Melissa Martorella from Geraci Law Firm Talks Business Purpose Lending 101

Alex Breshears:

All right, we are recording. Perfect. Alright, good evening everyone. Or good afternoon if you're out on the West Coast like Melissa is. It's only four o'clock there and I'm a bit jealous, but if you're watching this, my name is Alex Breshears, I'm an admin for Private Lending Lessons and tonight we are super, super honored to have Ms. Melissa Martorella, I got it, from Geraci Law, which is basically the law firm for private lending. So I'm super thrilled that they continue to come back and offer their insight into the legal side of private lending. So I will let her do her introduction and then get the ball rolling.

Melissa Martorella:

Awesome. And I'm going to share my screen in just a moment so that you guys can watch the slides that I'm going to go through. But as Alex said, I'm super honored to be here. Thank you guys for joining tonight. So I am a partner and a department head here at Geraci. I manage the firm's banking and finance team. The firm generally primarily represents private lenders, whether that's mortgage funds, banking divisions of banks or credit unions, wealthy individuals. We really specialize in private lending law generally across the country. So we have a corporate and securities team that drafts PPMs, does entity formations, licensing questions. We have my team, banking and finance. We primarily prepare loan documents and we also advise on compliance questions with regards to business purpose loans in all 50 states and any really document that would come out of that. So as soon as you've deployed money and then you're wondering how to get it back into the door, whether that's via a modification or a forbearance or some other agreement with your borrower, we're here to help you out on that.

And then we also have a small litigation and bankruptcy team for our California files. So really well-rounded, specialized in business purpose lending. I have a lot of people reach out sometimes asking other questions about employment related law or anything like that and I'm like, no idea. We don't do any of that. So we are very specialized in what we do and we would like to consider ourselves the experts in that area. So yeah. So I will get started here and share my screen. And as a quick just little FYI am at home and I do have two dogs and no one is here to watch them. So if they do start barking, I apologize.

Alex Breshears:

That is my whole life, praying nobody rings the doorbell for an Amazon delivery when I'm on a call.

Melissa Martorella:

Exactly. They're generally pretty good, but just in case, can you see my screen with the presentation?

Alex Breshears:

We can.

Melissa Martorella:

Perfect. Alrighty, so I will get started here. So that's me. So big picture, what we're going to talk about today, obviously business purpose lending 101, we're going to go through primarily what is a business purpose loan and how does that differ from a consumer purpose loan. And then going from there, talk about first some of the federal lending considerations that you need to pay attention to even though it is a business purpose loan. And then we'll dive into some of the state specific issues that pop up along the way. So to get started here, federal lending considerations that we have when we're evaluating whether our loan is a business purpose loan and then whether anything else applies to it. You may have heard some of these or all of these thrown out at some point in time, but we have the Truth in Lending Act. We have the Real Estate Settlement Procedures Act. These are also known as TILA and RESPA. They're probably the most commonly heard ones around. We have the Equal Credit Opportunity Act or ECOA, the Home Mortgage Disclosure Act or HMDA, then the Fair Housing Act, fair Credit Reporting Act and the service members Civil Relief Act. So in some way, shape or form, all of these acts are going to apply to business purpose loans or exempt business purpose loans specifically from their regulations. So it's really important to understand them in the context of lending and making business.

So jumping in here, first we have TILA - Truth and Lending Act. As we said, codified here. It's a federal law, so codified on 12 C ffr 10 26 TILA really applies to any credit offered or extended to a consumer and primarily for personal family or household purposes. I have those terms bolded because they're going to be super important going forward when you're evaluating what kind of loan you're making and to determine whether TILA will apply. The other definition that's really important is a consumer Who is that? So TILA defines a consumer as a natural person to whom consumer credit is offered or extended. A natural person is either an individual or a family trust of some sort. So really if you're lending to an LLCA corporation, some other entity structure, TILA just by way of definition will not apply to your loan. That said, we should also really make sure what the purpose of the loan is so that we don't have any allegations by the borrower that, oh, you made me create an LLC, it's actually a consumer purpose loan in disguise. You made me transfer to an entity. So you really want to make sure that the purpose of the loan is also for a business purpose, but on its face, if your borrower is not an individual or a trust, TILA is just straight up not going to apply to your loan.

A big exemption to TILA and why we focus on the purpose of the loan proceeds so much is an extension of credit primarily for a business commercial or purpose. And there's a lot that goes into that, but it's great. It's said right in TILA, right in the statute. Hey, if you have a loan for one of these three things, then you don't need to deal with any of the requirements or regulations that TILA put forth. We'll get back to that and talk about how we determine what a business purpose loan is or what's for commercial purpose. But first we're going to jump into RESPA really quickly. So that's that Real Estate Settlement Procedures Act. Also a federal law. It's going to really govern disclosures and loan transactions and the servicing of consumer loans. So again, it's really going to apply to those extensions of credit that are for family or personal use, not a business use. And again, they have a great exemption right there in their statute that says, Hey, these kinds of loans are not covered under RESPA and those are any extension of credit. That's primarily for a business, commercial or agricultural purpose as defined by TILA. So these two statutes really work together hand in hand. So if you're exempt from one, you're going to be exempt from the other. So now we really have to dig in and figure out, okay, well what's a business commercial or agricultural purpose so that we can figure out if our loan complies?

I get a lot of people reach out to me sometimes with loan scenarios trying to figure that out and they'll say, oh, well my borrower doesn't live at the property or it's, it's a rental property. That's fine. The biggest question that you have to ask is what is the purpose of the loan funds? That's got to be the first question that you ask when you're evaluating whether you have a business purpose loan, not whether the properties owner occupied. You can absolutely make a business purpose loan that's secured by somebody's primary residence. That's totally fine. You don't need to worry about TILA RESPA in that case. So that really that big question is what are they using the money for? And if you don't have a clear idea of what that is, then you should put a pause on that and figure that out before you proceed.

