COVID-19 Opportunity: Making Owner Occupied Business Purpose Loans

Nema Daghbandan:

Well good morning everybody, and for those of you joining us on the East Coast, good afternoon, this is Nema Daghbandan with Geraci LLP here. Thank you for joining us. For today's webinar, we will be discussing how to make owner occupied business purpose loans. So these are business purpose loans, which will be secured by the primary residence of your borrower. Before we go into the details of today's webinar, I want to go through some logistical issues with you first. The very first thing is that there is a question and answer feature built into the Zoom application. So if I believe it's at the bottom of most of your screens, but you may want to look around a little bit on your screen where you'll have the opportunity to ask questions. You do not need to wait to ask questions. You can ask questions at any time.

We will see all those questions getting entered and at the end of the presentation we will have time allocated to answer those questions. One of the questions that we always get so we can answer right now is can I get a copy of these slides? And the answer is yes. We always send follow up emails after the presentation and in that follow up email we will let you know how to get a copy of the slides. So I can answer that for you right now. But again, there will be a question and answer section. Please use that versus the chat as it's very hard to follow along with the chat and it's very easy to follow the question and answer format. And again, we will answer as many questions as you have. Assuming time is permitting, we are intending to try to keep this webinar short, sweet, and simple to permit time for you to answer any questions that you may have here.

Alright, so without further ado, again, my name is Nema, I'm a partner here at Geraci LLP. I'm here on the banking and finance team. What our team primarily does is the preparation of loan documents on a nationwide basis as well as providing compliance advice to our many lenders. And we are also the team that have a foreclosure practice, so we manage the terms or the firm's loss mitigation, so that's forbearance agreements, modifications, as well as actual foreclosure action. So nonjudicial and judicial here with me on the call today is Melissa Martorella, who's a supervising attorney in our practice as well. Melissa actually manages the day-to-day practice on the foreclosure side. So she is the person that is really our point person here related to foreclosure. So what are we doing here today? So today we're going to cover four things and in this order first we're going to identify what is a business purpose loan. That may sound silly, but at the end of the day is it's probably the most confused aspect of this entire presentation. So what is a business purpose loan? Second, we're going to dispel the myths related to owner occupied business purpose loan specifically. Third, we're going to identify state specific information so you can understand how to do this on a nationwide basis. And last we'll be answering your questions.

So let's first queue up the concept of why we are doing this webinar. Obviously this is a crazy period of time, it it's fluid and it is day by day, but there's one thing that is very obvious and what really got us thinking about this a couple of weeks ago before we had effectively locked down society was we were seeing and getting inklings of calls from business owners who were already feeling the effects of COVID-19. And these were really great businesses that were relying primarily on public meeting spaces. And so these businesses were getting hammered because they had a rush of their counterparties who were telling them Right now were getting all of our counterparties telling us that because of the fears globally about public meeting places, we probably don't want to continue this contract. And they were arguing that lovely French term force majeure that these contracts permit us to not perform right now because there's a force majeure event.

And that was prior to this lockdown concept. Obviously the world's changed dramatically in the past few weeks here. And so what was a few businesses that were running into liquidity problems was now pretty much half of the small businesses in this country were running into some sort of issue because they were being asked to stop working. And so we wanted to try to understand is how can private lenders help in this current environment? We know that there's federal programs and obviously it looks like we're on the brink of a huge stimulus bill and very curious to see what happens in there. We saw inklings of SBA programs that were coming out to place and we knew that the SBA could provide relief, but we also know that it's unlikely that that relief will come for at a minimum three to four weeks for probably months in a lot of situations. And that's just not fast enough for these businesses that need to make payroll now. And so private lenders, as a general rule have been able to move faster than the marketplace as a whole. And we thought this was a great opportunity to connect a huge need, which is getting business owners quick liquidity and getting 'em connected with people that had capital ready to go. So that was really the premise of today's webinar.

Melissa Martorella:

Hi everyone, this is Melissa. So I'm going to talk you through here some of the federal lending considerations that we have to think about in order to see if we have a way to make these business purpose loans secured by a borrower's primary residence. And so we're going to take these next few opportunities here to walk you through these statutes to kind of understand how you are able to make loans. So the first statute we have is TILA or the Truth and Lending Act. I'm sure a lot of you know what this is, but basically TILA applies to any credit offered or extended to a consumer primarily for a personal family or household purpose. There are two key considerations you have to think about when you look at that statement. The first is the word consumer and the second is primarily for personal family or household purposes. And we're going to dig into those in just a second.

So the first thing here, consumer TILA defines this out to mean a natural person to whom consumer credit is offered or extended a natural person and therefore a consumer is also further defined as either an individual, so you as your individual person or a family trust, otherwise all these other kind of entity formations here. So LLCs, corporations, partnerships, associations, everything else here, those are not considered to be natural persons and therefore are not consumers. So technically if we think about this definition for how Telo applies, if you are making a loan to any of those entities, you are technically not needing to comply with Pila because you are not making a loan to a natural person. That said, I would not want to auto rely on that exemption because you could have a lot of borrowers come to you and say, Hey, well you told me I had to put this property, hold it as an LLC in order to make this loan.

And it really opens you up to a lot of litigation down the line. So what we like to do is also make sure that not only does it matter who you're lending to, but what is the purpose of the loan that you're lending. So kind of getting into that a little bit, the other half of that point on TILA was not only lending to a consumer but making a loan for primarily family, personal or household purposes. And we have here a great exemption from TILA, which states that if you're making an extension of credit to a borrower primarily for a business, commercial or agricultural purpose, then you're automatically exempt from Telo, which is fantastic. And a couple of slides here, Nema is going to get into what exactly does this mean to be business, commercial or agricultural purpose? But we know that if we can make sure that our borrowers are taking out these loans for these purposes, then we don't need to deal with Telo.

That second federal law that we need to pay a lot of attention to is RESPA or the Real Estate Settlement Procedures Act. This also governs consumer loans and it governs disclosures and loan transactions and servicing for consumer loans. Thankfully, it is also very helpful. It ties right back to TILA and it says, Hey, an exemption to all of the regulations provided here in is if you are making an extension of credit primarily for a business, commercial or agricultural purpose as defined by TILA. So we know right away if we can confirm that our borrower is taking out the money for a business purpose, that we don't need to deal with these two regulations which are extremely strict.

So how do we know if we have a business purpose loan? Your first question always has to be, what is the purpose of the loan funds? A lot of people will come asking me questions about, Hey, I want to make this loan and its owner occupied, can I make it or is that a TE RESPA governed loan? And the first question is not whether it's owner occupied or the type of property. If you notice all of those definitions that we just went through didn't talk about the type of collateral securing your loan at all. It talked about the purpose of your loan proceeds. So that's the big shift that we recommend you lenders make is always focusing in to see what is the purpose of the loan proceeds? Why does the borrower need this loan? And a really helpful practice tip that we give here to all of our lenders is when you're accepting that loan application, ask the borrower for a handwritten statement of purpose. So have them write out in their own handwriting, Hey, this is what I'm using a loan proceeds for rather than a checkbox or, oh yeah, sure, this is for business purposes. Have them be very, very specific about what they're using the money for. Then you have a very clear exemption to both TILA and RESPA.

Nema Daghbandan:

And so what's the interesting here is when you actually look through the Truth and Lending Act, I'm assuming many on this call are familiar with those definitions, have had your counsel probably talk to you about this, have been to seminars. So you understand from a big picture perspective what is a business purpose loan and understand the business purpose loans are by nature exempt from the primary consumer regulations, particularly the Truth and Lending Act and RESPA. And the reason why the Truth and Lending Act and RESPA are so important is because most state laws are also modeled off of the same definitions. If you typically look at consumer regulations in any given state, they will typically say that the regulations apply to loans which are primarily for personal family or household use. The other nice thing about the Truth and Lending Act is they have this thing called the staff commentary.

