This article reviews financing events that trigger Regulation Z disclosures. This is the first part of a two-part series discussing Regulation Z involvement in private lender transactions.
Table of Contents
|Private loans and carryback paper disclosures
With the fading away of financing by conventional lenders and the rise in financing by private lenders and carryback dealers, federal disclosures on financing arrangements will again need to be considered by private lenders, builders and other dealers, and the brokers they employ. Federal Truth in Lending Act (TILA) disclosures are designed to give the borrower standardized loan information for easy comparison of terms between loans offered by different lenders. Regulation Z (Reg Z) implements the TILA disclosures required on federally defined consumer financing. Consumer financing, also called Reg Z financing or, more clearly, personal-use financing, arises out of:
Reg Z mandates disclosures on a loan transaction or carryback sale only if the loan funds or carryback notes are:
Additionally, the real estate encumbered by a trust deed to secure a personal-use loan originated by a private lender is not limited to the borrower’s principal residence to be controlled by Reg Z. [Regulation Z Staff Commentary §226.2(a)(19)-1]
Consider a borrower who obtains a loan to purchase a recreational boat to be enjoyed by his family. The loan is secured by a trust deed on a rental property he owns.
The loan is the sixth personal-use loan the lender has made within the calendar year which is secured by real estate the borrower owns.
Must the lender make Reg Z disclosures?
Yes! The lender is a regular financier and Reg Z applies to this, his sixth loan since the proceeds from each of the six equity loans were for each borrower’s personal use. More importantly, since the lender has made more than five personal-use loans secured by borrower’s real estate during the calendar year, the lender is now required to make Reg Z disclosures on all further Reg Z loans for the duration of this year and all of next year.
Most carryback sellers are exempt from Reg Z disclosures since most are not regular financiers. The typical seller of real estate to a buyer-occupant is a homeowner who rarely sells more than five properties in any one calendar year, and even fewer structured as carryback sales to assist buyers in the purchase of their principal residence.
Carryback sales include land sales contracts and lease-option sales, as well as carryback trust deed notes both — regular and all-inclusive. [In re Hanley (1990) 111 BR 709]
Real estate dealers, builders, and developers carrying back paper on more than five sales of buyer-occupied one-to-four unit residential real estate in any calendar year are the carryback sellers extending regular financing who are targeted by Reg Z. Also, the investor who purchases carryback paper from sellers who are not regular financiers (five or less sales) are not controlled by Reg Z. The seller is the original payee on the note, not the trust deed investor who is acquiring the paper by assignment of the note or trust deed.
Editor’s note —The remainder of this material addresses loans by private lenders only, whether referred to as a lender or private lender. However, the material applies equally to carryback sellers — dealers — who regularly finance sales of single family residences and duplexes to buyers acquiring their principal residence.
Before Reg Z controls the origination of any loan, the real estate or personal property acquired with the loan proceeds must be acquired for personal use. [12 CFR §226.2(a)(12)]
Personal-use acquisitions, funded by a loan, include:
A mixed-use loan requires Reg Z disclosures when more than half of the loan proceeds are used to purchase property or services for personal use. [Bokros v. Associates Finance, Inc. (1984) 607 F.Supp 869]
To advise the lender of any personal use to be made of loan proceeds, a loan purpose statement from the borrower about his intended use of the loan proceeds should be included as part of the loan application package the borrower fills out for the lender. The borrower’s statement will clarify whether the loan requires Reg Z disclosures. [See first tuesday Form 203-3]
A sale-leaseback of an owner-occupied one or two unit residential property with an option granting repurchase rights to the seller/occupant constitutes a personal-use loan and is subject to Reg Z. [Long v. Storms (1980) 50 Or.App 39]
Reg Z disclosures on an assumption of a loan by a buyer are limited to loans falling within a narrow set of facts, triggered primarily by the buyer’s occupancy of the property as his principal residence.
For an assumption agreed to by a lender to require Reg Z disclosures, four elements must exist:
Under Reg Z, an individual may only maintain one principal residence. Thus, a second or vacation home which the owner occupies for more than 14 days in the coming year is not a principal residence. [Staff Commentary §226.2(a)(24)-3]
A loan taken over by a buyer in a subject-to sales transaction, be it a legal or equitable (land sales contract or lease-option sale) transfer of ownership, when the buyer later assumes the loan, is not controlled by Reg Z. Thus, neither the transfer or the later assumption requires a Reg Z disclosure. [12 CFR §226.2(a)(24)(5)(iii)]
Further, a loan has not been assumed and thus is not subject to Reg Z disclosures when the buyer does not enter into a written agreement with the lender shifting the primary obligation on the loan to the buyer, called a subject-to transaction. Without a formal assumption shifting primary responsibility for the loan to the buyer who occupies the property as his principal residence, the loan is not subject to Reg Z disclosures. A loan assumption triggering Reg Z disclosures does not occur if the conduct of the lender is limited to only:
Reg Z disclosures are required on some refinancing, not because the refinancing pays off a loan and thus funds no present personal use, but because the loan paid off did fund a personal use for the owner of the property. Thus, the refinance is merely a continuation of a debt incurred to fund personal expenditures.