Little practice tip that I have for lenders is when you're accepting that loan application request, a handwritten statement from the borrower where they specify in detail their intended use of the loan funds, we find this really helpful. If it's handwritten, we get pushed back on that a lot, but if it's handwritten, there's no doubt that they wrote it. There's no doubt that there wasn't thought about what they were doing. If it's just a lot of times I'll see a loan application and it'll say, this loan is for business purpose, yes or no, and they just click the yes box and it's like, okay, that's great, but you should really do a little bit of due diligence and confirm that because if not, you have a lot of liability for not complying with TILA or RESPA, but if it's actually consumer purpose loan, so it's always better to be safe than sorry and really make sure you understand the purpose of the loan proceeds before you even get started and make that loan.

They also under TILA, it actually does this really great thing in the common sections of TILA. It gives you some examples to kind of help evaluate whether a loan could be for a business purpose. And again, these are right within the Teal commentary, so they're pretty well accepted As far as factors to determine whether your loan is for a business purpose, so the first one that we have here is the relationship of the borrower's primary occupation to the acquisition. The more closely related, the more likely it is to be business purpose. An example of that would be if your borrower does fix and flips by trade for example, and that's just what they do and they purchase investment properties, they fix 'em up, they sell them at a profit and you just have a long employment history or evidence that this is what they're doing and they come to you asking for another loan to purchase an investment property and flip it, chances are it's going to be a business purpose loan. Similarly, if say you're going to give somebody a loan secured by their primary residence, but the loan proceeds say they have a restaurant and they need a quick loan, a lot of times this happened in Covid a lot. They needed a quick loan to help them out, get through a tough time with payroll or supplies or something like that. Clearly a business purpose, they own that restaurant and you can really tie that together that it's going to be used for a business purpose.

Another factor that goes into consideration for determining whether it's a business purpose loan is the degree to which the borrower is personally going to manage that acquisition. The argument is the more personally involved the borrower is with whatever the business purpose is, the chances are it's actually for a business purpose. So similarly, if they're a flipper and they want to buy this new project, chances are if they're really going to be the one involved in it doing the work on the property, chances are that really does mean that it is business purpose. It doesn't mean if they're not, it's not a business purpose loan. I would just probably dig in and do a little bit more due diligence.

Another factor for the business purpose loans 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 purpose. Obviously it's just analyzing again, the way that their business is run, where their proceeds are coming from and where their business assets are coming from. And this ratio is another factor used to determine whether that loan could be considered business purpose, the size of the transaction. Again, people usually take out larger loans for business purposes rather than consumer purposes. Not always true, but it's something that tends to happen. And then finally, and I think the absolute most important thing is borrower's statement of purpose for the loan. That handwritten statement you get at the outset, what are they even telling you? The loan purposes. And if it's not clear, say you get one, it says, oh, I'm going to purchase 1, 2, 3 Main Street. Cool, are you living in that property? Are you renting that out? What's going on at 1 2 3 Main Street? I get that you're using the money to buy that place, but what's going to happen with that property so that you really understand whether it's business purpose or not. So these are factors to consider that are in the TILA commentary. Just because they're not true doesn't mean you don't have a business purpose loan. These are just helpful things to use to analyze the loan at hand to see whether it could be considered business purpose.

Some other examples of business purpose loans, again provided right in TILA. So it's really helpful if you have these to analyze first a loan to expand a business even if it's secured by the borrower's residence or personal property. So similarly say that guy that owns that restaurant, he might not own the building that the restaurant's in, but he wants to open up a new location, but he needs some proceeds to get started and he's asking for a business loan and securing it by his primary residence. Totally fine. Makes sense. Absolute business purpose. You can make that loan all day even though it's secured by his primary residence. Another example, and people are oftentimes shocked to see this one, but it is absolutely a business purpose is a loan to improve a principal residence by putting in a business office. So definitely in Covid times I've seen a few of these, but if say somebody wants to convert their garage into an office and they're going to run whatever their business is out of their garage, as long as you have a lot of evidence documenting that that's what it will be used for, you could absolutely call that a business purpose.

I would definitely not make that lightly because, and I would want to do a lot of due diligence into the facts of what's happening so that you understand it, make sure that business is legitimate and all that, understand why they're moving into their garage, but it's absolutely something that's permissible and can be done and it is not a consumer purpose loan. And then the last little, it's not really an example, but it's regarding where you should fund the loan transactions. So say the borrower has a business account and they occasionally use it to pay for consumer purchases. So they have, they're asking you to fund the loan into their business account, but then you see, hey, I see a couple random consumer transactions on here. I see you had to pay for your kids' daycare one month on here, whatever. It's so long as that account is primarily used for business purposes and there's just an occasional consumer expense that has been thrown on there for some reason, it's okay to fund into that account.

It's definitely still considered a business account and it would be okay to fund there and I know I do see some comments popping up and I was going to answer them during the presentation, but if I click on that, I'm going to lose my PowerPoint, so I promise you all I'll answer them. Then kind of going on, these are some other consumer purpose examples that TILA also puts in their definitions that I think are really helpful to understand and help analyze whether your loan is business or consumer purpose. First example is a credit extension by a company to its employees or agents if the loans are used for personal purposes, maybe not as helpful in our area, but even so it really explains that it doesn't matter if it's even a business making a loan to its employees. Yes, it's part of your business and those employees are part of your business, but if they're using that money for a personal purpose, that's going to be a consumer loan.

