Private Money Lending: Regulatory Oversight and Licensing Investments

By Dan Harkey
Educator & Private Money Finance Consultant
m: 949 533-8315  | e: dan@danharkey.com

Regulatory oversight and licensing in real estate lending are complex and change continually. Lenders and loan agents must remain aware of state and federal laws and regulations affecting their business. Knowledge of multi-state lending is required for those who operate in more than one state. Practitioners may need the technical support of lawyers and consultants. The contents of this article provide a limited overview.
 
A) Federal regulations and enforcements for loans secured by one to four residential units:
 
Loans are for consumer purposes when the loan proceeds are used primarily for personal, family, or household purposes. Individual(s) and family trusts are considered consumers.
 
Limited liability companies (LLCs), corporations, and various forms of trusts created for business enterprises are not considered consumers.1) (TILA) Truth in Lending Act of 1968 and The Consumer Credit Protection Act of 1968.

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Regulation Z was the Federal Reserve Board regulation implementing the Truth-in-Lending Act (TILA) of 1968,all part of the Consumer CreditProtection Act of 1968.

The purpose of TILA was to enable consumers to compare the total loan cost of loan options between different lenders.  TILA covers any consumer credit transaction with a finance charge payable in 4 or more installments.  TILA applies to many loan products, including consumer home mortgages, home equity lines of credit, reverse mortgages, credit cards, installment loans, and certain student loans.

TILA’s goal was to provide consumers with better information/disclosures about the actual cost of credit, partly through providing an annual percentage rate (APR).  An APR calculation includes all finance charges, which include interest, origination fees, or other amounts paid to the lender/or loan intermediaries.  Lenders are required to provide written disclosures about the loan terms and costs, including the APR.  For consumer purposes refinance loans secured by a borrower’s primary residence, the borrower is provided a (three-day right of rescission).

The Federal Truth in Lending Act (Reg Z) does not cover certain transactions. These include Federal student loans, business purpose loans, and loans for retail, agriculture, or organizational use.

2)  (RESPA) The Real Estate Settlement and Procedures Act of 1974

RESPA aimed to provide disclosures regarding real estate settlement costs.  The Act prohibits specific practices, such as referral fees paid to or by settlement service providers.  It also regulates the use of escrow/impound accounts.  RESPA provides consumers with improved disclosures of settlement costs and reduces closing costs by eliminating referral fees and (mark-ups) by settlement service providers.

RESPA applies to consumer-purpose transactions, including home purchase loans, refinances, lender-approved assumptions, property improvement loans, equity lines of credit, and reverse mortgages.  RESPA applies to all “federally related mortgage loans” (definition source- 12 USC S 2602 (1) ) secured by 1 to 4-unit residential family structures, including condominiums, cooperatives, and construction loans. Federally related mortgage loans are most loans secured by a lien (first or subordinate) on residential property.  Loans include home purchase loans, refinances, lender-approved assumptions, property improvement loans, equity lines of credit, and reverse mortgages.  RESPA also covers manufactured home loans, timeshare loans, and loans on vacant lots intended to construct a primary residence.  

RESPA does not apply to business-purpose loans, commercial or agricultural purposes, seller-financed transactions, or rental property purchases. Short-term bridge loans and swing loans are exempt.

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3) (Section 32) (HOEPA) Home Ownership and Equity Protection Act of 1994.

Amended Section 32 of Regulation Z was part of the Home Ownership and Equity Protection Act of 1994.  It amended TILA by establishing requirements for certain loans with higher interest rates and costs. These loans are discussed in Section 1026.32 of Title 12 of the Code of Federal Regulations.

Section 32.

https://www.consumerfinance.gov/rules-policy/regulations/1026/32/

https://www.law.cornell.edu/cfr/text/12/1026.32

Some loans with higher interest rates/or loan costs are covered by Section 32.  These loans may still be made but have additional limitations and require other disclosures. Few lenders remain in the business because of these additional disclosures and possible severe penalties.  

Section 32 loans apply to loans where the net proceeds are used primarily for personal, family, or household purposes secured by one to four residentialproperties.  Private residences could include a trailer or houseboat if used as a primary residence, even though they are personal property.  