So the staff commentary basically goes in and says, here's the statute where we state to you that the loan that in the loan is that is primarily for business, commercial or agricultural use is exempt. They then in the staff commentary start saying, well, what does this actually mean to us? Can we give you a few rules of the road? So even though this isn't in the law itself, in the statute, it has the same effect and weight as the statute itself does, and it tells us what the drafters were thinking. So they go into this concept of how do you know whether you have a business purpose loan and they provide these five factors and let's touch upon these a little bit here. So the first factor is the relationship of the borrower's primary occupation to the acquisition. The more closely related, the more likely it is to be for business purposes.

So lemme give you an actual example of that. A loan to a person who purchases properties and flips them. So a rehabber and they are buying an investment property, you have a direct relationship to their primary occupation and to the purpose of that loan. Let me give you a counter example. You have a dentist friend, that dentist friend watched HGTV yesterday and decided that they are going to get in the business of flipping homes. Their primary occupation is is to be a dentist. And in this instance they're buying an investment property. You no longer have the relationship to their primary business and to what this acquisition is related to. It's not that it's necessarily a consumer loan yet just this factor no longer weighs in your favor. The second factor here is the degree to which the borrower will personally manage the acquisition. The more personal involvement, the more likely it is to for business purposes.

So similarly, let's say for example, you're going to flip an investment property, you're going to rehab an investment property. If you are an owner builder, there is a more direct correlation to what you are doing here and your role versus hiring a third party general contractor. Even if you hire a third party general contractor, it doesn't mean again that it's for consumer purposes, it's just that this factor no longer weighs in your favor. The next one here is 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 purposes go right back to our professional flipper and our dentist, the ratio of their respective incomes that this particular acquisition we'll deal with should be different. The rehabber should have a higher relevance to them. And the last two are fairly self-explanatory.

The simple size of the transaction, the bigger the transaction, the more likely it is to be for business purposes. And lastly, the borrower statement of the purpose for the loan. So Melissa touched upon that in the last one, which is that is why we recommend that the very first thing you do when making a business purpose loan is you get a written, and by written I mean a handwritten statement by the borrower where we ask a very simple question, what are you going to use the loan funds for? Right? Where's the money going effectively? And I want that in their handwriting at the outset of the transaction. I don't want it at loan documents, I don't want it somewhere in the process. I want it right at the outset because I want to rule out whether this is business purpose or at least understand whether this is business purpose and it's trending in that direction right at the outset of the loan transaction.

And this next slide is oftentimes the one where a lot of people kind of have a light bulb moment. And so we'll kind of talk about this for a little bit here because what's nice is going into the staff commentary, they providing us very specific examples from a regulatory perspective, what is absolutely business purpose and what is not. And these examples oftentimes demonstrate and dispel a huge myth about what is business purpose. So the very first example that they provide here is a loan to expand a business, even if it is secured by the borrower's residence or personal property. That's really the basis for this webinar. So for example, expanding businesses in this climate can be the purchase of inventory, keeping payroll going in a traditional environment. This is oftentimes people who wanted to, for example, open a restaurant or start a business in these times.

We're really seeing this as the continuity of a business is really the business purpose. But they state here specifically that as long as it's there to expand the business, it doesn't matter that it's secured by the borrower's primary residence or even their personal property. They could pledge their car, for example here, their Mercedes could be collateral for your loan. Gold bars could be collateral for your loan, it doesn't matter. This is personal property in nature and what would otherwise be considered in a traditional world owner occupied or otherwise? That's not the important issue here. The next one we'll touch as a third one is the business purpose example, stating that it's a business account used occasionally for consumer purposes. So for example here they talk about the concept is let's say for example you have a business and you have a business credit card and on the business credit card, sometimes you make personal expenses on it.

They're stating that that's still a business account even though you might've used it occasionally for a consumer purpose. And the reason why I waited to use the second example is this one really demonstrates the heart of the regulation. And the second one here is a loan to improve a principal residence by putting in a business office. And so even if this is a loan secured by your primary residence and even if it's a loan to improve your primary residence, it could still be business purpose under the regulator's eyes if the purpose that you're expanding or the reason why you're expanding your home is for a business office, this is coming into play in California a lot for this concept of ADUs, right? These accessory dwelling units or these in-law units or other rental properties. So for example, you've got a big size backyard and you're planning on putting an accessory dwelling unit there and you want to put that as a rental or an additional rental property on your house. You could take a loan secured by your primary residence and the purpose of that is to build a accessory dwelling unit and that is a business purpose and that's really what they're describing here.

So then they also go into here and they say, well, lemme give you examples of what is a consumer loan from our worldview, from the regulatory worldview. So the first one is a business extending credit to its employees. So if you are out there and you're trying to give, and this is probably happening to a lot of people, which is hey, the employees are running into hard times and they're looking for loans. Even though you are a business and you're supplying the credit, it is technically consumer credit that you were providing. And so that would be considered a consumer loan. The second example here is a loan secured by a mechanics tool to pay for a child's tuition. Lemme give you a different example, which is probably more likely in your world and is often a myth we have to dispel. What if you have an investment property?

So you have a borrower they own, for example, a rental property, an investment property, but they want to borrow money on that to go buy a car for personal use. They want to go buy that Bentley they've always been looking for. Oftentimes when our clients are calling us, they simply state the terms, guys, this is a non-owner loan. I don't need to talk about this business purpose stuff with you. And this is the example I point right back to them, which is it's important to know whether it's owner occupied or not owner occupied. But that's not my first question and that's not the regulator's first question. They're trying to understand the purpose. So even though that's an investment property, the reason you are taking the money out of that investment property is important and we have to answer that question to understand whether the truth in Lending Act and resp a applies. And the last example that they provide here is a personal account. So for example, imagine your personal credit card, but sometimes you go and you go to Office Depot and buy business supplies with it. You didn't suddenly convert that otherwise consumer account to a business account through this occasional use of business credit.

So now that we've dispel the myth, we'll go into a little bit about how to actually structure one of these loans. And so one of these loans again is a business purpose loan made to a business owner, but it is secured by that business owner's primary residence. Here are things that I'm very careful about when looking at this loan to a great degree. When you're establishing what is consumer or business purpose, you are following the money and by following the money, I mean looking at the settlement statement and seeing where did these loan proceeds go, right? So for example, are they refinancing current debt? Is there a first position loan on this property? And let's just use a simple example where there's a first position loan for $300,000. You've got a distress business owner and they want to borrow $200,000. So a lot of our lender or a lot of our clients will only want to do first position loans.

And so let's say there's no problem, I'm willing to give you the additional $200,000 you're looking for, but I need to be in first position. So therefore I'm going to give you a $500,000 loan. 300,000 will be used to refinance the original first that consumer first on your property and the additional $200,000 will be for business purposes numerically looking at that loan, it is 60% for consumer purposes, the refinance of a consumer debt. There is conflicting case law on that particular issue arguing whether that's truly business purpose or consumer purpose. But I would generally say that you should err on the side of caution. And what that means is you generally speaking should not be refinancing any sort of consumer debt on the property unless there's such a disproportionate amount of what is being refinanced versus what is the new cash being provided. So look and be careful about whether you're going to refinance any preexisting debt on the primary residence.

The second is where else is this money going? And so for example, we're listing your property taxes and especially this becomes particularly relevant when there's a lot of delinquent property taxes. What about other liens? Do they have a franchise tax board lien? Do they have an IRS lien? Do they have other liens sitting on their property? And are your loan funds going to pay off those liens? What is that dollar amount versus the actual cash that your borrower is receiving at the closing table? That's the sort of analysis that you want to make sure that you're doing here in that loan transaction. So when we discuss the primary purpose of a loan and using the proceeds as the test to determine that if it was an investment property, we generally say is look, as long as 51% of the loan funds are being used for business purposes, it's a business purpose loan.