So it's just driving home that concept of what are your borrowers using the money for. Another consumer purpose example, which people also are a little bit mind blown by sometimes is a loan secured by a mechanics tools to pay for a child's tuition and you could swap out mechanics tools for his shop. The building that he owns, that he runs his company out of the purpose here is important. Yes, it might be business property that he's using to secure that loan, but the reason he's taking out that loan is to pay his kids' tuition and that's a personal or family use, a consumer use. So you could not make that without complying with TILA and RESPA and the last one, same thing, but the opposite for that funding account. If it's personal account and it's occasionally used for business transactions, I would recommend not funding into that account and asking them to have a separate business account that you fund into. It's just cleaner and gives a record a little bit better that it is truly going to be used for business use.

A lot of information there I know. So again, just kind of recap that. First thing is figuring out what the purpose of a loan proceeds are and the single most important thing that you'll have in your arsenal to figure that out and know whether you're dealing with a consumer or business purpose loan is that handwritten statement of purpose, which we recommend that you obtain at the outset of every loan transaction. TILA has some other cool too and by TILA then therefore RESPA, you would be exempt to kind of determine whether you have a business purpose loan. They deal with rental property. So if you know that the loan is being made to acquire, improve or maintain rental property and it's not owner occupied, so the borrower doesn't live in one of the units of the rental property, then it's automatically business purpose, which is really helpful.

So you don't need a lot of backup information. Always good to have it, especially if it turns out that rental is maybe to family members or something like that. You might want to look into it a little bit more, but still they do give you a very clear exemption here in TILA that if the loan is made to a borrower for acquiring, improving or maintaining that rental property and the borrower doesn't live in that rental property and you have an automatic exemption from TILA, but if your borrower expects to occupy it for more than 14 days during the coming year, then it can't just be considered non-owner occupied and get under the special rule. So where this comes in, but that doesn't mean it's not a business purpose loan, you just have to do a little more digging. So this might be an example like with an Airbnb.

So say you purchased an investment property, I don't know in the mountain somewhere or a beach house, but you're like, Hey, a month out of the year I'm going to go spend time there with my family. Well that's more than 14 days during the year, so you wouldn't qualify for this special exemption that it's to acquire, improve or maintain rental property because it wouldn't be considered non-owner occupied at that point. However, if you have clear documentation that you're going to be using it as an Airbnb or a rental or that backup documentation really showing that this truly is an investment property for you, you just like to enjoy it with your family every once in a while, you could absolutely treat that as a business purpose loan. It is just that automatic rule won't apply for you more on rental property owner occupied rental property.

So what happens if say I have two or three or four unit place and the borrower lives in one of those units, what do I do with that? I mean they want to maintain that property. What do we do? So if the loan is being made to acquire that rental property and it has more than two housing units, so it's at least three units and the borrower lives in one, then it's automatically deemed for business purposes. If the loan is to improve or maintain that rental property and the borrower lives in a unit and there are at least five units automatically deemed to be business purpose loan. That said it doesn't matter, it could be a two unit house. They live in one of them and you just have to evaluate, okay, you just don't get the benefit of these clear exemptions. You just have to dig in a little bit to figure out, okay, what percentage of the proceeds are going to upkeep the rental units, how much, if any, is going towards the borrower's unit and trying to make that analysis to figure out whether it's truly business purpose or if it's just to fix up their own place within the rental.

So just because you don't get to benefit from the clear exemption here doesn't mean it's not a business purpose loan. It just means you have to do a little bit more digging.

The last little weird exemption that I think you guys saw in that definition, it was business commercial or agricultural purposes. This, I don't think I've seen this maybe once, but basically if you have a farm and it's very clear that you're making a loan to a farm, even if there's a homestead on that piece of property, it's okay if the purpose of the loan is to deal with that farm planting, nurturing, harvesting, catching processing, any of these things on that land, you can consider that a business purpose loan even though there is a homestead there. So it's a really nice little exemption here. I don't think I've ever seen it, but it is there for you if you've ever making a loan to somebody.

That's the biggest thing. I'll just stop here for a second. I know that was a lot of information, but that big question, that number one question that you've got to go to when you're deciding whether to make a loan is what is this borrower using the money for? Is it a business purpose or investment purpose? Is that very clear or is it a consumer purpose? If it's very clearly business purpose, you are then exempt from TILA and RESPA. If not, then either you need to be licensed under TILA RESPA as a consumer lender or hand that off to somebody else because you wouldn't be able to make that loan.

Couple other little things. If you do have a consumer loan, there are things called TRID disclosures, otherwise known as the TILA RESPA Integrated Disclosure. They are not required for business purpose loans, but they are required for all consumer purpose loans regardless of the collateral type. I get questions about this a lot, usually from escrows who are unfamiliar with business purpose loans asking where are my trade disclosures? And then I have a lender who's in a panic that they did something wrong. It's pretty common, obviously necessary in consumer loan transactions, not at all in business purpose loan transactions. So if you're ever confronted by an escrow that's like, Hey, where are my trade disclosures? If you have a business purpose loan on your hands, you do not need to deal with these and provide any of these. And then my little last disclosure is that consumer loans are super highly regulated.

It's an area where I know to identify them and then hand it off to another expert on my team. It's something you absolutely should either have an attorney walk you through if you want to make consumer purpose loans or have an in-house compliance person because there's a lot of documentation, a lot of rules that apply for consumer purpose loans. My little disclosure to you all, just in case you're interested, private lenders make consumer purpose loans all day long, so it might be your business model to do it, but there is a lot. So that's TILA and RESPA. Those are by far the two most onerous, heavily regulation area of law that the federal government has with regards to business purpose loans. So if you are able to find that exemption, get out of TE and RESA land, you are well on your way to making your loans without any worry.

