Business Purpose Loan: Templates & More

A business purpose loan agreement is a contract between a borrower and a lender for credit that will be used primarily for business or commercial purposes rather than for personal, family or household purposes. The agreement defines the loan amount, the interest rate, the repayment terms, the collateral, the default provisions and whether the loan is secured or unsecured. The label matters because loans made for a business purpose are exempt from the federal consumer credit laws, so the lender's documentation and disclosures are different from those on a consumer loan.

Business purpose loans are used to finance commercial real estate acquisitions, non-owner-occupied rental property, equipment purchases, working capital and other investments related to the operation of a business. The agreement typically covers the loan amount, interest rate, repayment terms, collateral and any conditions the borrower must meet to receive the funds, and it may add provisions about the intended use of the loan proceeds and reporting or financial covenants the borrower must maintain.

Why the purpose matters

The Truth in Lending Act and Regulation Z apply only to consumer credit. Regulation Z exempts an extension of credit primarily for a business, commercial or agricultural purpose (12 CFR 1026.3(a)), as well as credit extended to anyone other than a natural person, such as a corporation or LLC. A business purpose loan therefore does not require TILA or TRID disclosures, is not subject to the ability-to-repay rule, the loan originator compensation rules or the high-cost mortgage rules, and does not carry the right of rescission on a home-secured loan. The Real Estate Settlement Procedures Act has a matching exemption for business purpose loans. State licensing and usury laws may still apply, and many states exempt commercial loans above a dollar threshold from their rate caps.

How lenders determine business purpose

The Official Interpretation to Regulation Z section 1026.3(a) directs lenders to look at the substance of the transaction, weighing the relationship of the borrower's primary occupation to the purchase, how much the borrower will personally manage the asset, the ratio of income from the asset to the borrower's total income, the size of the transaction, and the borrower's own statement of purpose. The commentary also sets rules for rental property: credit to acquire, improve or maintain rental property that the owner will not occupy is business purpose regardless of the number of units; for property the owner will occupy (meaning more than 14 days in the coming year), credit to acquire it is business purpose only if it has more than two housing units, and credit to improve or maintain it only if it has more than four. A loan to an individual to buy a primary residence is consumer credit even if the borrower calls it an investment.

Clauses specific to a business purpose loan

1. Business purpose representation and affidavit: the borrower represents, and often signs a separate affidavit, that the proceeds will be used solely for business or commercial purposes and not for personal, family or household purposes, and acknowledges that the lender is relying on that statement.
2. Use of proceeds: a description of the permitted use and a prohibition on using the funds for consumer purposes.
3. Entity borrower: many lenders require the borrower to be an LLC or corporation, with a personal guaranty from the principals.
4. Financial covenants and reporting: debt service coverage, net worth or liquidity tests, with periodic financial statements and tax returns.
5. Collateral and cross-default: a security agreement or deed of trust, UCC financing statements, and cross-default to the borrower's other obligations to the lender.
6. Waiver of jury trial, confession of judgment where permitted, and commercial-law remedies on default.

Why lenders document it carefully

A lender that treats a consumer loan as business purpose loses the exemption and faces TILA liability, rescission on a home-secured loan and state law claims. Private lenders and hard money lenders that make loans to real estate investors therefore collect the business purpose affidavit, evidence that the property is not the borrower's residence, and proof of the borrower's investment activity, and they keep those records with the loan file.