We are much more conservative in our approach when you're dealing with a primary residence because at the end of the day is I don't want to be arguing in front of a judge and getting into this very, very technical aspect of what is consumer, what is business, what's the primary purpose? I want it to be pretty unequivocal on its face that this was a business purpose loan despite the collateral being owner occupied. So the rule that we tend to recommend here is that at least 80% of the cash of the proceeds going out that it is cash going to your borrower and that 20% or less are things such as refinance of debt, property taxes, or other things that are arguably consumer in nature. So I'm looking to see to make sure that there's a sufficient cash going to your borrower. There's two points that I want to make here.

One is that documentation will keep you alive in this scenario. We talked about it a little bit already at the outset of this webinar, which was specifically getting a handwritten statement from the borrower about the use of their proceeds. What are you using this money for? Why are you borrowing this money? But in addition to that, I want a consistent loan file that keeps telling that same story. I don't know what your emails are saying or what the borrower's communicating to you all along, but I want to make sure that it is unequivocal that the borrower is using this money for this business purpose. The next thing, another cautionary tale that's not on the slides up here is these are business owners, right? So at the end of the day is they should have an operating business. I generally speaking, do not want to do this in a sole proprietor type situation.

I want to make sure there is an operating business in the background, so an LLC or a corporation, but some identifiable, true separated business. They need to have a separate business bank account that has statements that I can look at and I want the cash in this transaction to be deposited into that business bank account. That's where I want the money to flow into. And so in my lender's instructions to escrow, I'm identifying in here is please deposit funds into this account and I'm providing the wire instructions to the business bank account for my borrower to make it unequivocal that they are using this money for business purposes.

Melissa Martorella:

Just to add on to the one point that we've been talking about is getting that handwritten application with that statement of purpose at the application phase and then also at loan documents is because it really matters at the time you make the loan what the purpose of the loan proceeds are. So as long as you have clear documentation that's consistent throughout that the borrower intends to use the loan proceeds for a business purpose and you can back that up with their application with the loan documents, with representations throughout. It doesn't matter that you funded that loan and then they immediately went and paid off personal expenses with that money. It matters at the time you funded the loan what the borrower is representing the use of the proceeds are. And so that's why we want to make sure that you have that strong documentation in case they do decide to use the money for a consumer purpose later on and then try to sue you over that.

So kind of moving on here, the last little comment about consumer loans are trade disclosures. These trade disclosures, they're not required for business purpose loans. But that said, a lot of times I'll be dealing with title or escrow companies and especially when the loan is secured by a Wonder four family property or especially by the borrower's primary residence, they'll be asking, Hey, where are the tri disclosures? And so you just have to know that while these are required for all consumer loans, regardless of the type of collateral, they're not at all for business purpose loans. So just give that heads up to your escrow and title if they start asking for that.So now we know that on a federal level we are able to make these business purpose loans secured by an owner occupied property, which is fantastic. Unfortunately, the federal law just sets the floor for regulations. So that means states could differ from those regulations if they wanted to. They could be a little bit more strict if they wanted to. So the next question that we have to ask is the activity that you're conducting, does that require a mortgage broker or mortgage lender license? And your answer here is that it will vary wildly depending on the state you're intending to London. So we have a helpful little map here. Again, as a reminder, federal law only cares about consumer loans, but then we go into the different state analysis here. So for business purpose loans, we have to look at a state by state analysis to see if you can make that loan in that particular state.

So the states in red, these six states, you will need a license regardless of the type of collateral securing the loan for a business purpose loan. Doesn't matter if it's commercial property, multifamily, residential, these six states, California, Arizona, north and South Dakota, Vermont, and Nevada will all require you to have some sort of license in place. The five states that are in yellow will require a license if the property securing the loan is a one to four family property. Those are Utah, Oregon, Minnesota, Idaho, and Virginia. Finally, we have five states in purple here where you're going to need to be licensed as a lender if the property is an owner occupied one to four. So that's Georgia, Iowa, Kansas, Texas and Washington. That being said, there are a lot of exemptions or exceptions to licensing here that may be available to you. So this doesn't mean that, for example, in California you may not have a lender license.

However, there's a very easy exemption or exception to licensing here where if you are an unlicensed lender but a licensed broker arranges that loan transaction for you, then you're good to go. You can make that loan all day. A lot of states have exception or exceptions or exemptions like that that you can qualify under. So it's not just because these states are written up here doesn't mean that you can't run there. It just means that you have to do a little bit more due diligence to see if there is a viable option for you to make those. And also the positive side of this slide as well, if you look, we have 34 states plus DC which are in green. All of these states will allow you to make an owner occupied business purpose loan with no licensing consideration. So that's really great news for you. The majority of this country will allow you to make these business purpose loans to help out these business owners with no questions asked.

Nema Daghbandan:

Alright, so now we've covered licensing. Let's talk a little bit about some of the loan level limitations. So what is unique when dealing with business purpose loans, which are secured by the primary residents is that states oftentimes create specific restrictions. So for example, default interest, prepayment penalty lead charges may be different because the property is owner occupied because a lot of these regulations do not tie into the reason for the loan, but more so what is the security for this loan. So we'll talk a little bit about what are some of the restrictions you can expect as well as some solutions for those. So the very first thing that you want to think about and tends to be problematic is usury. So usury are very old laws pretty much in every state, oftentimes in state constitutions, and it was really designed to prevent loan sharking.

And so the practical application of a usury law, and these are for owner occupied versus even non-owner occupied business purpose loans is they oftentimes create restrictions on what sort of default interest a lender may charge. So we'll go into some examples in the next slide here, but know that usury is pretty complex. There's lots of exceptions and exemptions and it's a very wild area of the law. It's something that we're counseling on a daily basis. One thing and one solution, oftentimes when dealing with user related issues is using what is called a foreign choice of law. So for example, you have a property in the state of California, but you are a lender in the state of Florida. And so you obviously have to have a deed of trust here in California and that's going to be your security instrument when you record your loan.

But you could govern the promissory note in that transaction and the promissory note governs usury. And so you could govern the promissory note by the state of Florida, which is where the lender is located, and a traditional business purpose loan that is secured by investment property. Most states will permit you to use that foreign choice of law. It is less clear about whether a state will be as permissive about using a foreign choice of law because the collateral is owner occupied even though it's for business purposes. That said, that is a strategic option you can think about and one big picture on usury itself is usury is generally a prohibition or a maximum rate of interest. What is interest is not clearly defined. So what California considers interest is different than what Florida considers interest. Lemme give you an example of that. For example, in the state of California, a late charge or default interest are not considered interest.

The state of California says, look, those are elections by the borrower. If you choose to be a late payer or you choose to not pay and therefore your loan goes into default, that was a choice that you made borrower, and that can't be considered interest for purposes of usury. So know that each state defines what is interest differently here. So some examples of what is USY throughout the country. In the state of California, if you are not a licensed lender, the general cap is 10% and that is a 10% a PR. So that will include your points and fees. However, loans made by a licensed California finance lender or a loan arranged by a licensed real estate broker are exempt from usy. Under estate's laws, there are other exemptions available as well, but just the primary exemptions. Tennessee has a really interesting usury regime. So in Tennessee, the maximum rate of interest is 4% above the prime rate offering at that time, right?