The Section 32 disclosure requirements cover the following loans:

• Purchase money
• Refinancing
• Equity loans, including loans funded by private parties.
• Loans for home improvement and remodeling
• Reverse mortgages
• Home equity lines of credit
• Second homes

If a loan is subject to Section 32 through an APR test and if the total loan amount exceeds the Average Offer Rate (AOR) for a comparable transaction on the same day that the rate is set by more than, then special disclosures are required by the originating lender.

Thresholds and conditions change annually, so I will not bother with the current entries.  They are available online.

https://www.consumerfinance.gov/rules-policy/final-rules/truth-lending-regulation-z-threshold-adjustments/#:~:text=Based%20on%20the%20annual%20percentage,1%2C%202023.

Transactions exempt from Section 32:

• Loans where the proceeds are not primarily for consumer purposes
• Financing for Income/commercial property
• Reverse mortgages
• Construction loans for financing the initial construction of a new dwelling.
• Loans originated and funded by a Housing Finance Agency
• US Department of Agriculture Rural Development Section 502 direct loans
• Federal student loans

4) Secure and Fair Enforcement Act of 2008 (SAFE ACT)

The SAFE Mortgage Licensing Act oversight responsibilities were transferred to the Consumer Financial Protection Bureau (CFPB) for administration and enforcement effective July 21, 2011.  It established a nationwide multi-state licensing system (NMLS) to provide for Federal Registration of Residential Loan Originators for consumer purposes 1-4 lending.  A mortgage loan originator (M.L.O.) is an individual who, for the expectation of compensation, takes a residential mortgage loan application or offers or negotiates the terms of a residential mortgage.

A residential mortgage loan is any loan made primarily for personal, family, or household use, secured by a mortgage or deed of trust, as defined in the Federal Truth in Lending Act (TILA). Dwelling means a residential structure that contains one to four units, whether or not the structure is attached to real property.  Dwelling includes condominium units, stock cooperative units, mobile homes, or trailers if used as a residence.

The Safe Mortgage Licensing Act was designed to enhance consumer protection and reduce fraud by encouraging states to establish minimum licensing and registration standards for state-licensed mortgage loan officers.  From the previous (patchwork) of different state loan originator licensing laws, NMLS provided a nation-based financial regulation platform for improved coordination and information among regulators. NMLS aims to offer a one-stop database for state licensing information for mortgage lenders and loan officers.

Reciprocation of licensing in multiple states:  As per a bulletin from the CFPB, consistent with the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act), a state may grant a transactional loan originator license to an individual who holds a valid loan originator license from another state.  The SAFE Act allows states to provide a transactional license to a licensed loan originator who has a valid license from another state.

5)  (Dodd-Frank)-Financial Reform and Consumer Protection Act of 2010

2010, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Among numerous changes, Dodd-Frank established a new Consumer Financial Protection Bureau with the authority to supervise and regulate entities that offer or provide consumer financial products or services.

The CFPB enforces over a dozen consumer financial protection laws, including the Fair Credit Reporting Act, Fair Debt Collection Practices Act, and Truth-in-Lending Act. In addition, the CFPB can take action to stop “unfair, deceptive, or abusive practices.” The FTC shares authority with the CFPB to enforce consumer protection laws concerning non-bank financial institutions.

Dodd-Frank added the requirement to prove the borrower’s repayment ability to repay the loan. The requirement eliminated the ability to provide stated income loans, where the borrower has no verifiable source of income.

The Dodd-Frank Act prohibits consumer-purpose financing when the property is a buyer’s principal residence unless the loan is originated through a licensed mortgage originator (as defined under the Act.) Dodd-Frank does not apply to residential mortgage loans on a buyer’s second home or investment property.  The Act also excludes the mortgage originator provisions for certain seller financing transactions.

Dodd-Frank stipulates that loan securitizers who bundle many loans and sell them in packages cannot pass on all the risk of the mortgage loans to investors; the securitizers must hold at least five percent of the equity to share the risk of the mortgages.   

6) The Federal Trade Commission (FTC) and its 1000-plus employees enforce laws protecting consumers from deceptive mortgage practices by specific lenders. The FTC enforces federal consumer protection laws for mortgage companies, brokers, creditors, and debt collectors.

The FTC does not oversee banks, savings and loan institutions, and credit unions. The Office of Comptroller of the Currency (O.C.C.), an independent US Department of the Treasury Bureau, charters, regulates, and supervises all national banks and federal savings associations.  OCC also oversees federal branches and agencies of foreign banks.

