorized, or willing, to express those of others.**

Thank you to Ben Giumarra, Spillane Consulting Associates, Inc., a member of our Education Committee, who with the support of other experts at SCA have put together this newsletter.

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