So if the average rate for a consumer loan in Tennessee is 4% for example, then the cap that you can charge is 8%, which is pretty low, particularly for these types of short-term bridge loans. That said, Tennessee has codified a foreign choice of law. So they'll say is we will actually let you California lender, use your choice of law over us here and use your user exemption here in Tennessee. So long as you meet a multifactor test, are you actually a resident of California? What's the relationship between the parties? So there's a little bit of a test you've got to pass by, but they've codified saying, we will actually permit you to use a foreign choice of law here in Tennessee. You have states like Texas for example, that will toggle the maximum rate of interest that you can charge based on the loan amount.

Florida is a similar regime as Texas in this regard. So based on the loan amount, there's a toggle about what the maximum rate of interest is. This typically means what is the maximum default interest rate that you can charge for a loan, but this is definitely something that you're going to want to make sure you have absolute clarity on when you're making this type of loan. We touched upon this a little bit already. So other limitations. So for example, there may be late charge limitations, there may be prepayment penalty restrictions and they may be different because this is a loan secured by the primary residence of the borrower. By way of example, the state of California has a very specific restriction for owner-occupied business purpose loans. For a regular business purpose loan, there is no prepayment penalty restriction, but if the collateral is the primary residence of the borrower, there is a six month maximum prepayment limitation here in the state of California.

That's just an example. So know that you've got to be on the lookout for late charge restrictions, default usury as a general rule and also probably prepayment penalties. So know that that's going to change on a case by case basis. Our recommendation here in these circumstances and in particular during this time period is to be very conservative in your approach because these are primary residence loans at the end of the days, you want to make sure that you are treating them more consumer than you would a normal business purpose product. So what does that mean for us? We're typically recommending at least a 10 day grace period, if not a 15 day grace period, a maximum late charge of 5% after that grace period is over and a maximum default rate that is 4% above whatever the note rate is if you're going to use a default rate at all. So what are some of the key takeaways from this webinar?

The first thing is it is your purpose, not your occupancy. That is the primary matter of importance. Why are you borrowing the money? It goes back to that initial letter. The second thing that we talked about is know your state issues, partially licensing, partially loan level limitations in the states that you're going to be operating and doing this in. The last thing is consistency and consistency, meaning that it is absolutely clear throughout your entire loan process, through your emails, through anything in writing with your borrower that the reason they are using this money is for business purposes, that you have an established business, it's going into a business bank account. All of this is establishing a level of consistency to make sure that you can defend this loan through litigation. And we've done a lot of these sorts of things where it's very, as long as we can have clear unequivocal approach, we can quickly get rid of any sort of litigation at the outset by having a clear business purpose letter at the outset that's separately being affirmed at time of loan documents, right? It's not some sort of check the box. Yes, this is business purpose. You want handwritten stuff, you want really clear borrower intent of why they use this money and what it was going to.

And one more thing here as well is one of our partners out there and during this time period we're really just trying to promote all the people who have helped us throughout the years. One of our partners reached out to us and said that they've got a marketplace. So right now, as many of you know, there are a lot of lenders who are currently just kind of freezing up their activities, people that would normally be lending just not for this time period. And so a lot of our clients are kind of scrambling trying to figure out where do I send loans to? How can I find active lenders? Is one of our partners out there is Liquid Logics and Sam wanted to let me know that they've got a platform in place where borrowers can go on, lenders can go on. We're here for that.

Anyone else out there on the webinar, we want to partner with you as well. And so I want to make sure that you know that this is just us trying to help the community as a whole here. So last going into this are we'll open up the floor for Q&A to kind of give you a scale of this presentation. We have over 200 people on this call. So thank you for everyone on here currently, I see 21 questions in the queue and we'll start going through question by question and answering them and we'll basically answer every question that's on here. For those of you that want to drop off, just thank you for your time. Like I said, we'll be providing this webinar later through slide, but we're happy to answer any questions that pop up at this time. And just a friendly reminder too is the best way to, there's an actual Q&A box, please don't raise your hand or try to enter into a chat because it's hard for us to see out on our end, but we do see all your Q&As being asked in the Q&A box.

So the very first person that is asked a question here is it is really a recommendation and it's a smart recommendation. So the person who asked the question is an Mahalia, and sorry if I put your name here, it's more of a statement which is making sure that per diem interest on owner occupied business loans begins a day prior to borrow receiving the funds, which also could be the recording date if the borrower does not get his or her funds on the same date as the recording correct. So this is a very California specific question and I will rephrase it to hopefully make it clear for the audience. California has a very specific rule in place about when a lender may charge interest. So generally speaking, throughout the country, lenders are able to charge interest the day that they fund the escrow, the day that they deposit funds into escrow or to the title company.

California has a different rule on that, and the rule in California is that if the collateral for your loan is a one to four family residential property, then the first day you can charge interest is one day, one calendar day prior to the escrow releasing those loan funds. So the day that the borrower gets the money, regardless of the day you the lender funded the loan. So that's a California specific rule and it applies to all one to four family properties. It does not matter that it is owner occupied. So yes, it would still apply here for an owner occupied property just as much as it would apply for an investment property here in California.

All right, the next question here is can a lender require the borrower to obtain hazard insurance higher or greater than the replacement costs, which would include flood and earthquake as well? So the answer to this question is and does not matter that it's the primary residence or not, is that there is a replacement cost to rebuild whatever the structure is. It's the primary residence of the borrower. It is a dental office. It doesn't matter what your collateral is. The maximum that a lender can require from an insurance perspective is that replacement cost. Why the insurance company does not care what the insurance amount is. It could be a billion dollar claim or a billion dollar policy. They're going to replace the structure. That's the insurance contract, they're going to replace the structure and that's all they're ever going to do until replacement cost is all you could ever ask for regardless of what your collateral is. And in particular, I would be very wary in a situation in which you're using the primary residence because you definitely want to make sure that it doesn't appear that you are trying to take advantage of your borrower under any circumstance here.

Melissa Martorella:

And to kind of elaborate on that a little bit as well is sometimes it may be that the property itself is also very, very valuable. So you might have a $2 million loan amount because the entire property with the improvements structures on it, plus the land itself is worth $5 million. However, the improvements those structures, maybe they're just cheap little shacks that are located on the property. The insurance company is only going to provide you with the replacement costs for those structures. So they may only be willing to offer you a million dollars in coverage even though your loan is all the way up to $2 million just because the property value itself of the land is so much higher. So that's something to also take into consideration here.

Nema Daghbandan:

Great. The next question, which is one we're getting a lot of, and it's a great question, is from Alex lik, which is can you comment on lender's ability to foreclose on non-owner occupied in California in this current environment and the forbearance agreements? So I'll give a very, very fast primer on this issue. First, there is no federal prohibition on the foreclosure of anything other than a federally related mortgage loan. So those are FHFA loans. It does not matter that you are dealing with a business purpose or consumer, or sorry, a business purpose owner occupied or non-owner occupied property. Right now, if you are in the state of California, there is no prohibition on a business purpose foreclosure. You can initiate a notice of default today on any business purpose loan regardless of whether it's owner-occupied or not. Owner-occupied, whether you want to or choose to is a discretionary matter.

There is no legal prohibition in the state of California in many other states. There is an actual legal prohibition in many other states. There is a practical prohibition, which is that the courts are, so for example, you're a judicial foreclosure state and the courts are closed. You can't initiate a foreclosure to a great degree in many other states. So there's about six other states, I can't remember them off the top of my head other than I remember it was Indiana and Massachusetts, I think Iowa and Kansas, New Jersey, New Jersey, look, I do remember them, fantastic. But at least in the state of California, you can initiate a foreclosure action. What is unique in the state of California right now is you probably can't complete a foreclosure action. And that's not because the law says you can't do it. It is a practical matter in order to complete a non-judicial foreclosure action in California and very much every other state is there is a public action.

