Seller Financing is About to Get Ugly on January 10

Seller Financing is being squashed by Dodd Frank
Seller Financing is being squashed by Dodd Frank

In 3 months private seller financing will come under the control of the Empire, err… actually the Consumer Financial Protection Bureau (CFPB).   Congressmen Dodd and Frank in their zeal to protect the public from unscrupulous lenders have burdened every real estate investor who engages in seller financing with new regulations that will ultimately feel like 10 additional gravities weighing upon their investing.  If you are not aware of this legislation, it essentially removes the real estate investors’ ability to self-finance the sale of real estate without becoming a licensed mortgage loan originator.  Here is how it works.

  • John recently purchased a mobile home park that included 10 vacant mobile homes in the purchase.  Desirous to monetize his investment, John advertises the mobile homes for sale and begins filling them quickly with his attractive financing.  John offers each purchaser a mobile home for $500 down and the remainder amortized over 20 years at 6% interest with a balloon payment in year 5.  John sells all his mobile homes within 3 months and his park is fully optimized.
  • Kevin builds small single-family homes in Missouri.  Kevin typically sells his homes to buyers who are rebuilding their credit due to a recent foreclosure or do not have the necessary 15% down to qualify for a traditional loan.  After Kevin sells a home he will sell the note to various note buyers.  Kevin’s loans are typically written with a 30-year amortization, 7.5% interest, 5 points, and a 5-year balloon.

Both Kevin and John have problems under Dodd-Frank.  John is selling mobile homes for between $10,000 and $15,000 each.  This is a win-win for both parties.  The purchaser can get into a home for under $170 per month and John can fill his park.  Under Dodd-Frank, John can no longer sell more than 3 mobile homes a year if he seller finances without becoming a licensed mortgage loan originator.  Even if John is willing to limit his seller finance to 3 mobile homes a year, John is in violation because he cannot offer balloon loans terms with a 30 year amortization to keep the payments low.  Dodd-Frank has placed a stranglehold on John’s mobile home park investing.

Kevin has far more problems under Dodd-Frank than John.  For Kevin, his investing career is over unless he can come up with a new strategy to sell homes to distressed buyers.  Under Dodd-Frank, Kevin is prohibited from seller financing any home he has constructed, or acted as a contractor for the construction of in his ordinary course of business.  Assuming Kevin is able to work around the construction issue with the use of related business entities, his note buyers are all but guaranteed to dry up because Kevin can no longer offer terms that contain a balloon payment.  It will be very difficult for Kevin to find investors who are willing to tie up their money for potentially 30 years or find buyers who are willing to take a shorter fully amortizing loan i.e., 5 year loan with monthly payments of $3,200.

Dodd-Frank is definitely going to have a significant impact on real estate investors who seller finance.  In addition to the individual problems faced by Kevin and John, if either finances more than 3 homes in a year they could fall into the mortgage originator category, which requires licensing with their state.  If this occurs then Kevin and John will need to ensure their buyers/borrowers have the ability to repay the loan i.e., the borrower cannot be using more than 43% of his income to service all of his debts including your loan and all points and fees cannot exceed 3 points.

However, all is not bleak.  Dodd-Frank only applies to property that includes a dwelling that the buyer is going to reside in. There are no new rules that affect seller financed transactions for vacant land, commercial property, multi-family and single-family residence where the buyer does not plan to move into the property.  (When dealing with an investor who does not plan to move into the property it would be prudent to obtain a written declaration from him stating as much to protect yourself from possible future claims.)  If you are wondering why this is important consider the penalties for violating Dodd-Frank are onerous.

Case in point is the fact the CFPB is run by Richard Cordray, former Ohio State Attorney General who is well known for his strong consumer protection stance.  As Ohio State’s Attorney General, Mr. Cordray was very litigious when it came to allegations of wrongdoing involving the consumer.  His atmosphere of enforcement is already apparent with the release of a 4-digit phone code consumers can use to access the CFPB for purposes of filing complaints.  If you are found in violation of Dodd-Frank the penalties can range from double statutory damages to an affirmative defense to foreclosure actions i.e., you won’t be getting the property back if your borrower stops paying the mortgage.  Dodd-Frank is ultimately going to give your borrowers leverage over you if you are not in compliance.  Thus, as an investor you must be aware of its reach and follow the rules or else consider becoming a licensed mortgage loan originator.

