Owner Financing, Seller Financing, Dodd Frank, Safe Act, and You!

Tired of hearing about owner financing laws?

We share your pain.

First the Safe Act had a say on Seller Financing and then the Dodd Frank Act.

Why the government would want to slow the housing rebound further by putting stringent restrictions on seller financing – one of the few alternatives to bank financing available in today’s struggling  economy – is beyond us.

And it’s not over yet.

Government agencies are still sorting through how to implement portions of the laws affecting both seller financing and lenders in general. The outcome will affect sellers that want to owner finance and when they want to “sell my note!”

URGENT UPDATE: There are new proposals for laws relating to seller financing that need action and comments by October 16, 2012.  Please visit this article for the updated details: Seller Financing Regulation Proposals On Dodd Frank and TILA

Ric Thom, a long time note buyer and servicing agent, shares our concerns.  He recently wrote in to urge NoteInvestor.com readers to take action by commenting on proposed rules before an upcoming deadline. He’s spent considerable time researching the issues and you are sure to find his following thoughts insightful.

Owner Financing Laws – From the Desk of Ric Thom

The Federal Reserve is requesting comments on the proposed rule of the ability-to-repay.  NAR refers to it as Qualified Mortgage which appears on page 10 of the proposed rule.

This standard would be applied to seller financing.  It’s the same underwriting standards that banks are required to perform.  The bottom line is that the only people who will be able to use seller financing are the same people who would be able to qualify for conventional financing.

This rule also allows the buyer a three year right of rescission if the seller did not properly qualify them.  This right to rescission also applies to anyone who has bought the note.

Comments are due before or on July 22, 2011.  I have attached my comments.  Please get the word out.

I have also given a link to the National Association of Realtors (NAR) website which summarizes the final SAFE Act rule as it pertains to seller financing and a brief update on Dodd-Frank.

My Comments on the Dodd-Frank Act and Seller Financing

Submitted by Ric Thom President of Security Escrow Corporation

The Dodd-Frank Act does not exempt property owners who wish to use seller financing (installment sale) even though no money is lent, there is no table funding, and under the Truth and Lending Act they are not considered creditors.

The Dodd-Frank Act (ACT) does exempt property owners who offer seller financing from having to become Mortgage Loan Originators (MLO) provided they only sell 3 properties or less in a 12 month period and they follow the restrictions below. Yet, the Act subjects the property owner to the same liability as an MLO.

Title XIV Section 1401 (2) (E)

1. The seller did not construct the home to which the financing is being applied.

2. The loan is fully amortizing (no balloon mortgages allowed).

3. The seller determines in good faith and documents the buyer has a reasonable ability to repay the loan.

4. The loan has a fixed rate or is adjustable after 5 or more years, subject to reasonable annual and lifetime caps.

5. The loan meets other criteria set by the Federal Reserve Board.

Under this Act the only buyers who will be able to use seller financing are the buyers who can already qualify for conventional financing with perhaps the exception of how much of a down payment they need. Seller financing has always been the alternative to government regulated financing. It is a meeting of the minds between two private individuals who negotiate an arm’s length contract to purchase property using an installment sale.

The following is a breakdown of these restrictions. I listed them in order of greatest impact on property owners, buyers and the economy.

3. The seller determines in good faith and documents the buyer has a reasonable ability to repay the loan

The implication is that the seller must use the ability-to-repay underwriting requirements when offering seller financing consistent with the Dodd-Frank Act which amends the Truth in Lending Act. This new, proposed rule is 169 pages long. http://www.gpo.gov/fdsys/pkg/FR-2011-05-11/html/2011-9766.htm

The Consumer Financial Protection Bureau has spent a lot of energy developing a new, easy to read, two page mortgage disclosure form. It is unreasonable to expect sellers and buyers to fully understand and apply this 169 page rule. If buyer’s and seller’s negotiations deviate in the least the buyer has up to three years to rescind the sale and demand back all money paid to the seller, or anyone that the seller might have assigned rights and interest to, or any bank who takes the note as a collateral assignment.

This could be financially devastating to the seller. Let’s not forget that today’s buyer will be tomorrow’s seller. These sellers are a diverse group. They come from all walks of life: low income, high income, non-English speaking, seniors, widows, minorities but this requirement places the same standards on individuals as banks and mortgage lenders, only with more risk – the banker is in the business of mortgage loan origination and factors that risk into his business plan, whereas the individual seller does not have capital reserves and doesn’t do this as a business. Also, unlike a bank, they do not carry errors and omission insurance.

Unlike banks and mortgage lenders, both the buyer and seller are consumers. They should both be equally protected. The buyer is purchasing real property and the seller is investing in/creating a financial product where they receive their equity over time. The seller is relying on the buyer to make monthly payments and maintain and protect the property. Terms are not dictated to either party, but rather they are negotiated between the parties.