Public auction require a gathering of people to meet at the auction steps to conduct the sale In California, you cannot have a public meeting right now due to our lockdown orders and therefore the sale effectively is invalid because it wasn't a public auction, it would be a contested sale. So prudently foreclosure trustees such as ourselves as your Rossi law firm, which we are foreclosure trustee as well, we are not holding sales, but we are very actively filing notices of default and in fact, recommending to our clients right now that they do file notices default and do them actively because you are going to have a backlog and back jam of the system and there is a clearing process. So in California, for example, it takes about five months to complete a foreclosure. It is good and important to start that clock. Now we will flood the system with foreclosure claims in the very near term future all throughout the country. So we recommend starting that process even if you don't intend on finishing that process.

Melissa Martorella:

And to just jump on this as well, you've also asked about forbearance agreements. We're going to be going into depth on this topic on Monday during another webinar at 11:00 AM We'll be circulating links to sign up for that webinar. They've been on LinkedIn and via email we'll make sure that they go out again. But we'll be really going into depth on these topics. So look for that webinar this coming Monday at 11:00 AM.

Nema Daghbandan:

Next question here from our dear friend, Carl Maggio. In order of service, the loan, the servicing company we use is tightening the requirements to service owner occupied business purpose loans. One main recommendation they mentioned is to require the title company wire loan proceeds to a business bank account at closing. The title companies we work with won't do this for liability purposes. They will only wire to an account associated with the property owner. Are you seeing many title companies that will do this? Great question. And as we talked about earlier, we do recommend that they fund to the business bank account, and that's why I definitely recommend that your loan instructions state that they are to do this. It may be impossible. Title companies are a brick wall that you will not be able to fight in this situation. They may have underwriting or other policies in place which prohibit you or prevent you from actually wiring into the business bank account. But your intent should be clear as the lender here. So I just want to make sure that you are instructing the title company to fund to the business bank account. Even if they push back and say, we can't do that. We've got issues from an anti-money laundering or other perspective that prohibit us from doing that. I just want to make sure that your intent is known in this transaction and that in litigation we can demonstrate that your intent was always to have a business transaction.

Melissa Martorella:

The next question we have here is can you discuss the late charges pertaining to this type of loan? As we discussed on that last slide that NEMA went over, typically the late charges, because these are business purpose loans, they're going to be the same restrictions that you would have generally on other business purpose loans. But some states will require lesser kind of late charges because the property's owner occupied. So as we discussed, our recommendation here was to have a 10 day grace period and a 5% late charge just to make sure that you're safe across the board.

Nema Daghbandan:

All right, and the next one is an anonymous question as you guys probably were able to see. You can also ask questions anonymously. I've been saying names because I really appreciate all the support here. And so if you don't want us to say your name, we're happy to not disclose it. Just ask an anonymous question. So an anonymous question here is can you explain the potential complication of foreclosure for owner-occupied business purpose loans? So there are in most states, they don't delineate on the foreclosure process. They don't say if it is owner occupied, you therefore have to follow these rules. And if it's not, you have to follow these rules. Generally speaking, when states have written their foreclosure laws, they don't care oftentimes about business purpose either. California is somewhat of a rare exception where they do have specific laws in place dealing with consumer purpose, owner occupied loans, but these loans would be exempted from California's regulations as well.

But there is a practical issue, which is that unlike an investment property loan, you do have a person who's living in this property. What does that mean? What does that translate to? There's no real legal difference here. You're going to proceed with a process like normal in most states that said, there's a practical problem. This is a person who will be in front of a judge and is their home. So yes, you can expect that if you make this type of loan, you'll have a more deferential borrower and a more sympathetic borrower in the eyes of the law. The judge will likely give them more leniency, will give them more opportunity, particularly for pro se borrowers where they represent themselves, the process will likely take longer for those sorts of people. That said, there is no legal change here

Melissa Martorella:

And also for the practical method of how you actually complete this. So you've completed the foreclosure process, but then what has to happen afterwards to remove that borrower from the property is an eviction action.

Nema Daghbandan:

So the next question here is from uni, is there any new advantage to international borrowers in this specific of COVID-19 atmosphere? So I think the question being asked here is, well, maybe there's a question. I think you're asking a question that I think others probably have. One is the effect of a foreign national owner of real estate. So one is this actually maybe beneficial for people who are not in the United States currently and are not suffering from COVID-19 in their home state. So they could also tap access to capital here. But effectively is the foreclosure of a foreign national borrower is no different than a US resident. It's not that they get some sort of special protection and they also don't get any sort of detriment. There's no legal change based on your borrower's residency or citizenship.

Melissa Martorella:

The next question we have here from Patrick Kell is keeping a business afloat for payroll inventory, et cetera, truly considered expanding a business. It sounds more like it is to maintain a business rather than expand it. I don't care whether it's maintaining or expanding. Clearly being able to provide funds for payroll inventory so that business can keep operating. That's a very clear business purpose here and that would qualify as a business purpose loan. So you'd be okay to make that.

Nema Daghbandan:

Our next question here is from Rich Walter. So is there a minimum ratio of new funds for business to refinancing a large portion of the existing debt? So earlier we had talked about our golden 80 20 ratios that we like to recommend here. So what that looks like is when I'm looking at the settlement statements, I want the cash to the borrower. That line where it says cash to borrower, I want numerically speaking the ratio that number is 80% of your loan proceeds or greater. That's what I'm really looking for here. When determining whether you can refinance preexisting debt or tax liens or settlement costs, whatever looks like, I want to see 80% of the funds that is going cash to your borrower, comparative to your loan amount.

Melissa Martorella:

And as an additional note, some states do have restrictions if the loan amount just generally is too small. So for example, in California, I believe if it's a junior loan and it's only like $30,000, you run into a lot of other regulations, those are considered Article seven loans and there's a lot of other restrictions on those loans. So ideally in this situation, you're providing that junior loan to give an influx of cash to a business. I would probably make sure in all states that it's at least $50,000 at the borrower's netting from this. That way you don't run into these kind of small loan issues that could pop up.

Nema Daghbandan:

We have an anonymous question here, which is the payment of income taxes considered business purpose. There is no clear case law on this issue, at least from what I've understood and read, I would consider these consumer purposes. I generally do not believe the payment of taxes should be considered for business purposes. The next question is not necessarily clear, so I'm going to jump that one. All right.

Melissa Martorella:

The next question is, as long as we have a detailed use of proceeds on the loan that we are paying off as part of our loan, is that sufficient? So if I'm understanding there's a current loan existing on the property and you want to refinance that so that you are in first, if it's very clear that that current first is another business purpose loan that's very helpful, then you could absolutely refinance that one. But as NEMA was talking about before, if that's a consumer loan, if that's their home mortgage that they had, you probably don't want to refinance that one when you make the business purpose second.

Nema Daghbandan:

Alright, next question here is we often get a sworn affidavit, which we are told is the highest level of legal standard that the loan is for a business purpose is getting a sworn affidavit sufficient to cover all bases. So here's what we do at generosity. So when we're preparing a set of loan documents, our recommendation is this. First, there is a handwritten letter at the outset of the loan, at time of loan application. What are you using the loan proceeds for? In the borrower's handwriting at time of signing loan documents, we have a standalone disclosure document called Business Purpose Declaration. That document, it has a bunch of empty boxes in which the borrower must write in their own handwriting the amount of money they are taking out and where that's going to get broken down to. So applying that relevant standard here is, let's say for example, you have a restaurant owner who's applying for a loan.

They're stating that they need $50,000 for inventory and the remaining $350,000 of the loan needs to be used for payroll purposes. And there's also tax their, there's property taxes or otherwise. And so there's a separate box that they would answer, and 10,000 is going to property taxes and 10,000 is going to closing costs and that's the breakdown of your loan. So I'd want that level of detail in writing, in their own writing. And at the bottom of that document, it is a document which is sworn under penalty of perjury. Meaning that if the borrower later comes back and says, well, you know what? Actually I told my lender the entire time that I was really using this to buy that dream Bentley of mine. We would then take that same document and provide it back to them saying, you swore under penalty of perjury that this was your use of loan funds. So effectively you either committed loan fraud in your application and on the execution of your documents. When you sign this form or you are lying to me today, one of these two situations has to be true.

