The private lending industry of today can trace its near-exponential growth over the past decade back to government regulation. Regulation of parallel industries, that is. Strictures that have reined in traditional institutional lending practices have largely benefited private lenders, spurring borrowers to come knocking at the door.

Private lenders have, for the most part, operated outside licensing and reporting requirements affecting institutional lenders. That’s because their clientele is primarily businesses transacting                                                        business-purpose loans secured by non-owner-occupied dwellings rather than consumers looking for traditional mortgages on a primary residence. Today, only 11 states require a mortgage license to transact these loans, with federal regulation being limited to a few (albeit still burdensome) disclosure and reporting requirements.

Whether state or federal, most recent regulation impacting private lenders seems almost accidental, effected through vague wording like “lien on a dwelling” (Equal Credit Opportunity Act and Home Mortgage Disclosure Act) instead of the more widely adopted “credit offered or extended to a consumer primarily for personal, family, or household purposes” (Truth in Lending Act and Real Estate Settlement Procedures Act). The latter exempts private lenders, whereas the former does not.

The past several years have seen only two states—New York in 2021 and Florida in 2018 and 2019—attempt to change that status quo to purposefully regulate private lenders. While the New York legislation is ongoing as of the time of this writing (see aaplonline.com/NY-ab1420), the Florida bills either did not pass or were passed without the regulating language. Their failure was largely a result of advocacy efforts from the American Association of Private Lenders and its general counsel Geraci LLP.

This is not to say that private lenders are completely unregulated. They must still comply with anti-usury, anti-discrimination, fair advertising, loan servicing, foreclosure laws, and more. Speaking of the private lending industry as “largely unregulated” applies in the context of comparison with institutional lending and other financial industries.

The regulation gap between private and institutional lending is not only what has allowed private lending to grow but also to exist as a recognized industry at all. While large national private lenders might be able to survive regulatory hurdles, the smaller lenders that make up much of the industry would not: Their operational costs would skyrocket as demand shrinks with fewer differentiators between “bank” and “not bank.”

Ok, we’re “largely unregulated.” What do we have to worry about?

The common answer is that as any industry grows, its practices increasingly come under the watchful eye of legislators. Private lenders need to establish and follow best practices now to be able to  mitigate bad actors that can become the face of the industry and a reason to regulate.

But while the soundbite makes sense, it’s still unhelpfully vague. When does the industry magically become large enough to regulate? Who is the “we” that establishes things? What “best practices” will avoid regulation? How do we stop “bad actors”?

As with much of history, it often takes a crisis to shine a light on what’s wrong. In the aftermath, government picks up the slack—often clumsily—to prevent it from happening again. While the 2007 financial crisis is a clear example of possible impacts to an industry for unwise decisions, a more immediate one is the present COVID-19 crisis.

COVID-19 is a litmus test of our ability to self-regulate.

As with pre-COVID-19, the nature of most private lenders’ business means that there is limited regulation in play. Federal foreclosure and eviction moratoriums only applied to government-backed loans from Fannie Mae and Freddie Mac. And while some states enacted regulation that applies to private loans, most such moratoriums are ending soon, if they haven’t already.

Court closures and local ordinances may slow down proceedings, but private lenders without federal or state considerations are under no legal obligation to extend forbearances or deferrals, or to delay foreclosure. There is also little regulation on when the missed payments from forbearance or disclosure are to be made up, allowing lenders to call the total of the deferment due when the borrower (and most of the nation) is still recovering from the crisis.

This is what is legally permissible. But following the letter of the law does not prevent future regulation should the industry come under scrutiny and it is decided private lenders profited from the crisis and/or contributed to its economic impacts.

Although the American Association of Private Lenders and Geraci LLP published a Forbearance Request Guide and Request Form (available at aaplonline.com/covid19), not all private lenders will see them, and for those that do, not all will follow them. While most lenders feel a sense of “we’re all in this together” during a crisis that impacts everyone, lenders face their own resultant financial hardships, with some having to weigh compassion against possibly having to shut their own doors.

The balance between legal, business, and best practice considerations is delicate, and we often don’t realize we’re failing until the crisis has passed and we’re in the post-mortem.

There is a silver lining that has for the most part kept us on the right track: Unlike decision-makers at banks, private lenders for the most part are not so far removed from the borrower as to lose feeling for what they are going through. It’s harder to pass the buck in our industry.

If private lenders can show they helped borrowers in the face of this crisis, they will have a powerful platform when talking to legislators about their ability to self-regulate, and the industry will less likely be lumped into the regulatory aftermath of COVID-19 and future issues. Where institutional lenders may fail in the eyes of the public and legislators, private lenders need not. Ultimately, it is our choice.

This article has been updated and reprinted with permission. It was originally printed in Originate Report