Requiring the buyer to turn over all their financial information to a stranger opens the door for Identification theft and fraud. Furthermore, why should the buyer be required to divulge their income and assets to the very person with whom they are negotiating the terms of a sale? This is not required when there is a 3rd party lender.

This also creates the opportunity for predatory borrowing. This is where an unscrupulous buyer knowledgeable about the Dodd-Frank Act leads an uninformed seller (and this will be the majority of sellers) into negotiations not in compliance with the ability-to-repay requirements. (An example of that could be a balloon, an interest rate greater than 1.49% above a standard mortgage, or the seller did not know how to calculate the income to debit ratio correctly, or know what residual income means). That buyer lives in the property trying to resell it for a profit and if they are not successful within three years they rescind the sale and get all their money back.

The SAFE Act does not put in place the ability to repay requirements, or any other requirements, unless the individual habitually and repeatedly uses seller financing in a commercial context. So there is some consistency between the two laws the Dodd-Frank Act should not require sellers to use the standard of the ability-to-repay unless they use seller financing more than three times in a 12 month period. It is HUD’s feeling that Congress never intended under the SAFE Act to restrict private property owners from using seller financing, unless they did it as a business.

2. The loan is fully amortizing (no balloon mortgages allowed).

There is a good chance that a seller 55 years or older will die before receiving all their equity by not allowing them to negotiate a balloon payment. A lot of seniors have invested in real property with the intent of selling it using seller financing (an installment sale) in order to supplement their income in retirement, but also with the hope that they would not be stuck with a 30 year investment. The Dodd-Frank Act does the same thing insurance companies do who sell 30 year annuities to seniors. Our government has criticized this deplorable practice because seniors will die before they receive all their investment.

The restriction of no balloon doesn’t affect just seniors, it has financial consequences for anyone using seller financing. Under the Dodd-Frank Act community banks are allowed to originate fully amortizing loans with a five year balloon. The rationale is that they hold these loans in their own portfolios and the government recognizes their need to hedge against inflation and rising interest rates. Yet, the Act refuses to recognize that private property owners who have 100% skin in the game need the same protection. Obviously the Act does not feel that a five year balloon is predatory lending. This restriction should not be placed on seller financing until a property owner sells more than three properties in a 12 month period. If there has to be a restriction it should at the very least be the same allowance given to community banks of a balloon in 5 years.

4. The loan has a fixed rate or is adjustable after 5 or more years, subject to reasonable annual and lifetime caps.

This restriction is reasonable, but it will eliminate the ability for any buyer to wrap an existing obligation that has an adjustable rate even if they feel they can afford any rate increase. Again, for consistency with the SAFE Act there should not be any restrictions on any property owner that uses seller financing 3 or fewer times in a 12 month period. If the seller does not know about the ability-to-repay requirements and that they are not able to have a balloon, they certainly will not know that you have to have a fixed interest rate for the first five years.

1. The seller did not construct the home to which the financing is being applied.

There are a lot of small builders that have a spec house or two that they can’t sell unless they offer great terms using seller financing. Otherwise they have to let these properties go back to the bank which does not help housing or the economy. There is also that group of out of work construction workers who built their own homes when times were good and now need to sell. This takes away their ability to use seller financing. Builders should not be subject to any restrictions unless they sell more than three properties in a 12 month period using seller financing. Builders are in the business of building; not of originating loans.

Using a mortgage loan originator to facilitate a seller financed transaction creates additional risk and expense for both the buyer and the seller.

It has been said that a seller financing the sale of his or her own property would completely avoid the issue of licensing by retaining the services of a licensed loan originator. If a mortgage loan originator (MLO) fails to properly follow the ability-to-repay guidelines the buyer still has three years in which to rescind the sale which leaves the seller at risk and will most likely bankrupt them. Furthermore, there is no provision in a MLO’s errors and omission insurance that covers seller financing. None of the continuing education classes or the exams that an MLO must complete has a single chapter or question regarding seller financing.

Who is supposed to pay the MLO? MLOs can charge a flat fee or up to 3% of the transaction. The only advertisements I have seen so far advertise a flat nonrefundable fee of $450. This fee has to be paid in advance, which makes sense because why would a MLO spend hours and hours on an installment sale transaction which might not close? If the buyer pays the fee, then this is a forced origination fee never before imposed on buyers seeking seller financing. Why should the buyer have to pay money just to have an offer presented to the seller? A lot of buyers use seller financing because they are low income and seller financing, up to now, has been an inexpensive way to purchase property. If the seller pays they will have to pay money for the simple act of the MLO forwarding them the installment sale offer. If the seller receives multiple offers this could easily run into thousands of dollars in MLO fees just to sell their property. A lot of sellers are also low income individuals. The MLO will have to be a part of every offer and counteroffer because the sale and terms of an installment sale are one and the same and cannot be separated. For instance, the buyer might be willing to pay a higher interest rate if the seller is willing to come down on the price and down payment. A lot of seller financing takes place in rural areas that are underserved by mortgage lenders and banks. It is going to be very difficult to find a MLO in those areas who are also willing to take the risk facilitating a seller financed transaction. This has the potential of pushing seller financing underground – not a desired result.