Melissa Martorella:

The next question we have is what happens if you're taking funds to fix a rental one to four, but they don't have a specific operating business? So as we were talking about funding into that business or making sure that they have a separate LLC or corporation set up for this kind of business is very important. That doesn't mean it kills the deal. All that I would want to see in this situation is very clear documentation and explanation about the use of the proceeds to support the fact that this is truly a business purpose loan. And what they're using the loan proceeds for.

The next question is talking about the tri disclosures that I mentioned, and the question is about should we go ahead and provide these disclosures regardless or does it confuse the situation if it's being provided, I would not provide the tri disclosures. If you're making a business purpose loan, I think it does confuse the situation and if there is any unclear aspect of whether this is a business or consumer purpose loan at all and you've provided consumer disclosures to your borrower, I think that weighs heavily against you. So if you're making a business purpose loan, there's no need to provide these trade disclosures and so I would not provide them.

Nema Daghbandan:

Yeah, and one, there is a legal technical side of this as well. If you read through the statutes, they technically state that you can provide them and that it shouldn't be judged against you if you do. But Melissa's making the absolute right practical point is I don't want to be educating the judge about the nuance of the truth and Lending Act. I want to make it very clear that I am a business purpose lender and I make business purpose loans and that's what I do and therefore I do not have a practice whether I was owner occupied or otherwise of providing these disclosures because that is not the world in which I live and the credit in which I provide.

The next question here is house hacking. So what if you have a borrower, and this is really dealing with more of an investment property, so borrower is purchasing an investment property and they plan on living in this property while they are rehabbing it. So is that considered effectively? What do you consider the occupancy side of that? I would definitely consider this an owner occupied business purpose loan. I'm very skittish about the business purpose nature of it, if they're going to be living in the property while they plan on expanding it, and I always use the example of what if they fall in love with that home? It's going to be a difficult argument to make in front of the judge at that juncture. They bought this property and they developed it and they ended up living in it and you lender probably or could have known differently at that time. So I generally do not like when developers are going to live in the property they're developing, but again, unfairly unrelated to today's webinar.

Melissa Martorella:

The next question we have here is my client lives in California and he plans to purchase a portfolio which includes 17 single houses to rent to the government. Is this a business purpose loan? Generally? I would say yes. This is a business purpose loan. Clearly purchasing properties in order to rent them out, whether that's to the government or to just regular everyday people directly, that's clearly an investment property for that borrower.

Nema Daghbanda:

This is a real question I promise you even though it's an anonymous attendee, but what does ity charge for loan doc prep and title review in this context? Our emails, most of mine are on this slide. Feel free to email either of us. We have a wide variety of options. I promise you a real question and not something we did ourselves. Alright, next question. Do you need to source emails or other communication from brokers who arrange the loan? So we had talked about this kind of consistency is king concept and does it matter whether effectively if you are the lender and you're going to have your own communications, should you also be weary about your broker's communications? And the short answer is yes. I mean at the end of the day is even if you're not worried about it from a big picture legal liability, there's probably, you may have a meritorious claim in court if you can demonstrate that you as a lender have clean hands, but who cares? You're stuck in litigation anyways. I don't want to be stuck in litigation. I don't want to be fighting over well is the broker's liability or my liability at the end of the day is I don't as a lender want to be dragged into unnecessary litigation. And so yes, I do want to see communications and I want to make sure that the broker is not providing any sort of misrepresentation to me for this type of loan.

Melissa Martorella:

The next question, does Ohio require a license to make a business purpose loan? No. Ohio does not require a license. So you could make an owner occupied business purpose loan in the state of Ohio and you are good to go from a licensing perspective.

Nema Daghbandan:

Next question, and I should have actually clarified this at the outset. So not only will the slide be available to you, but we actually do record all of these webinars. They're available on our website. So if you went to Geracillp.com, you could actually see old webinars currently on our website. So this actual webinar with us talking and this Q&A period will be live on our website probably early next week as well. So the actual presentation will be saved and recorded and on our firm website.

The next question here is what is the loan size guideline in the state of Texas to determine the usury default rate of 18 to 28%? Well, I'm going to give you some bad news on this one altogether because Texas has what we call homestead laws. So even though Texas doesn't have a legal restriction in terms of from a licensing perspective of making this type of loan, they've effectively made it impossible to make this type of loan due to their homestead limitations and regulations and therefore you really can't offer this product in the state of Texas. The next question here is can you show that Nova link from the last page again so there was an exchange in which borrowers and lenders can go on to exchange these deals rather than jumping back to that last slide, we will be offering these slides shortly hereafter for all of you to keep kind of continuity going here.

Melissa Martorella:

Next question is when you were going over the maximum interest rates, it was 10% over in California, would that be the same for seconds? Yes. In California it doesn't matter if it's a junior or senior loan, 10% is that cap unless you have some sort of exemption to usury. Some states do differ when it's a first or second. For example, Virginia has a different usury rate versus for a junior versus a senior loan, but California does not have that. If you have specific questions about certain states, I'd be happy to walk you through that. Again, my email and email's email are down there and we can walk you through usury in different states.

Nema Daghbandan:

Next question. Usury the 4% increase in default interest you mentioned, is that a national suggestion? Yes, that's correct. We are trying to provide you pretty big rules of the road to play with. Our recommendation was on the national basis of a minimum 10 day grace, a maximum percent late charge after that 10 day grace period and a 4% above the note rate as your default interest rate on a national basis.

Melissa Martorella:

The next question we have here is, so again, in California without a broker or lending license involved, a lender can charge late fees and default interest above 10%, correct. So this is a little bit of a complicated question. So technically if there's no broker and you are an unlicensed lender, you're capped at the regular rate of interest in California at 10%. That said, California does exempt default interest from its usury law, so you could charge higher than 10% for the default interest rate in California. That said, I'd like to, for this person, I would like to walk through the other terms of your transaction to make sure it's compliant with California law generally.

Nema Daghbandan:

Next question. I've often seen commentary that the purchase of an investment property is business purpose, but today's information would lead me to believe that it is not the case if it's an individual or sole proprietor who is not a real estate investor, landlord flipper by trade. Can you comment on that? Great question. So is the acquisition of an investment property necessarily for business purpose? The short answer is yes, the acquisition of an investment property, but it depends on how do you determine whether it's an investment property. So for example, if you are purchasing rental property, that is always and unequivocally going to be considered a business purpose loan. The staff commentary tells us that directly. But if you have a situation in which you have a rehabber or actually better yet a non rehabber, right? You have NEMA dog, Bandon has called you up, I'm a lawyer by trade sometimes.

So I call you up and I say, I want to buy an investment property and I'm going to flip that house, right? I'm going to do this loan for you. To you that loan is not necessarily business purpose, it's probably business purpose, but it's not necessarily, it's not a bright line rule anymore to look at because then you're going to waive those factors. Well, what is my regular income comparative to what income am I expecting from this property? How big of a transaction is all those factors will start getting waived. So it's not a black and white business purpose loan if it's not done by a professional.

Melissa Martorella:

The next question here is can you address how bankruptcy filings and foreclosure moratoriums will impact these loans? Nema touched upon this a little bit earlier, definitely expect delays. Certain states have put moratoriums on the foreclosure process. States like California, we recommend at least jump starting now. That said, we do expect a lot of delays with regards to finishing any foreclosures here and bankruptcy considerations are definitely part of that. And again, we will have a webinar dedicated to this topic on Monday at 11:00 AM so please sign up for that.

