Private lenders play a crucial role in offering financing solutions to real estate investors. However there continues to be uncertainty and misunderstandings about the licensing regulations for private lenders, particularly for business purpose loans (BPL) secured by real estate. Contrary to common belief, several U.S. states do require a license for BPLs. It’s essential to grasp the specific requirements, obligations, and complexities tied to licensing in each state to ensure success. This article seeks to clarify state-specific licensing rules, spotlight key requirements in certain states, and emphasize the importance of carefully navigating the licensing process.
The main challenge in many states is ensuring that the private lending company is properly licensed. Although states have different rules regarding usury, prepayment penalties, and other loan conditions, these can typically be addressed by adjusting the loan agreement. But, if a license is required, no lending activity can take place until the license is secured, effectively halting operations in that state.
What Type of Lending Activity Needs to be Considered?
Before entering a new market, you should understand each state’s licensing requirements for your company’s lending activities. Each state is different and may require a license for lending, brokering, and/or servicing mortgage loans.
The rules can be complicated. For example, several states require a real estate broker license to act as a mortgage broker, even though lenders can originate loans in those states without a lender license. In California, you have a choice of licenses that present lenders with different lending authorities and restrictions. Additionally, each state presents an array of licensing exemptions that may apply to your activities. For example, certain states allow an unlicensed lender to fund a loan arranged through a licensed mortgage broker.
Which Entity Should Get Licensed?
When managing funds or multiple entities, determining which entity should hold the lending license is crucial. The right entity depends on state-specific regulations and the structure of your business. In California, where the California Finance Lenders (CFL) license mandates balance sheet lending, the debt fund or the lending entity that provides capital fund for the loan must obtain the license. This ensures that loan proceeds come directly from the licensed CFL entity, which serves as the lender of record. Closing and funding loans through the fund manager or another entity without proper licensing could lead to complications and create regulatory compliance issues.
Which States Require Licensing?
Several states are well-known for their licensing regulations, including California, Nevada, and Arizona. These three states, as well as North Dakota, South Dakota, and Vermont, will require a license regardless of the underlying collateral. In addition, Idaho, Oregon, Utah, and Minnesota will also require licenses for BPLs secured by a 1-4 unit residential property. Additional states may require licensing depending on the type of property and borrower type. For example, Florida does not require a license if the loan is for a 1-4 unit residential property or the borrower is a business entity and the lender is an “institutional investor.”
Licensing applications will generally require foreign registration of the licensing applicant in that state, placement of a surety bond, and background/credit checks of certain owners and managers (control persons).
State-Specific Licensing Considerations
Some states enforce net worth thresholds and require brickand- mortar offices in the state. Additionally, states like California are known for having particularly long processing times for license approvals. As of 2024, it takes over 10 months for CFL approval.
- Arizona
Arizona has one of the higher thresholds for entry due to its requirement of audited financials reflecting a minimum company net worth of $100,000. Additionally, Arizona requires both an in-state office location and a qualified individual who meets certain experience requirements and resides in Arizona to oversee the office. - Nevada
While Nevada does not require audited financials, it does require a brick-and-mortar office located in the state, as well as a qualified individual who meets certain experience requirements and resides in-state. - Utah
The Utah license requires an individual who has their Utah Lending Manager License and can meet experience requirements. - North Carolina
While not requiring a traditional license, North Carolina mandates a broker filing or registration for lenders who have made loans of less than $1M in the previous year. This involves submitting a disclosure statement, a recent financial statement, and posting a $10,000 surety bond with the Secretary of State.
Additionally, states like Tennessee, Washington, and Texas impose additional obligations beyond licensure. These obligations may include exceptions, special rules regarding owner-occupied BPL, usury, or specific exemptions that must be adhered to.
Exceptions for Licensed Broker Involvement
Many states provide exceptions that allow lenders to operate without directly obtaining a license, provided they follow specific guidelines. California is a prime example of a state with stringent licensing requirements. Any private lender making a loan in California must have the transaction brokered by a California-licensed real estate broker (DRE Broker). This broker must be actively involved in the loan process, collecting information from the borrower and providing required disclosures. The intent is to ensure that borrowers are adequately represented, and the loan complies with California’s Business and Professions Code and the California Code of Regulations. State regulators enforce this rule strictly, requiring brokers to actively engage with borrowers rather than serve as “brokers in name only.” If a broker is listed on the documents without handling disclosures or communicating with the borrower, lenders could face penalties during regulatory audits.