The Dodd-Frank Act allows a property owner to use seller financing without having to become a mortgage loan originator as long as they don’t use it more than three times in a 12 month period and comply with the above restrictions. In the SAFE Act there are no restrictions to the number of times seller financing can be used as long as you are not in the business of being a mortgage loan originator. The coauthor of the Dodd-Frank Act, Representative Barney Frank, sent a letter to HUD on July 22, 2010 urging them to place the maximum amount of seller transactions that an individual could do before becoming a MLO, or having other restrictions on them, at five in a 12 month period. I would propose that the Dodd-Frank Act adopt that same number and place no restrictions on seller financing until 5 is surpassed. The only restrictions that should apply to 5 or less are those restrictions that the States already impose either through state statute or case law.

Under The Act loan officers at community banks do not have to become a Mortgage Loan Originator if they originate 5 or less transactions in a 12 month period. The rationale is that this is burdensome, costly and there is not enough volume to create a systemic risk. Ma and Pa on Main Street should be granted those same allowances. The Act puts more restrictions and risk on Ma and Pa than it does on financial institutions.

In watching the debates in Congress last summer it was repeatedly said that the Wall Street Reform and Consumer Financial Protection Act would not negatively affect or over regulate Ma and Pa on Main Street. If this doesn’t negatively affect and regulate seniors, minorities, and lower income individuals on Main Street I don’t know what does. These restrictions will all but do away with seller financing which will have a negative impact on housing, existing property owners, those desiring to be property owners and the economy.

Related Articles on Owner Financing Laws From NoteInvestor.com

Dodd-Frank Hijacks Seller Financing

Safe Act and HR 4173 Update – Is it Good News for Seller Financing?

How HUD Safe Act Will Hurt Seller Financing

Update 10/9/2012 Seller Financing Regulation Proposals On Dodd Frank and TILA

Comments

  1. How do these new rules effect a contract for deed or a lease with option to purchase?

    • Tracy Z says:

      Hello Ed Lee,
      There are some situations that don’t include the Contract for Deed or Lease Option but the implementation can vary by state and the specifics of the transaction so I’d have to suggest talking to a good real estate attorney in your state.

      Thanks for reading and commenting at NoteInvestor.com!

  2. Government needs to get out of our way, they react to problems and create more problems.
    The Dodd/Frank act is a disaster not a solution.

    Who is John Galt?
    Currently I am reading the novel Atlas Shrugged by Ayn Rand this book explores how society collapse because of government increasingly asserts control over all industry and where leading innovators, ranging from industrialists to artists, refuse to be exploited by society. In their efforts, these people “of the mind” hope to demonstrate that a world in which the individual is not free to create is doomed, that civilization cannot exist where people are slaves to society and government, and that the destruction of the profit motive leads to the collapse of society.
    Go read the book or see the move it will blow your mind in comparison to what is happening.

    We all need to make sure our voices are heard.

  3. I agree with Ken Gold above, the Dodd/Frank act is a disaster all around! If you think that these rules are affecting just the Housing industry, you should see the problems it is creating on Wall Street!
    This legislation is ridiculous. It is a knee-jerk reaction to what we have just gone through, and should be repealed, analyzed and re-written. It will affect too many industries in a negative fashion. Just the implementation of these rules have come under fire lately, much less the can of worms that it will open down the road. Entire divisions of brokerage houses have had to close down, and business models changed.
    There is no reason to take this lying down. All of the industries affected should band together, to eliminate this stagnant chain!

  4. Ric Thom says:

    Some people are missing the point in their comments. I have seen where people have said the Truth-in-Lending Act only applies to businesses, not Ma and Pa, and that seller financing will not be affected by the new proposed rule on the buyer’s ability to repay. It doesn’t make any difference if it does or doesn’t. On July 21st the Federal Reserve will be passing comments on the rule to the Consumer Financial Protection Bureau along with its authority to create the final rule for Truth-in-Lending. The Bureau will then also have the authority to create new rules for seller financing. You’re only allowed to offer seller financing for no more than 3 properties in a 12 month period if you meet certain conditions. One of those conditions is that the “loan meets other criteria set by the Federal Reserve Board” who is passing that authority to CFPB. There is nothing to stop CFPB from saying, “Let’s don’t reinvent the wheel when it comes to the buyer’s ability to repay and seller financing. Let’s just use the rule we use to define ability to repay under the TILA”. I feel it is essential that we send our comments speaking out against using any portion of this proposed rule on the ability to repay when it comes to defining the standard on seller financing to the Federal Reserve Board so they get passed on to CFPB.