The numerous agencies assigned to regulate and oversee financial institutions and financial markets in the United States include the Federal Reserve Board (FRB), the Federal Deposit Insurance Corp. (FDIC), and the Securities and Exchange Commission (SEC).

The FTC also has law enforcement and, in some cases, regulatory powers under the Truth in Lending Act, the Home Ownership and Equity Protection Act, the Consumer Leasing Act, the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, the Equal Credit Opportunity Act, the Credit Repair Organizations Act, the Electronic Funds Transfer Act, and the privacy provisions of the Gramm-Leach-Bliley Act. The FTC’s extensive consumer education efforts help consumers manage their financial resources, avoid fraud and deception, and learn about emerging scams.
 

7)   Regulating commercial and business purpose lending:

Commercial and business purpose lending has mostly remained outside the scope of stringent borrower protection laws that have expanded dramatically in consumer lending.

“Regulation Z/TILA” oversight is “purpose-driven” rather than “property type driven.”That means any property loan where the proceeds are used primarily for family, consumer, and household purposes falls under Regulation Z/TILA. “Purpose-driven” under Reg Z applies even if the property is more than one to four commercial units or any other property type.

Recently, multiple states, including California, New York, Utah, and Virginia, have passed laws and regulations to heighten disclosures for commercial loans, in some ways like those under consumer-purpose lending.

The Consumer Financial Protection Bureau (CFPB) has determined that Consumer Finance Lenders (CFLs) and California Residential Mortgage Lenders Law (CRMLA) and loan servicing licensees are now required to give state-law disclosures for commercial transactions.  (State of California Department of Financial Protection and Innovation website, California Code of Regulations, Title 10, chapter 3)   

https://www.consumerfinance.gov/

California has a similar version codified under CA Financial Code sections 22800-22805.  The new regulations, effective December 9, 2023, require CFL licensees to make disclosures on commercial loans of amounts less than or equal to $500,000.

We can expect continuing increases in the number of regulations for loans on income and commercial properties.  

B) Outside of California: licensing and regulatory oversight

All 50 states have different licensing and regulatory oversight schemes, some more restrictive and controlling than others. Certain states use laws and regulations to grow government oversight bureaucracies and tax the related parties.

Some states have licensing or regulatory requirements for all real estate loan transactions; others require licenses only for 1 to 4 residential units and do not require licensing for loans secured by other properties. Some states require a broker’s license with a (brick-and-mortar) office location in that state to obtain and maintain the license. Some states require only a simple registration for an occasional loan.

Most states require state and federal lender licenses (NMLS) for single-family consumer-purpose lending by 1-to-4 units, both owner and non-owner-occupied.  

Many states do not require an (NMLS) license for 1-to-4-unit business purpose loans. Many states do not require a license or registration to make loans on five or more residential income units, commercial, industrial, and land loans.

For all properties otherthan single-family 1-to-4 units, licensing and regulations to procure loans, with the expectation of compensation,differ ineach state.  Also, licensing and oversite depend on the state’s political power structure, type of real estate, the purpose of loan proceeds, the use of the property, the location, property quality and amenities, and conformity to zoning and building regulations.  

C)  California; Licensing and regulatory oversight:

There are three different types of lender licenses in California.

1) The Department of Real Estate issues a real estate broker license for individuals and corporations who arrange or service loans on behalf of others who make certain loans with their funds. The real estate broker license is the most common license to arrange private money loan transactions.

Applicable code sections may be reviewed and understood, including Business & Professions Code Sections 10131.1 (a), 10131.3, 10177 (n), 10237-8, and 10232.3-5.

California Business and Professions Code 10131.3

Real estate brokers’ permitted activities are referenced in 10131, 10131.1, and 10131.3.  Specifically, 10131.3 states, “A real estate broker with the meaning of this part is a person who, for another or others, for compensation or in expectation of compensation, issues or sells, solicits or obtains listings of, or negotiates the purchase, or exchange of securities about those entities specified in Section 25206, which are partnerships, limited liability companies, joint ventures unincorporated associations, general partnerships, but not corporations.”

2)California Finance Lender (C.F.L.) issued by the Department of Financial Protection & Innovation issued licenses: The California Financing Law, referred to as (CFL), (Fin. Code, § 22000 et seq.), requires the licensing andregulation ofbrokers making and brokering consumer and commercial loans.

A finance broker is any person or entity engaged in negotiating or performing any act as a broker in connection with loans made by a finance lender.  As with any lender, CFL licensees who make loans secured by 1-4 family residences would be required to obtain an NMLS endorsement.