A lender who provides financing to fund the pay off of an existing loan is required to make Reg Z disclosures when the existing loan paid off and replaced by the refinancing:
A lender holding a loan which was originated by the lender as a Reg Z personal loan and is secured by any type of real estate may be asked by the property owner to modify the terms of the loan. If the modification of the Reg Z loan increases the lender’s portfolio yield on this loan, the modification is classified as a refinance of a personal-use loan and requires Reg Z disclosures. [12 CFR §226.20]
However, modifications which do not increase the lender’s yield and do not trigger Reg Z disclosures include:
Reg Z does not apply to a loan which:
Real estate acquired for business, investment, or agricultural purposes include:
Editor’s note—While loans for the purchase of owner-occupied, three-or-more units are exempt from Reg Z disclosure requirements, equity loans funding the maintenance or improvement of owner-occupied, one-to-four unit residential property require Reg Z disclosures.
Thus, financing used to purchase, improve, or carry the costs of income-producing, investment, dealer, agricultural, or business use real estate is exempt from Reg Z disclosure requirements, even if it is secured by the borrower’s principal residence.
For example, an equity loan secured by the borrower’s residence, the net proceeds from which are used to start a business, or buy or improve rental or investment real estate, is exempt from Reg Z. [Staff Commentary §226.3(a)]
A private lender must first be classified as a regular financier of Reg Z loans before he is required to make disclosures and notice the right of rescission on any loan. To determine if a private lender is a regular financier depends on how often during the prior or current year he makes a loan for the purpose of the borrower’s personal use, called an annual count.
Like business-purpose loans which are exempt from Reg Z, so also are personal-use loans for more than $25,000 which are not secured by real estate (or a mobile home used as the borrower’s principal residence).
For the private lender to be considered a regular financier, the lender must have an annual count of non-exempt, personal-use loans for a calendar year of:
Disclosures on Section 32 loans are controlled by a different count. Further, Section 32 loans require disclosures, notices, and repayment limitations without concern for the count needed to be classified as a regular financier. Thus, a private lender could be a Section 32 equity lender required to make Reg Z disclosures and not be a regular financier — until he has made more than five Reg Z loans, including any Section 32 loans.
The number of personal-use loans originated by a lender to bring that lender under Reg Z disclosure requirements is determined by his lending volume during the preceding calendar year, and if not, then by the current calendar year. [Staff Commentary, §226.2(a)(17)(i)-4]
Consider a private lender who began making personal-use equity or refinance loans, secured by one-to-four unit residential real estate, whether or not owner-occupied, in January 2004.
In calendar year 2004, the lender made only five such personal-use loans and was not subject to Reg Z during 2004, and thus was not a Reg Z lender in 2005. None were Section 32 loans which would have independently required disclosures.
However, in 2005, he originated seven personal-use loans. Thus, his sixth and seventh loans in 2005 became subject to Reg Z. He is now required to make Reg Z disclosures on all Reg Z personal-use loans originated in 2006 since he exceeded five originations on one-to-four unit properties in 2005.
In 2006, he funded four personal-use loans secured by any type of real estate. The lender made Reg Z disclosures on all four loans since his lending volume in 2005 under the more than five one-to-four unit test established him as a regular financier under Reg Z for 2006.
If the lender makes only five loans secured by one-to-four unit residential property (owner-occupied or not) in the calendar year 2007, must he make Reg Z disclosures on each loan?
No! During the preceding calendar year (2006) he only made four personal-use loans secured by one-to-four unit properties. Thus, he is not considered a regular financier required to make Reg Z disclosures on his first five personal-use loans during the following year (2007).
However, if the lender exceeds five loans secured by one-to-four unit residential property in 2007, he will once again be required to make Reg Z disclosures with every personal-use real estate loan he funds after the fifth loan — no matter the type of property which is the security — as well as all personal-use loans made in 2008. T
he same prior and current year annual counting applies to becoming a regular financier based on originating more than 25 personal-use loans annually, which are not secured by real estate (or a mobile home which is the borrower’s principal residence). [12 CFR §226.2(a)(17)(i)(A)]
The use of a loan broker does not alter the count for the lender, except for those Section 32 personal-use equity loans secured by one-to-four units occupied by the borrower as his principal residence which requires disclosures if a broker arranges the loan.
Personal-use services rendered by a person who is paid on an installment plan are extensions of credit (credit sales) controlled by Reg Z.
For example, a broker, in lieu of a cash payment for his brokerage fee on the sale of a single family residence, accepts a note executed by the buyer and secured by a trust deed on the property purchased. The seller reduced the price by the amount of the brokerage fee paid by the buyer. The buyer will occupy the property as his principal residence. Thus, the purpose of the extension of credit to the buyer is to finance a personal use. [See first tuesday Form 203-3]
The broker has “sold” his services and extended credit to the buyer. He accepted a note fromt he buyer for the deferred payment of his fee and either included interest or a repayment schedule of five or more payments.
The note given for the payment of the brokerage fee on the personal residence is treated as consumer financing under Reg Z. The extension of credit is comparable to a note carried back by a seller and more particularly, treated as though the broker had made the buyer a purchase-assist loan.
Thus, a broker who receives a personal-use note executed by a buyer in lieu of a cash payment for fees on the purchase of a one-to-four unit property, whether principal residence or second home, must make Reg Z disclosures if during the prior or current calendar year, the broker acting as a principal made:
Brokers avoid Reg Z disclosures when they accept notes:
A broker could receive for his consumer services the buyer’s unsecured note in lieu of cash. Thus, the broker could accept up to 25 notes, none of which would be secured by real estate (or a mobile home which is the principal residence), each year from buyers without having to make Reg Z disclosures. Again, the target of Reg Z is the larger brokerage and private lender operations.