Article By: Gregg Oberg, Spillane Consulting Associates, Inc.
It’s that wonderful time in the quarter when we put our HMDA data on the LAR once again. Ah, scrub season, you keep us so busy with interesting questions.
While we obviously want to get EVERYTHING right in HMDA, erring on Primary Purpose may be the single most costly mistake you can make.
Here’s a few tips on how to avoid making a critical mistake.
What’s the Big Deal?
Determining whether credit is extended for business/commercial or consumer purposes has long been a key aspect of TRID, but somewhat overlooked in HMDA. In the past (so I’m told) lenders would often simply err on the consumer when this determination came up, knowing that there were few to no consequences in over-reporting a business purpose loan as HMDA applicable.
As of January 2018, that is no longer the case. Whether a transaction is for a business/commercial purpose or not will impact how you report the data. As all of you who have attended my HMDA trainings well know, there are substantially fewer data points to be reported on a Business Purpose loan. Wrongly classifying a loan as Business Purpose likely would cause you to under-report data on that loan. Getting determination wrong can, and likely will, cause cascading failures in reporting.
There is one other way (at least) that mis-classifying a loan can bite you. Under HMDA, all consumer purpose dwelling secured loans are reportable, absent defined exceptions. BUT, a business purpose dwelling secured loan is sometimes not reportable; this depends on the actual use of the funds. I’ll give an example:
Consumer purpose closed end dwelling secured loan, funds to be used to pay for a wedding.
This is reportable, and the proceeds of the loan are used for an “other” purpose.
Business purpose closed end dwelling secured loan, funds to be used to purchase a work truck or make payroll.
This is NOT reportable
1003.3(c) (10) Official Interpretation-4 makes clear that “other” as a loan proceed purpose is not covered for commercial or business loans.
How to Get it Right?
We know a few quick rules—if the credit is extended to a non-human entity, it is a business purpose.
As a matter of practice, we also know it’s generally safe to assume a transaction on the residential side of the bank is consumer, and a transaction on the commercial side is business/commercial. But there are some lesser know bright line rules that can help, particularly on the residential side of things.
For purposes of these examples, we assume that the transaction is secured by a dwelling, and the borrower is a human.
Non-Owner Occupied=Business Purpose
“Credit extended to acquire, improve, or maintain rental property (regardless of the number of housing units) that is NOT owner-occupied is deemed to be for business purposes.” 12 C.F.R. 1026.3 (a) Official Interpretation-4.
This gets a bit tricky in language, but can be very simple in applications. What the rules say is that if a property is to be owner occupied (lived in for 14 or more days in the next year), the determination of business credit will rest on a combination of the loan proceed purpose and the number of units in the property. Paraphrasing 12 C.F.R. 1026.3(a) Official Interpretation-5:
Purchase 3+ unit dwelling
If credit is to acquire property=business purpose
Improve or Maintain 5+ unit dwelling
If credit is to improve or maintain property=business purpose
If the property and loan proceed use fit these criteria, the loan is conclusively deemed Business Purpose. However, the reverse is NOT true. Just because a loan falls below these thresholds, doesn’t mean it is conclusively a consumer purpose loan. For that, you need to fall back on the Factor Test from TRID, discussed below.
Properly classifying a loan by its primary purpose is possibly the most impactful single point on the HMDA LAR, as outlined above. I consistently recommend clients implement at least a dual-control environment around this factor specifically. The MLO should make an initial determination, and there should be a check by a different employee (ideally in a compliance role) performed. It is less important to get it right the first time than it is to have it right at the end of the day after scrubs are performed.
Consider having MLOs err on the side of consumer purpose. If the loan is ultimately deemed Business Purpose, you can either delete the now-exempt fields from the LAR, or over-report. We know a consumer purpose loan has more data points, and the data points applicable to a Business Purpose loan are a subset of those applicable to consumer purpose loans. Thus, we can infer that initially processing the application as consumer credit for the purposes of HMDA will ensure we have all data reportable if the loan ultimately is a Business Purpose.
TRID Factors Test
This is one I rely on my loyal readers to correct me on, if wrong. That caveat aside, I have struggled to come up with scenarios in which the bright line rules discussed above fail to solve the question of primary purpose. In any case, I feel fairly confident saying well over 90% of transactions can be conclusively classified using the bright lines, and only in rare circumstances would you need the Factors Test.
Suppose a human borrower gets a loan to improve a 3-unit dwelling, secured by the dwelling. The owner lives in one of the three units. This doesn’t meet the bright lines of 1026.3(a), but under the TRID Factors Test, you could determine this is business purpose.
The Factors Test is defined in 12 C.F.R. 1026.3(a) Official Interpretation-3, and states:
“In determining whether credit to finance an acquisition – such as securities, antiques, or art – is primarily for business or commercial purposes (as opposed to a consumer purpose), the following factors should be considered:
A. The relationship of the borrower’s primary occupation to the acquisition. The more closely related, the more likely it is to be business purpose.
B. The degree to which the borrower will personally manage the acquisition. The more personal involvement there is, the more likely it is to be business purpose.
C. 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.
D. The size of the transaction. The larger the transaction, the more likely it is to be business purpose.
E. The borrower’s statement of purpose for the loan.”
Perfectly clear and helpful, right? Unfortunately, the regulation text itself provides no further clarification on how to balance these five. You simply have to evaluate each factor, and determine on balance whether the loan is more likely consumer or commercial. But remember, this test is really only going to be necessary in a small percentage of loans.
Is this Helpful?
We advise dozens of clients on one-off questions and ongoing projects a week, and often the questions our clients pose to us end up in the newsletter, as is the case with this blog. The thinking is, if one client had the question, others may as well. I hope some of you found this useful, interesting, or maybe even mildly entertaining.
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Thank you to Gregg Oberg, Spillane Consulting Associates, Inc., who with the support of other experts at SCA have put together this newsletter.