There's just a couple more federal laws that come into play even if you are dealing with a business purpose loan. So the first one we have here is eCOA or Reg B. It will apply in three different scenarios with appraisals with regards to discrimination and then adverse action letters for the appraisals to apply. The loan has to be secured by a first lien on a one to four family property. Doesn't matter if it's consumer business purpose, doesn't matter if it's owner occupied or non-owner occupied. If you have a loan secured by a one to four family property and the loan is in first position, eCOA will apply. So we'll get into that.

Basically what the requirement here is you have to tell the borrower that they have a right to receive a copy of the appraisal within three days of the submission of an application or well the right, you have to notify them that they have that right within three days of the application and then you have to provide that valuation as soon as it's received or at least three days before the loan closes and you cannot charge the borrower any money for providing a copy of that appraisal. I get a lot of questions. Well, what if I don't get an appraisal? What if I just look on Zillow and figure out what it's worth? It doesn't matter. Whatever you did to value that property, you have to give a copy of that to that borrower if it applies. So reminder, first position, lien one to four family property, you have to let them know they have a right to that appraisal.

You have to give it to them as soon as it's received and at least three days before the loan closes. My recommendation to all of you in your loan application package include that notice because then it's all dealt with. You don't have to worry about, it's been three days. Make sure you sent the notice out, include it right in your loan application, and within that you can have the borrower waive the timing requirement, and by doing that, you can give them the copy of whatever you use to value the property at time of closing or if you end up denying the loan, you can give it to them when you deny the loan, but that way it's just dealt with right up front. You don't have to worry about like, oh my God, is it three days before the loan closes? Where am I? You've got it dealt with, they've waived it, they've signed it, good to go. And also under this, the borrower or the applicant does not have to request a copy for this. You have a duty to provide it. So it's just something again, just make sure part of your closing package, if you have them waive it at time of application, just send them a copy of your valuation with the loan docs and you're good to go.

Another area where eCOA would apply is with regards to discrimination. Obviously don't discriminate. eCOA prohibits it with regards to any credit transaction based on race, color, religion, national origin, sex, marital status, age, and whether an applicant's income comes from a public assistance program. So I mean the reality though with business purpose loans is that a lot of lenders are not even looking, they're not meeting their borrower, they're not looking into the person's background or their credit score. They're really looking at the collateral primarily for the loan and then project type experience, maybe a credit score, but it's really separate from who the borrower is and oftentimes your borrower is an entity, so it's really difficult to evaluate that. So it's just interesting. Obviously you still can't discriminate, but the reality is you're looking at things other than who that borrower is. Anyways, so my recommended practice is postmortem your files and just look at them and make sure that you're not unintentionally redlining or saying no to certain loans by people in protected classes. That way you're not unintentionally discriminating against certain borrower groups obviously without meaning to. That's the biggest advice that I have aside from don't intentionally discriminate, but also after the fact, look at what you're doing and make sure that you don't have a preference for certain areas or you don't deny every single type of loan from a certain area, so there's no potential claim for discrimination.

The last area where eCOA will apply is with regards to adverse action letters. And a lot of times people are like, what is this? Do I have to do this? So an adverse action occurs whenever a lender denies or revokes credit changes the term of credit or refuses to grant credit. It doesn't apply if you're saying, Hey, I don't want to extend the loan, I don't want to give you more money after I've already given you the loan, or if the borrow is in default, it doesn't apply, but it will apply if say a borrower takes an application with you and you end up denying it, you just have to let them know why you're denying it. So my recommended practice provide the applicant with a notice upon receipt of their application that if their credit is denied, they have the right to request the reasons for denial.

That puts the onus on the borrower to request the reasoning for the denial. It's the best practice. It's easy enough to comply with, and it's up to them to be like, Hey, why'd you deny my loan? Rather than you having to say every single time why you denied the loan. The second recommended practice here would be to say why you denied the loan every single time, but I think it's probably a lot easier during time of application, you put that burden on the borrower to ask you why you denied the loan, and that's that. That's ecola. The biggest area that you'll see is it really deals with that appraisal requirement or that valuation requirement. The other items obviously don't discriminate. And then if you're going to deny an application, just know that if a borrower asks you why you have to let them know. Big picture.

Moving on to the next federal regulation that applies to Business Purpose Loans, HMDA or the Home Mortgage Disclosure Act. A couple years ago there was a lot of uproar with this and it's because it didn't apply to Business Purpose loans and now all of a sudden it does. It's very frustrating, but it's something that we now have to deal with. But thankfully, it only applies to certain kinds of business purpose loans. So the ACT basically requires certain financial institutions to collect, report and disclose certain aspects of their mortgage lending activity. The requirements typically deal with demographic and loan type information, and this requirement is going to apply to any extension of credit that's secured by a lien on a dwelling, which includes one to four family properties, but also multifamily structures, manufactured homes and condos. So they really expand that definition of what a dwelling is to beyond just a one to four family property and include especially multifamily in there. That means even development projects would have to comply with this. And what's interesting about this new definition too, and why it was an uproar a couple years ago is the property type rather than the loan purpose is relevant for reporting purposes. It's one of the few that doesn't care about what you're using the loan proceeds for. They just say, Hey, it's this kind of property. You have to provide the reporting.