Nema Daghbandan:

Alright, next question is can you speak to foreclosure in the event of a bankruptcy versus a non-primary residence loan? And also I'm guessing similar rules will likely be in effect for pandemic consumer loans.

So the key here is that most of these statutes that you're dealing with, so for example, California's foreclosure statutes or any other state's foreclosure statutes or bankruptcy laws generally speaking are not looking at occupancy. They don't care. It's not something that the legislative bodies have generally looked at and split apart. Generally speaking, in most states there's not this dual track process. California is an exception here for consumer owner occupied loan, there is a dual track process under federal law, they're treated very differently from a telo resp a perspective. So for example, under resp A, you could not start a foreclosure unless you had 120 day payment delinquency on a consumer owner occupied loan. But generally speaking, you're not seeing this crazy bifurcation all throughout the system. So bankruptcy is another example of that. Again, you have a more sympathetic borrower, it's their primary residence involved, but it doesn't mean that there's a whole new system.

That said, when it deals with commencement and completion of a foreclosure, right now we are in a whole new unknown. So what this will look like in the next few months, we'll find out, and that's why we're recommending to our clients is look, you have to start a statutory clock. Start that now, especially for borrowers. If you've had a borrower who's been in default since January that's not related to covid, you should immediately be filing enough of default on that property and you should really be setting the tone because effectively as covid defaults are going to happen in five days from now, they're not happening for your February one payments. That's not for most businesses a covid related default. That was just probably or a person who's habitually been late or habitually been in default, probably unrelated to your current crisis. So I would say if you definitely want to start the clock on people sooner than later for a known bad borrowers, right, and know that regardless of whether it's business purpose or consumer purpose, you are likely going to face some resistance in the months and maybe years to follow about foreclosing during this time period.

So the completion of foreclosure looks very different than the start of a foreclosure.

Melissa Martorella:

Next question. Does that one day rule about per diem interest also apply to business purpose loans in California? Yes, it does. As long as the property securing the loan is a one to four family property, doesn't matter if it's owner occupied or not, it doesn't matter if it's consumer or not, that per diem rule will apply in California.

Nema Daghbandan:

Next question here, given

In the event the property goes to a trustee sale and given the current environment, there may be very few people that go to a trustee sale, correct? We talked about this a little bit earlier in California, which is effectively most trustees, including ourselves, are currently not completing the foreclosure. We're not actually going to the trustee sale currently. And the reason we're not going to a trustee sale currently is because of a lockdown. It's more or less impossible to have a true fair public sale. And so our concern is that if you tried to hold a public sale that it would easily come under contest and that there wasn't a public sale availability because you couldn't congregate. So until these lockdown orders are lifted, it is going to be very challenging to run a trustee sale. And so we're basically taking a week by week approach. Most common guidance right now is saying that there's no availability for trustee sales, at least in California through at least April 5th. That's kind of the current conventional wisdom, and it'll likely get pushed even further than that contingent upon what happens at the state government level.

Melissa Martorella:

Next question. So what should we do now if the borrower is asking to defer their payments on their loans for the next three months? So thankfully we've been thinking about this. We've had a lot of lenders asking about this question. So we've prepared a basic forbearance agreement that you can enter into with your borrower whereby you defer a couple of monthly payments and tack those payments onto the balloon payment of your loan so you can work with your borrower during this period. Some of them are truly struggling and I'm sure you have great relationships with some of your borrowers and you want to help them get through this time period. So we do recommend you enter into a forbearance agreement on this type of situation. Again, we'll be talking about this more in depth on Monday during that 11:00 AM webinar, but also if you want help now kind of getting that agreement in place with your borrower, feel free to email either myself or Nema and we can get that drafted up for you.

Nema Daghbandan:

All right. For a primary residence, no DBAs. And you recommend that the funds go into an LSCR corporation with its own separate bank account with a business name? That's right. Don't, the question you asked is whether A DBA is sufficient. I think what you're probably meaning is that you have a sole proprietor who is operating as A DBA, right? So they haven't actually incorporated, they don't have an LLC or a corporation or limited partnership, which is their true business. Yes, that's right. I generally would not fund a sole proprietor because I would be worried about the business purpose nature of that loan. The second issue as well is I would also want 'em to be operating business. So for example, if it's something they set up this month, it's going to look a little suspicious that you are, that's suddenly a corporation appeared and you're now calling it a business purpose fund. So I generally want to make this to a preexisting business that has been around for a couple of years, ideally that's got a bank account, bank statements, that kind of stuff.

Melissa Martorella:

Next question. I'm a California broker interested in what did you do? I'm a California broker interested in brokering owner occupied business purpose loans. Is there a list of items? Each file must have to be compliant with the DRE and also to protect the beneficiary. Also, most of my lenders steer away from owner-occupied private money loans. Is there any info I can provide them to give them a comfort level that lending on owner-occupied business purpose loans is okay and permitted by law? So the first question list of items you have to have on every file to be compliant with the DRE and protect the beneficiary. It doesn't matter that these are owner occupied business purpose loans versus a regular run of the mill business purpose loan. The same disclosures that you would be providing to both of your borrower and your investor for DRE compliance, so the M-L-D-S-L-P-D-S investor questionnaire, securities disclosures, all of those documents are still going to be required here.

So make sure that you definitely have them in those files. If you have any questions about what those are, please reach out to us. You'd be happy to help. Also, as far as if lenders that you're working with aren't comfortable with these kinds of loans, we'd be happy to talk to them as well to get that comfort level up to make them understand that these loans are okay, but also some lenders, this just may not be within their risk profile. That is something that we didn't really talk about here, but as it is kind of come up through some of these questions is obviously it will become harder down the line for bankruptcies or they do. These borrowers do look more sympathetic in front of a judge. This just may not. There's also a higher opportunity for fraud from these borrowers. They could be lying about the nature of the loan proceeds. So there is a higher risk to this kind of a business purpose loan. So that just may not be in the risk profile of that lender. It may be for other lenders, and that's wonderful for them, and they can make these loans all day. But if it's outside of that risk comfort for your particular lender, they don't have to make that kind of a loan, but we'd be happy to talk to them.

Nema Daghbandan:

And one last point on that as well is that as a broker you have a disclosure requirement to your investors. I would create a specific disclosure to your investors about the fact that this is owner occupied and the nature of that side of it. The next question here is basically a series of questions regarding what is considered interest in the state of Florida. Florida is one of those very challenging states because effectively is a, there's not guidance on certain issues. So for example, I don't think they've ever opined on late charges. Default interest is included, but most states are actually gray on this issue. So what is considered interest for usury purposes is not necessarily clear in most states. The one thing that I know in Florida, for example, is they bifurcate between origination fees and they'll say, well, how much of the origination fee was actually a processing cost? And they will not consider that part of interest. But really, when you're dealing with usury in most cases, you're going to want to look at this on a loan by loan basis.

Melissa Martorella:

The next question here, does Dodd-Frank affect anything beyond RESA related to these types of loans? So we talked at the beginning, the two major federal loans, or I'm sorry, federal regulations that we have to deal with when we're thinking about making these kinds of loans are TILA and RESPA, and we showed you how you're exempt from those two major bodies of legislation. However, there are some other federal laws out there that you will have to comply with, but that doesn't matter just because it's owner occupied. It's on all types of business purpose loans or ones that are particularly secured by one of four family properties. Those are eCOA requirements dealing with appraisals, the civil service member reporting acts. There's a few other federal laws that do come into play. Nema and I did a webinar on that I think about a year ago on this topic. So as Nema pointed out before, if you go to our website and you look at our previous webinars, you'll be able to find a webinar called the Consumer Loans or Consumer Laws that Apply to Business Purpose Loans. And that's where you'll get your answer there. And also, if you have any specific questions, we would be happy to answer those if you email us.