Several other states have similar broker-related exceptions for private lenders, such as Arizona, Oregon, and Utah, where the licensing rules parallel California’s, requiring a broker to actively participate in the loan process.
Navigating License Applications
State-Specific Eligibility Requirements
As mentioned above, some states have unique eligibility requirements. For example, California requires the lending company’s net worth to be at least $25,000, while Arizona requires $100,000. In Arizona and Nevada, it is mandatory to have a brick-and-mortar office location and a qualified individual residing in the state. Although all states generally require a surety bond, the minimum bond amount varies from state to state.
NMLS – MU1 and MU2s
Any applications for state licenses as well as documentation or other required forms for licensing are filed through the Nationwide Mortgage Licensing System and Registry (NMLS). NMLS is a web-based platform that many lenders find to be complicated and not very user-friendly. Managing the requirements to maintain a license on NMLS can be time-consuming and extremely stressful. Each license application includes at least 2 separate NMLS applications: (i) the lending company’s application (MU1), (ii) an individual application for each control person of the company (MU2s), and (iii) potentially a branch application for each additional office location; and all applications and records need to be linked in NMLS.
Financial Statements and Other Documents
As mentioned above, most states require you to submit your company’s financial statements, but the specific requirements of the financial statement vary between the states. While California requires an unaudited financial statement prepared, in accordance with GAAP, showing a minimum company net worth of $25,000, Arizona requires the most current CPA audited financial statement, and Minnesota does not require a financial statement to be uploaded. Additionally, document uploads require specific file names (which vary by state) and must be uploaded under different locations within the NMLS. For states that require electronic surety bonds, bond companies must also link the bond to the company account.
Business Plans
Most states require a formal business plan outlining the company’s products and marketing strategies. Depending on the state, there are additional state-specific business plan documents required, and certain states like California and Nevada each have their own business plan forms and requirements.
Organizational Structure, Management Charts, and Background Checks
Companies will need to provide their organizational structure and management charts, which is where most of the headache and confusion arises. Organizational structure charts generally need to include the ownership percentages of direct owners, indirect owners, and depending on the state, any other individuals who own a certain percentage of “voting shares” of the company. Management charts need to show all managers, officers, and directors of the company, including any other individuals who have control and authority over the company’s lending activities.
Getting this part right is crucial as it has a trickle-down effect on the rest of the application. Depending on the state, the individuals ultimately listed in these charts may be required to submit to an FBI or criminal background check, fingerprint processing, and credit checks. For example, background checks are generally required for each executive officer or control person of the company, but California additionally requires a background check for any individual who directly or indirectly owns 10% or more of the company and has authority over the company’s lending activities. Arizona requires background checks for all individuals who hold 20% or more of the company’s voting shares, and Nevada requires this for holders of 10% or more of voting shares in the company. Additionally, Nevada also requires credit checks for such individuals. A careful analysis of a company’s organizational and management structure is critical in accurately completing any state lender license application.
Complications and Nuances
Timing for the entire application process depends on various factors, including the time needed to compile and prepare all necessary state-specific information and documents, obtaining foreign state registrations needed, completing the MU2s, sponsorship approval of MLOs as needed, and of course, getting the correct bond in place.
Once the licensing application is submitted, the waiting time for a state to review the application may take 4-6 weeks or more. There may also be multiple rounds of follow-up items from state regulators before you get final approval for any state license.
Best Practices for Private Lenders
For private lenders looking to operate nationwide, understanding state-specific licensing requirements is essential. A clear grasp of each state’s laws, exceptions, and the proper structuring of company and/or Fund licenses is crucial for staying compliant and avoiding legal challenges. To confidently navigate these complexities, consult with an experienced BPL licensing legal professional to keep your lending operations compliant across all states.