It applies to parties who originated a limited number of loans. We can go into detail on this. There's a lot of analysis. So if you're worried that you must comply with this, I'm happy to talk to you outside of this to understand your business practice. But basically originators have to prepare a loan activity, register the CFPB each year once they meet the threshold, and there are over a hundred fields to report, many of which are in inapplicable to business purpose loans. There is software down at the bottom here, quest Soft for example, that will collect this information for you. The 10 0 3 loan application, this is generally used for consumer purpose loan applications, however, I see a lot of lenders use it and modify it a little bit. For business purpose loans, they actually have an addendum to that 10 0 3 that collects all the relevant information for MDA compliance.

So you could make sure that you tack that, even just that page onto your loan application, even if you're not using the 10 0 3, but it asks you for all sorts of information about demographics in addition to the type of loan that you're making or extending or denying. It's interesting, and again, why there's a lot of uproar in the business purpose community is oftentimes these business purpose loans are not made to individuals. They're made to LLCs and corporations and other entity borrowers, but then you still have to report what gender is the borrower an LLC? Do I report for the manager, the members? Who do I say? And there's no not applicable selection. You have to pick one. So it's really frustrating. It really should not apply to business purpose loans, but it is something that's out there. If you're concerned whether this applies to you, again, feel free to reach out to me directly, I'd be happy to walk you through it. There's a lot of if this, then this requirements that go into it. So I'm happy to walk through that with you.

Another one, another federal law that applies, I believe there's three more. These are really fairly straightforward, but the Fair Housing Act very similar to eCOA and it's another anti-Discrimination Act. So again, don't discriminate. This one primarily deals with one of four family properties, but also land sold for the construction of that kind of a building. So again, based on property type net loan purpose, but even so just like with the eCOA, don't discriminate and to make sure that you're not unintentionally discriminating, do a postmortem of your files. It's really how you'll have to comply with the Fair Housing Act FCRA or the Fair Credit Reporting Act. It's going to deal with credit reports. It does apply to business Purpose loans and really it's just making sure that you have the correct authorization before you pull a credit report. So recommended practice is really figure out who your applicant is.

If it's a natural person, so it's Melissa Martorella, get my signature. But if the bar is an entity, so it's Melissa, LLC, the current law doesn't authorize you to pull the credit of any principle unless they're personally liable on the loan. So like signing a personal guarantee. So if Melissa, LLC is the borrower, unless you ask for Melissa Marrella's credit report or I'm guaranteeing that loan, you can't pull my credit. You can only do a check based on what that LLC is done and look at that LLCs financials unless you get my authorization specifically. So just know whose credit you are pulling and make sure you have the authorization to pull credit for every individual that you're looking to dig in on.

The last one that we have here on the federal side, that will apply to you Business Purpose Loans is the service members Civil Relief Act. This provides certain financial protections to service members that are on active duty when they have a change in military status. The important thing about this one is the change has to be from off duty or reserve to active duty for this law to apply. So if your borrower was an active duty when you made the loan and there's still an active duty, this is not going to apply. Or if they're going from active duty to reserve or off duty does not apply. It's only if it's off duty or reserved too active that it applies and it makes sense If somebody's going into active duty, it's high probability that they're not maybe paying attention to their loans so much, might want to give them a break, might want to help 'em out.

That's the whole point of this thing. The other interesting thing about this is that the service member borrower has an affirmative duty to notify the lender of their change of status and therefore qualifies for relief under this act. That said, recommended practice. This generally comes into play when there's loan enforcement issues. So borrower's not paying, so you have to start foreclosure or you want to do a forbearance or something like that. What I generally recommend is if your borrower is an individual and there's some sort of default issue before you start foreclosure, before you start doing any enforcement thing, you can actually go online to the Department of Defense website and they have a search for this and you can see any person's status. So even if you don't know, you have no idea borrower's, Melissa Martorella, she defaulted on your loan. Is she a service member?

No idea. You might not have asked that question. You can do a quick search on the Department of Defense website, find out whether I am a service member at all. If I am and it says I'm active, then you can ask the borrower, Hey, were you off duty or reserve and become active or have you always been active? And then you'll know whether you have to comply with, it's really just forbearance and foreclosure mitigation laws that come into play here, but it's just a quick search that you do only applies if your borrow is individual and it will apply to all loans regardless of purpose just to protect our service members.

Yes, that is the last federal loan or federal law that will apply to business purpose loans. I know that's a ton of information I went by very fast. We're going to get into a couple of the issues that come up when you are talking about states and state licensing and state regulations with regards to business purpose loans because it's a little bit different across the country, but this is just big picture federal. What does the federal government have to say about these kinds of loans? So now we go into the states. So we've figured out we've got a business purpose loan on our hands. We don't need to deal with TILA and RESPA and therefore any licensing at the federal level. We know which federal laws might apply to our business purpose loan. How do I actually make that loan in the state? I want to make the in.

So the question you have to ask is, does the activity you're conducting require a mortgage broker or mortgage lender license? And the answer will vary wildly by state. Most states, thankfully, will exempt business purpose loans or business purpose loans from needing a license. All those states in green don't care. The business purpose loan, go right ahead. No license required, no reporting, no disclosures, good to go. There are six states where the license is needed regardless of collateral. You'll see three big ones here, which are usually the most problematic for people. California, Nevada, and Arizona, very restrictive. The other ones which come up less frequently, north and South Dakota and Vermont only done a couple of loans in those states. They don't know that has a booming practice, but if you're going to make making loans in there, make sure you're licensed. Five states where you only need a license if the property securing the loan is a one of four family property, those are in orange.