Nema Daghbandan:

Alright, and the next question's fairly unrelated to what we're talking about. So I want kind of get through, we do still have 23 more questions and I do want to try to hopefully speed up the process as we are at 1215, and I very much want to honor all of your time here as well. The next question is, we can't charge a late fee on a balloon. So people will ask us oftentimes is can I charge a late charge on the entire principal balance if they don't pay it at maturity? And the short answer is no. It doesn't matter whether it's business purpose, consumer purpose does not matter whether it's owner occupied, not owner occupied. You just simply cannot charge a balloon on the principal balance of a loan. It is just too great of a penalty compared to what the actual damage was to the lender.

Melissa Martorella:

These next couple, we've already addressed these questions. You can keep scrolling. Sorry, just trying to review, some of these questions are duplicative, so we want to make sure we answer some new ones for you guys.

Nema Daghbandan:

Yeah, this is a great question, which is kind of the practical implications of this. So the question here is you note a handwritten note at the beginning listing the use of funds. However, in light of current circumstances, once they write it and want to send it with their application, they don't have the ability to scan it and send with the application. Do you recommend that they mail it then? So you've got a lot of really practical closing issues that are occurring right now in society, right? So challenges with getting notaries, challenges with getting documents transferred back and forth. Technological challenges I think to a great degree is the biggest issue is do you have consistency in your file, right? So the good thing is technology is also pretty readily available. So for example, we talked about that handwritten note. Well, you can write the handwritten note, take a photo, have your borrower take a photo of it on their phone and send it to you in lieu of your traditional scan and send type deal. At the end of the day, you want a consistent application and loan documents. All throughout that it's clear that one message has been stated the whole time and that's really the most important aspect of it.

Yeah, so the next question here is, my borrower lives in the house but wants the money to pay off outstanding tax liabilities resulting from income from their business. I am generally reticent to ever pay taxes of any kind, whether they're from business or from arguably personal issues. I've never seen the case law on it and I would be very skittish about the payment of taxes as a general rule and necessarily considering those business purpose. And similar with payroll taxes, I mean really any taxes of any kind just makes me nervous. I would generally consider taxes a consumer loan.

Melissa Martorella:

The next question is, does a personal guarantee from the borrower help to recoup the principal? And if in case the loan is given for this house hacking scenario where they're going to live in the property and fix it up? Generally, I would say no in the sense that if they've determined that it ends up being a consumer purpose loan, you're going to have to deal with the fallout from that. But as a general consideration, outside of this very specific example, if you can have an additional personal guarantee, that's also generally very helpful in case there's any sort of deficiency. If you end up having to go through a foreclosure sale, you could do a breach of guarantee suit. So having a personal guarantee is very helpful here.

Nema Daghbandan:

Alright, next question is, can the funds be used by the consumer to start up a fund or a new business? Yes. So generally speaking, paid to be a technical person here, but I wouldn't call this person a consumer anymore. I would call this it's a business owner or soon to be business owner that it's going to secure the loan, and that was pre covid. This was very much what these loans were typically used for is people wanted to start a restaurant, for example, and they wanted the money to start a restaurant. They were pulling the loan against their property to start the business. That was very much what these were used for. So yes, very much the starting of a business is a business purpose loan.

Melissa Martorella:

The next question is, what is the maximum default interest rate in California? So technically there is no maximum default rate. It does not say anywhere that it's 50% or 10% above your note rate. There is no specific guidance on the maximum default interest rate in California. That said, there's a concept called unconscionability, meaning that the contract terms are so unfair and unreasonable that you just shouldn't uphold it. A reasonable person would not have entered into that. So if you had a savvy borrower, if you charged too high of a default interest rate, you could have them come at you and say that the contract terms were unconscionable and therefore the default interest rate that you charged is unenforceable. It's really a case by case basis, depending on the risk factors of the loan, things like that. But in general, that's why we recommend the 4% above the regular interest rate as what your default rate should be.

Nema Daghbandan:

Next question here is California question. Did you say that HOBAR does not apply to business purpose owner occupied loans? So HOBAR stands for the Homeowner Bill of Rights here in California. It created a dual track system in which foreclosure occurs here in California. There is additional protections for owner occupied consumer loans and specifically first position owner occupied consumer loans. And so that is what hobar applies to. Hobar does not apply to any business purpose loan regardless of occupancy, and it also doesn't only apply to first position loan. So if you did a second position loan, it would further be exempt from Hobar.

Melissa Martorella:

Next question is, do any states require that you register as a foreign entity to write business purpose loans backed by properties outside the lender state of formation? This is a great question, and the answer is yes. Not all states, but some do require entity lenders to register as a foreign entity in their state prior to making a loan there. So if you have any specific questions about whether a certain state requires foreign registration, feel free to reach out to us. We do have all of that research completed.

Nema Daghbandan:

Great. Next question here is if your current business purpose borrower wants an extension on payments, do you prefer forbearance to note modification? And the answer is absolutely. I would absolutely prefer forbearance during the time period. Forbearances by nature are there is either a default or you're expecting a default and you as a lender have rights, right? So you could have initiated a foreclosure action. You have effectively the right to accelerate the loan. You are choosing not to take your rights from taking your rights even though there's been a default. And so therefore you're not actually changing the terms of the loan. You're effectively waiving your rights under the loan for a short period of time per the terms of that forbearance agreement. Conversely, a modification is you are actually changing the terms of the loan and it is different. A modification typically requires you to record it in the county recorder's office. You should usually get an endorsement from your title company. It is usually a much more documented process, whereas a forbearance tends to be less formal and does not usually require the use of a title company. And so yes, we absolutely would recommend a forbearance rather than a modification for people who are experiencing those. That's something we'll obviously be discussing on our Monday webinar regarding loan defaults during this time period.

Melissa Martorella:

The next question, is it acceptable to make a business purpose loan if at time of loan application the borrowing entity has not been created yet? Yes. However, I would generally want that entity to be created as a condition to closing because that way the person you're actually lending to is this LLC. In this situation, it may be that the borrower, maybe the property owner is willing to transfer the property to the LLC, things like that. Or maybe they're purchasing an investment property and they want it owned by the LLC. I would much rather have that all documented at the time of loan closing than dealing with it as a post-closing condition.

Nema Daghbandan:

Alright, next question. How about if it was a rental and the borrower moved in after the loan enclosed? So when you were determining, and Melissa touched upon this earlier, is when you determine the nature of the loan, whether it's for business purposes or consumer purposes, the purpose can only be established at time of origination. A borrower cannot later change the purpose of a loan no matter what they do with their loan. So as long as it's clear that the loan was for business purposes. So for example, the acquisition of rental property is always for business purposes, even if they later move into the property, they did not change the nature of the loan. They changed the occupancy of the loan, but didn't change the nature of the loan. It is still very much a business purpose loan.

Melissa Martorella:

And the last question that we have here is, since a late fee cannot be charged on a balloon payment, can you still charge a late fee on the regular payment at maturity? The answer is yes. So if say your monthly payments under the loan are a thousand dollars and at the balloon you have a $100,000 principle that needs to be repaid along with another $1,000 regular interest payment, you can charge the late charge on that $1,000 monthly payment that was due at the maturity date, but not on the full $100,000 principal balance.

Nema Daghbandan:

And this is a record for us. We have answered 58 questions and had over 200 of you on this webinar. We hope you have found it valuable. Thank you for the a hundred of you that are still sitting and listening to this. It means the world to us. We really hope all of you are safe. We hope your families are safe. We hope your businesses are still working and thriving. We just are so thankful to our community out there. Thank you for sitting on this.

Melissa Martorella:

Thank you everyone. Have a great day.