The CFL license is primarily for entities that lend their money instead of brokering loans to other lenders.  They can broker loans, but only to other CFL lenders.  They cannot accept investment funds from or sell investment trust deeds to private parties or unlicensed entities.  Their capital must be from their own funds or money obtained from lines of credit.

Private money lenders sometimes make loans with a CFL license, then use a California real estate broker license to sell the loans to private parties or a mortgage fund comprised of a mortgage pool of private investors.  There are many examples of different licenses working for other business models. There are many.

3. California Residential Mortgage Lenders Law License  (CRMLA) issued by the Department of Financial Protection & Innovation.

This license is most commonly used by mortgage bankers who fund institutional for bank quality loans, the bulk of which are sold to government-sponsored entities (GSEs), such as FNMA, FHLMC, and GNMA.

A lender must maintain a $250,000 net worth and a $25,000 surety bond.  The individual applicants must have and maintain a $50,000 net worth.  

Persons and entities who may become licensed include natural persons, sole proprietorships, corporations, partnerships, limited liability companies, associations, trusts, joint ventures, unincorporated organizations, joint stock companies, governments or political subdivisions of governments, and any other entity.

The CRMLA requires that any person engaged in making or servicing residential mortgage loans within California do so only under the authority of a license under the CRMLA.

Numerous entities are exempt from the California Finance Lenders Law licensing requirements.  They include, but are not limited to:

• Banks, trusts, insurance companies, federally chartered savings and loan associations, federal savings banks, and credit unions.
• Licensed California real estate brokers are exempt because the licensing scheme is a separate regulatory agency, the Department of Real Estate.
• California finance lenders because licensing is under the jurisdiction of the Department of Financial Protection & Innovation.

Usury:
 
Because of a borrower’s financial strength or credit, type or condition of property, availability of capital, or other conditions, private money loans are made at interest rates or annual percentage rates that exceed 10%.

California’s usury law prohibits lending at rates above 10% unless the transaction is somehow exempt from the provisions of California’s usury law. Texas also has a 10% maximum rate, while many other states have different usury laws.
 
In California, loans made by banks, credit unions, California Finance lenders, and attorneys are exempt.
 
Most private money loans are made or arranged (for compensation) by licensed real estate brokers, making those loans exempt from usury.
 
Article 15 of the California Constitution states that the maximum interest for a loan secured by real property is 10% per annum in 1979.  The 10% is an annual percentage calculation (APR), which includes all fees charged, including the interest rate.
 
California allows specific lenders and other parties to be exempt from usury limitations. An in-depth analysis is beyond the scope of this article.  Most California licensed and federally related lenders who make loans are exempt from California usury—real estate brokers who make or arrange loans with the expectation of compensation.
 
Most California-licensed or federally licensed lenders who make loans, such as real estate brokers, CFLs, banks, credit unions, and lawyers, are exempt.
 
The smart mouse can successfully meander through the maze.

The smart mouse can successfully meander through the maze with sufficient study, development of compliance systems, and the help of real estate and securities attorneys. With the purported goal of protecting the public, there will always be regulations and agencies, more government employees, attorneys, and an ever-busier court system.
 
Lenders, brokers, and other practitioners may study their market and lending area to gain a master’s level competency in their state’s licensing, regulations, laws, and customs. It may take hundreds of hours of study and effort to achieve adequate compliance and to set up appropriate systems.
 
I hope this information provides valuable insight into possible licensing schemes and requirements for private money lending.  Licensing, legal requirements, and regulation of real estate lending create obligations and at the same time, opportunities for informed participants.  
 
I hope the information in the article gives some insight into the licensing scheme necessary to engage in private money lending and the interconnectedness with securities regulations. Compliance with both real estate and securities laws and rules adds a dimension of complexity.
 
Thank you!
 
Dan Harkey

Dan is President and CEO at California Commercial Advisers, Inc. He consults on subjects of Business Growth & Private Money. Dan often creates articles interrelated to these subjects. He has been active in the real estate and financial services industry since 1972 & possesses a lifetime teaching credential for secondary and adult education. He has taught over 350 educational seminars on subjects related to real estate lending, private money lending & loan underwriting for commercial/industrial properties.

Contact Dan Today
Mobile:     949.533.8315
Email:      dan@danharkey.com

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