So we've got Oregon, Idaho, Utah, Minnesota, and Virginia. There's all sorts of little restrictions there. If the property securing on is one of four family. So that means if your loan is secured by a commercial property, industrial property, multifamily property, you're fine in these states, but if it's a one or four family property, you'll have to deal. And then there are five states here in purple where you would need a license if it's a one or four family property and it's owner occupied. So Washington, Texas, I believe that's Nebraska, Iowa and Georgia, those ones will have an issue if it's an owner occupied one of four. That said, there are many exemptions to licensing. For example, in California, even if you're making a business purpose loan and you are not a licensed lender, if there is a licensed California arranging that loan transaction for you, you're good to go. You're exempt Washington with their wonderful or no, I'm sorry, Oregon with their one to four family property restriction. Again, if a licensed broker arranges that loan for you and you're not licensed as a lender, good to go, you could make that loan. So there are exemptions here. This is just a really quick overview. Hey, this state has a problem. I better go ask and dig in and see if I can make this loan or if this is a hard stop for me. It's only these states in green here that are really good to go.

Other issues that pop up just based on our experience, Alabama, it's good to go generally, but from our experience, it's recommended to lend only to entity borrowers that's just from council based on what they've seen in the foreclosure process. It'll go by faster if it's an entity, Georgia, we've mentioned it, but don't lend on owner occupied properties, even if it's a business purpose loan. Just all sorts of problematic issues there. Tennessee, this is outside of licensing, but they have extremely strict usury laws. We will get into that in just a moment, but make sure you have an exemption to usury. Otherwise, even though you might not need a license still in there, it will make it basically impossible to lend. And then North Carolina, there is a registration requirement with their Secretary of state if you make less than a million dollars of loans in a year.

So it's not a licensing requirement, but if you don't make more than a million dollars worth of loans secured by real property in their state, they're going to make you register. So there are issues that pop up. We can help walk you through them if you're ever curious about where to end, where to go. But just know most states don't care. But some of them have some quirks. A really fun one that we have on here and talk about this on the other page, but Florida is really interesting. The way that they talk about their business purpose loans. There's a lot of definitions here, but I'll just generally talk about it is you can basically make a loan in Florida secured by any type of property, but if it's commercial or multifamily property, your borrower can't be an individual, which is a really weird limit to their laws. Most states say if it's a commercial piece of property or multifamily, then go ahead and do it. And they really only care about the one of our family properties. For some reason, Florida put this weird little carve out in there. So if you do have commercial or multifamily property and the borrower is an individual, you can't make that loan without having a license. Really, really weird state. So to all my Floridians, you guys have something going on there, but we like it. It keeps us on echoes.

Foreign registration. This is another issue that you'll have to deal with as a lender if you're deciding to lend in different states. So say I'm a lender. I'm here in California, I have an entity that I lend from. It's Melissa, LLCA, California Limited Liability Company, and I want to go lend in another state. There's a concept called foreign registration of your entity, and do you need to deal with that before you can lend in that state? Generally conducting business in another state is going to require you to file for foreign registration with your entity. But most states, thankfully, exempt mortgage lending, the exceptions where registration is required are here highlighted for you, mostly Midwest to East Coast states, but they will require your entity to register as a foreign entity before you make a loan there. So just a little heads up, other regulations, usury.

Again, this varies wildly by state and it can become complicated. Big picture, what is usury generally? What is the maximum interest rate you can charge on a loan without it being problematic? And it really depends. The rate will vary depending on what state you're in, whether it's a business purpose loan might exempt you from usury in certain states and not in others. What's included in the usury analysis is different across all different states. So just know that the loan, that might be okay in Washington, it may not be okay in Utah, so just know where you're going. For example here, I just use California a lot because here, but I will talk about other states. So here in California we're capped at 10%. That said, if you are either a licensed lender or you're using a licensed broker to make that loan, then you're exempt from mery.

You can charge whatever you want. In Washington and Utah, they exempt business purpose loans from usury. So you could charge whatever you want on those loans. Totally. Okay. And then we have weird states like Tennessee, I believe we're going to talk about it here, Tennessee, it's 4% above the prime offering rate than in effect at time of making a loan. So right now, I think that's like nothing. It's real low. And I mean even at its high point, that means you're only making loans at eight or 9% maximum. But right now I think that's probably like five and a half percent, 6%, something like that. So it's a pretty low, especially for a business purpose loan. So it's something to take into consideration when you're lending other states. I have Texas up here as an example. It depends on the size of the loan. If it's above a certain loan amount, Florida's the same.

If the loan's above a certain loan amount, you can jump to a higher user cap. If it's below that, you're restricted. So there's a lot going on there. Other states, Montana is by far the worst with usury. They include all sorts of things in there, even if you haven't charged them yet. So late charges, even if you're not charging them at the outset of the loan, they are included in the A PR analysis. There's a lot that goes into it. So if it's a new state you've never lent in before, usury is definitely an issue that you want to make sure you understand. Thankfully, there's this concept called governing law and choice of law, and that helps us get around these issues. Basically, if you can prove that you have a nexus to a state that has fun usury laws for you. So say you're based in Utah, which exempts business purpose loans from usy, you're a lender there.

You live there, your company's based out of there, you want to make loans in Tennessee, which has this crazy usury limitation. But you can prove, hey, I solicited borrowers from Utah. I'm based in Utah, I'm collecting payments in Utah. I have a clear nexus to Utah. You can use Utah's laws to govern your loan transaction under the choice of law scheme there. So you can actually use Utah's law to govern the transaction, and therefore you don't have to deal with Tennessee's crazy user laws. So there's a lot that you can play with and deal with if you're in a market that you know probably know this stuff and you've dealt with it. But again, if it's you're expanding to a new area that you've never lent in before, I strongly recommend you ask about usury issues before you just make a loan there. Because what might be fine in the state that you're currently working in might not be going forward.