    When the SAFE Act came out it was unclear whether or not you could use seller financing on property other than your personal residence. I was told by a regulator that HUD was stunned by the 5000 comments we all sent. Their final rule says you can use seller financing on any of your properties. We need to make sure that CFPB hears our concerns before they consider what the new standard for the ability to repay will be under seller financing.

    • My comments were intentionally brief. When I said “Good to know”, I meant that it was good to know there are fine people like you out there fighting for the little people like me and my husband. When my husband first approached me with the idea of real investing, I was terrified. I didn’t realize that it was a viable means of earning income or wealth-building for everyday people like us. Now I learn (just as I’m learning how) that over on “the other side”, people are working hard at coming up with all kinds of rules and restrictions to control the private lenders who don’t need to controlled! I’m not a genius lawyer but I do understand basic contractual arrangements. I don’t see the need for introducing unnecessary and unclear regulations. Who is that helping?

  5. The Dodd-Frank act is a disaster for the housing industry as well as the Note industry. I would suggest that Note Investor pen a letter to the Senate and House members that all your readers could (if they desire) send to their Senators, Representatives, and White House, via a link. NAR recently used this method (Call To Action) to bring to their notice the expiring Flood Insurance program.

    • Hello Ken,

      I am not a big fan of form letters as I feel comments are more meaningful when they share the unique perspective of the writer. However, I also know that people are busy and it saves time to start with something. Ric has shared his comments so that others could use as needed. I am also happy to share my comments submitted to the Federal Reserve Board on this matter as follows:

      Seller financing is an important option that allows average people to buy and sell homes without the expense of a traditional bank loan. This option is especially important in a down real estate market.

      Over the past 20 years I’ve seen seller financing provide a solution when either the buyer or the property did not qualify for a conventional mortgage.

      *The retired couple needing affordable housing.
      *A single mother wanting a safe haven for her children
      *The rural homeowner buying a small home with a few acres where banks don’t lend.
      *And now more than ever, the buyer with a few dings on their credit that the banks just won’t consider unless their score is 750 or better.

      We must preserve basic property rights by enabling buyers and sellers to continue using seller financing. It was a great first step to specifically exempt seller financing from the mortgage loan origination laws (up to 3 per year) as outlined in the Dodd Frank Act. However, we need greater clarification.

      It appears 3 seller financed transaction are exempt within a 12 month period provided they meet Title X1V Section 1401 (2)(e) which states:

      1. The seller did not construct the home to which the financing is being applied.
      2. The loan is fully amortizing (no balloon mortgages allowed).
      3. The seller determines in good faith and documents the buyer has a reasonable ability to repay the loan.
      4. The loan has a fixed rate or is adjustable after 5 or more years, subject to reasonable annual and lifetime caps.
      5. The loan meets other criteria set by the Federal Reserve Board.

      Of particular concern is requiring a seller to underwrite a buyer’s ability to repay under the same standards that are set forth for lenders in the Truth and Lending Act. How is the average seller able to determine a buyer’s ability to repay? How will they know if the seller financed note meets all other criteria set by the Federal Reserve Board. And if they don’t, does the buyer have the opportunity to rescind? Will unscrupulous buyers take unfair advantage of sellers that are unaware of these rules? Will investors stop buying these notes on the secondary market for fear the seller did something wrong?

      Another concern is the requirement for a loan to be fully amortizing. Most sellers do not want to wait 30 years to receive payments, especially if they are in retirement years. It seems reasonable to allow a provision for a 5, 7, or even 10-year seller financed balloon mortgage to still be exempt. This provides protection for the buyer and the seller.

      We’ve all seen the devastation from excess lending and understand reform is necessary. However it was NOT seller-financed transactions that caused the sub prime lending meltdown. The only seller financing transactions at risk of crossing these boundaries are the professional sellers and the Act already covers this by making it apply to more than 3 per year.

      Saying seller financing is exempt if it meets loan criteria set by the Federal Reserve Board in essence takes away the exemption. Please help preserve private property rights by not including seller financing in any mortgage loan origination laws, provided a seller does not exceed the limit per year.

      Sincerely,

      Tracy Z. Rewey

      Of course I’d love for them to exempt all owner financing regardless of the number per year however, that is highly unlikely as lawmakers feel it is a loophole that needs to be closed. Hopefully our voice will be heard!

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