By C/A Staff
So this might be shocking to some, but not all “investment” properties are exempt from Reg. Z.
Now, let’s break this down a little bit. For Reg. Z purposes, we’re generally looking at the purpose of the loan itself and not so much the purpose of the property securing the loan. As we all know, if the purpose of the loan proceeds is primarily business purpose, then the whole loan will not be subject to Reg. Z.
Reg. Z doesn’t even use the term “investment property,” but it does have exemptions for rental properties. These exemptions depend on three things—whether the property is owner-occupied, the purpose of the loan, and the number of units. If your loan meets all these conditions, then it’s automatically exempt from Reg. Z.
For owner-occupied rental properties, the exemption is split in two. For the first one, if the loan is to purchase rental property that has three units or more, then the loan is automatically exempt. For the second one, if the loan is to improve or maintain a rental property, then the property must have five units or more to fall under this exemption:
5. Owner-occupied rental property. If credit is extended to acquire, improve, or maintain rental property that is or will be owner-occupied within the coming year, different rules apply:
i. Credit extended to acquire the rental property is deemed to be for business purposes if it contains more than 2 housing units.
ii. Credit extended to improve or maintain the rental property is deemed to be for business purposes if it contains more than 4 housing units. …
https://www.consumerfinance.gov/policy-compliance/rulemaking/regulations/1026/Interp-3/#3-a-Interp-5
On the other hand, for non-owner-occupied rental properties, the property can have just one unit and still be exempt. So any loan to buy, improve, or maintain non-owner-occupied rental property is considered exempt.
4. Non-owner-occupied rental property. Credit extended to acquire, improve, or maintain rental property (regardless of the number of housing units) that is not owner-occupied is deemed to be for business purposes. This includes, for example, the acquisition of a warehouse that will be leased or a single-family house that will be rented to another person to live in. If the owner expects to occupy the property for more than 14 days during the coming year, the property cannot be considered non-owner-occupied and this special rule will not apply. For example, a beach house that the owner will occupy for a month in the coming summer and rent out the rest of the year is owner occupied and is not governed by this special rule. …
https://www.consumerfinance.gov/policy-compliance/rulemaking/regulations/1026/Interp-3/#3-a-Interp-4
But what if the property is not a rental at all? For example, a purchase of raw land that is expected to appreciate in value or a “fixer upper” that the borrower is expecting to flip. Well we know it won’t be “automatically” exempt as a rental property, but the commentary also gives us several factors to consider when trying to determine whether the purchase is primarily business purpose. For example, what is the borrower’s primary occupation? Is this just a one-off personal investment and not the borrower’s primary line of business? How much of the borrower’s total income will come from this investment property? How large is the transaction?
A. The relationship of the borrower's primary occupation to the acquisition. The more closely related, the more likely it is to be business purpose.
B. The degree to which the borrower will personally manage the acquisition. The more personal involvement there is, the more likely it is to be business purpose.
C. The ratio of income from the acquisition to the total income of the borrower. The higher the ratio, the more likely it is to be business purpose.
D. The size of the transaction. The larger the transaction, the more likely it is to be business purpose.
E. The borrower's statement of purpose for the loan.
Even considering all of this, so many people make the mistake of thinking that the label “investment” automatically makes the loan exempt from Reg. Z, but next time you have an investment property come across your desk, you’ll know to look a little deeper.
As always, if you have any questions about Reg. Z exemptions, feel free to ask us on the Hotline.