And I think this is my last slide, the last thing you want to look at is our late charges and default interest, again, varies depending on the state. A really good rule of thumb to go by is give the borrower a 10 day grace period to miss payments and only charge a maximum of 10% on that missed payment. It's pretty standard across the country. Texas messes set up, and I believe it's 5%, but for the most part 10 and 10, easy to remember. It'll be consistent across the country. And a reminder about late charges and default interest has to be reasonably related to the harm suffered to the lender for that late payment or default. So you can't just charge a blanket like, I don't know, 20% charge for a missed payment or 20% of the principal balance for missing something. It's not reasonably related to the harm you've suffered by that missed payment.

So just know that. And then default interest, sometimes it's tied to usury, sometimes it's not. Generally you cannot charge default interest on a balloon payment. You could charge it on the installment payment that might have also been due on the maturity date, but you cannot charge it on the entire amount that was due. So just a little fun thing with that there. But again, changes depending on the state you're going into. So a lot to consider. My email is here, feel free to reach out to me. This was a ton of information I realize. But business purpose loans are fun. There's a lot going on with them on the federal level. You have all sorts of little weird ticky tack rules you have to go through. And then once you actually figure that out, then you're like, okay, now I want to make loans in Massachusetts. What do I have to know about Massachusetts? Happy to walk you through and help you out there or any other state. Yeah. So I don't know, Alex, how do we do the, I'll stop sharing.

Alex Breshears:

We just have a couple questions here if you have some time. Awesome.

Melissa Martorella:

Yes, they're just in the chat box.

Alex Breshears:

Yep. So the first one is, would it matter if the business is incorporated or they are a sole proprietor for creating a business home office in their primary residence?

Melissa Martorella:

Absolutely. It doesn't truly matter, but I would probably want to see it as incorporated to get that formality. So if I were going to start my own business out of my house, I would probably want to see evidence that I've started a company and that company, rather than me just being like, oh yeah, I'm going to sell jewelry out of my garage, or whatever it is. It always helps to have a little bit more evidence. Not necessary, but I think it definitely helps you.

Alex Breshears:

Perfect. And I think this question, this next question relates to is something a business purpose loan? And they're asking what if the borrower wants to pay off a personal loan that they got to start their business and they're looking to streamline their business lending into their actual business.

Melissa Martorella:

So I think I'm a little bit confused by the question. So a personal loan that they got to start their business.

Alex Breshears:

I think it's asking if somebody wants to borrow money from you as a private lender, and part of that purpose is to pay off a personal loan they took to start their business.

Melissa Martorella:

Okay. If you're refinancing a loan that was for a business purpose, then the refinance of that loan is also going to be a business purpose loan. I don't know. Yeah. So say I took out a $50,000 loan to start my business and I'm like say, Hey, I need to refinance this thing. Somebody help me out. You could absolutely do that and have it still be a business purpose loan. Interesting little sidebar that happens with this is sometimes, say you buy your primary residence and then you go buy a new primary residence and you're going to keep your old house and rent that out. You still have a mortgage on your old house and you want to do some work on it. You want to fix it up because the use of that property has changed. You can argue that a loan to refinance that original consumer debt is a business purpose loan now, because now the property is a rental property, it's an investment property, and you've changed the type and purpose of that piece of property. So interesting. I think it related a little bit to this one.

Alex Breshears:

And the next one is for short-term rental investment property. Is there a maximum number of days the borrower can spend there in a year and it still be considered business purpose?

Melissa Martorella:

Sure. So this kind of goes into that big question is what is the purpose of the loan proceeds? Because again, you could make a loan secured by a primary residence as long as it's for a business purpose. So there's no maximum number of days a borrower could spend in that rental property. You just need to now go through and determine, okay, is this actually a rental property? Show me the evidence that during certain seasons or months, this is up on the market for being rented. Show me the rental transactions history, whatever it is, so that you can evaluate and see that, oh yeah, this is truly a rental property or not, this is a cash flowing asset for you or not, rather than just a second house.

Alex Breshears:

And then are there any templates or standard language for ecola disclosures that we can obtain?

Melissa Martorella:

Yeah, there's definitely, if you reach out to us, my email was on that last slide, and I know if you email Alex, she'd be happy to give it to you. I'd be happy to talk to you and give you any templates or walk you through what your current templates are, your current loan application, and make sure you have information in there that covers these scenarios.

Alex Breshears:

Alright. And then the next one is a little bit long, so I don't know if you potentially want to read it, but I'll start it. If a loan app to Melissa, LLC is to be personally guaranteed by two owners, Melissa and Alex, and Alex's credit score is four 50, which results in the loan being declined, does the adverse action notification need to be sent to the entity and both guarantors? That's question number one.

Melissa Martorella:

Yes. Will need to be sent to, because I'm assuming what happened, the person being denied. Yes. Alex's credit score unfortunately killed the loan, but the person applying for the loan, remember was Melissa, LLC, not Melissa and Alex. We were just going to guarantee that loan.

Alex Breshears:

Alright. And then how do we ensure credit privacy rights for Alex? If Melissa wants to know the reason for the denial?

Melissa Martorella:

Sure. I probably wouldn't put in there what Alex's credit score was, but I would say guarantor credit score, something like that was too low to be considered. And then Melissa can reach out to Alex after and be like, what the heck is going on? Well, you got to get your credit back into shape.

Alex Breshears:

And then there was a question from Mark, and if he is still connected, maybe he can unmute himself because the question just says, so this applies to seller finance, my own home in Texas. So I'm not sure what part of the presentation that came up in.

Melissa Martorella:

So yeah, kind of going through. So Texas is only going to care if the loan you are making is going to be secured by an owner occupied property. So if you're selling your home in Texas and it's going to be to a borrower for an investment purpose, you do not need to be licensed as a lender in Texas to do that. But if you are selling the property to a new owner who's going to live in that property, it's not necessarily a license that you need. Texas has just a ton of disclosures and restrictions on homesteads and they're going to require a lot to go into that. So that's where this comes up. So you don't need to be licensed to sell your property or to sell or finance your property unless you're selling it to ultimately somebody who's going to live in the property.

Guest:

So owner occupied, if I'm an owner occupant selling to an owner occupant, I thought there's some kind of exclusion. I can use an RMLO.

Melissa Martorella:

Yes. So exactly, you could use an RMLO, you could go run that through somebody else, but as a general statement, you can't do that without the RMLO or without the disclosures in place to do it. So it's just a blanket general statement, I guess for all those state licensing issues that we put up there is those are just really, those are stop signs or yield signs to be like, Hey, slow down. There might be an issue here. But oftentimes there are exemptions that allow you to make those loans in those states.

Guest:

Okay, thank you.

Melissa Martorella:

Absolutely.

Guest:

Okay, thank you.

Alex Breshears:

And then the next question looks like it's so what differentiates between private lending and hard money loans, if anything?

Melissa Martorella:

To me, I mean, haven't been in this industry very long, but to me these are really very similar terms. It's really, the way I like to think about it is these are generally business purpose loans, but they're also generally loans made by non-banks. It's not bank of America making this loan. It's either an individual or a mortgage fund or something like that. That's really what, to me, private lending or hard money lending is, I think hard money Lending for a long time got a bad rap because it was associated with high interest rates, really aggressive origination fees. But at the end of the day, it's a private loan made by individual investors or mortgage funds. They're really the same thing.

Alex Breshears:

All right. And then I think this question probably was just answered by your previous answer, but it says, can I lend through a family office or fund the vehicle?

Melissa Martorella:

Absolutely. And we'd be happy to talk to you about that as well. There are lots of different ways that you can make loans. I see them through family offices. Sometimes it's either with individuals on the loans, sometimes it's with IRA accounts, sometimes it's with family trust that are lending the money. Other times it's a mortgage fund and maybe that mortgage fund is made up of a bunch of who are making investments. But there's a lot of different options available to you to make these kinds of ones.

Alex Breshears:

Alright. And I believe that is everything in our chat, so if anybody has any other questions, feel free to unmute yourself or go ahead and put them in the chat. Melissa, I want to thank you so much. This was a ton of really great information. How would you prefer people reach out to you to ask questions? Was it just use your email?

Melissa Martorella:

Yeah, if you want to send me an email, I can definitely respond to your question. If you have more in depth things you want to talk about, happy to set up a call or a zoom with you to kind of walk through what you're doing to make sure that whatever you're doing is compliant and Okay. Yeah, happy to help anyway.

Alex Breshears:

And then one last question popped in here right under the wire and said, what would be good questions to ask title companies to make sure they understand private business purpose loans?

Melissa Martorella:

This is a great question. It's really interesting. For some reason lately, title companies have been pushing back on business purpose loans and the type of title policy. Really what the most important thing to do when you're doing a business purpose line and you're getting title is let them know upfront, Hey, this is for a business purpose. This is the type of policy I'm going to require. And the amount of the policy and any endorsements you generally require, if you have questions about that, we actually did a webinar on this recently to reach out. We can give you the information on that. But that's usually what happens. Sometimes you'll see pushback from the title companies that are like, oh, well, we're going to slap on a couple of random exceptions to your policy because it's a private lender loan and we can push back on those pretty fast. And if they really don't understand, then I recommend the threat of moving title companies and you'll be able to get your loan insured.

Alex Breshears:

And then Michael says he has two questions. I don't know if you want to unmute yourself,

Guest:

Michael. Yeah, I didn't want to interrupt you all before. So, okay. So if I'm just private money lending, then that would be, and this might be more of a tax question, would be passive income, whereas if I'm actually lending through an LLC, that would be like business income. Is that correct?

Melissa Martorella:

If you're the lender, to me it's one and the same. You could make, I have a lot of lenders that have various sources of funds. So they might do one loan with their trust, they might do another one with an entity, they might do another one individually. So to me, they're still hard money loans, private loans.

Guest:

Gotcha.

Melissa Martorella:

I don't know if that answers your question.

Guest:

Yeah, kind of then, so I'm in Texas, but I'm loaning to other states. You said I've got a foreign file. So with just personal private money loans where you're not having loaning from an LLC, you're just loaning to an LC. So it's still business purpose. You be filing, and I guess this is another tax question, should I be filing tax files for that state?

Melissa Martorella:

Got it. So this is another fun thing that I tell my people is I know a lot about how to make loans, put your money out there, get the money in the door. I can absolutely recommend you to some awesome CPAs who can answer that question, but I have no idea. Yeah,

Gues:

Fair enough. Fair enough. I realize those are tax questions. Thank you.

Alex Breshears:

Alright, well I want to thank everybody for stopping by and spending some time with us this evening. I know I learned a whole lot from this and I feel like I learned something new every time I talk with you guys. So I really, really enjoy. So I'm thankful for all of you that decide to stick it out here this evening with us. And if you have any other questions, please feel free to reach out to Melissa. Everybody at Geraci is just absolutely wonderful and very, very friendly and super helpful. So I cannot say enough great things about them.

Melissa Martorella:

Awesome. Thank you all so much. I really appreciate the opportunity to talk to you guys today.

Alex Breshears:

Thank you.

Melissa Martorella:

Have a good night everyone.