Here is a recap of some of Dodd-Frank’s restrictions on private seller financing of residential property scheduled to take effect on January 10, 2014:

  • The seller cannot have constructed the home.
  • The loan must be fully amortizing. No balloon payments are allowed.
  • The seller must determine the buyer has reasonable ability to repay the loan.
  • The loan must have a fixed interest rate for a minimum of five years.
  • The loan must meet criteria identified by the Federal Reserve Board i.e., the rules will continue to change on you.

For further clarification and interpretation please contact the Consumer Financial Protection Bureau at (202) 435-7700 or via email at CFPB_reginquiries@cfpb.gov.

 

UPDATE as of January 1, 2014

The CFPB recently released revised their interpretation to allow a person to seller finance one property a year and the loan does not have to be fully amortizing.

60 comments On Seller Financing is About to Get Ugly on January 10

  • I just shared a link to the blog with this article. This will be an important topic and one that training would be beneficial for some mastery and inner circle students.

    Mike Guess 503.327.5476

  • Clint, since some of us are using a TRUST what are your thoughts of financing the beneficial interest of the trust. Now that it is personal property.

    • Jon,

      Most likely this would fall under Dodd-Frank because a person could argue the substance of the transaction was the indirect purchase of real estate. Assume a home buyer purchases your trust and you carry the note. If the intent was to purchase personal property then the interest on the loan would not be deductible to the purchaser. Real property interest is deductible and I would assume the purchaser would take a deduction for interest paid. There is also the issue of securing your note against the trust assets. I doubt many investors would be willing to sell a land trust without securing it against the property held within. Overall it is most likely a sale of real estate rather than personal property.

      • I disagree on the Trust. The IRS only requires it be ‘secured debt.” to be deductible. You can secure the debt with a recorded Financing Statement on the trust interest which is personal property. Here’s the language from the IRS publication 936. “Secured Debt

        You can deduct your home mortgage interest only if your mortgage is a secured debt. A secured debt is one in which you sign an instrument (such as a mortgage, deed of trust, or land contract) that:

        Makes your ownership in a qualified home security for payment of the debt,

        Provides, in case of default, that your home could satisfy the debt, and

        Is recorded or is otherwise perfected under any state or local law that applies.”

        Your thoughts/comments?

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  • Clint,

    Would a Lease with an Option contract be the way around this new law? Or will lease options be interpreted as Seller Financing?

    • Sean,

      Until the option is exercised it will not fall under Dodd-Frank. That being said, I have reviewed some lease options that are disguised sales and most definitely would fall under Dodd-Frank. An example of this might be where all of the lease payments are deducted from the sale price if the lessee exercises the option.

      • Clint,

        I have a couple questions;

        I assume that any seller financing done in the past is grandfathered in?

        Your earlier statement; “if either finances more than 3 homes in a year they could fall into the mortgage originator category, which requires licensing with their state” Would that be 3 homes per state?

        Instead of, Contact for Deed/Land Contract/Options, (and already sold 3 homes in the same state) rent for say.. 60mths then gift/quit claim deed the home to them?

        Thanks

        Brett

        • Brett,

          Yes you are grandfathered for past SF deals.
          The rules is 3 homes per year not per state.
          You could but if it is a disguised sale then you will still fall within Doff-Frank. Why not run 3 deals per LLC?

  • Clint,
    Very helpful article. Thanks for sharing.

    I shared it with my blog and E-Newsletter list on 10/29, and I made some additional comments from the perspective of adapting as a real estate investor.

    I look forward to sharing more in the future.

    Chad

  • Great phone call / conf today. Thanks Clint.. Can you put up the replay URL?
    I do owner financing in GA a few a year so 3 per entity per year is not a problem.

    There’s a requirement in D-F that the lender get and pay for an appraisal by a 3rd party at no cost to the borrower. Do you feel this is needed for a QM qualified mortgage that you can go out side of QM and NOT get an appraisal and use a LMO and be D-F compliant?

  • Most regulatory laws are not designed so much to speed things up or improve, but to limit the fallout of bad choices. While the two examples are unfortunate, the goal of the changes is prevent a worse recession. I don’t agree with the changes, as a Realtor, I want more sales activity. But as a taxpayer, I get it.

  • I see the comment re 3 deals a year. Something this complex is going to have mis-interpretation and wrong info. I’m hearing that if you do less than 3 owner financed deals a year, no LMO or Dodd Frank impacts, which my reading believes to be not true. Can someone clarify the impacts to the <= 3 deals a year folks like me?

    My plan is: to assume my loan is not a QM, use a LMO, qualify to <= 43% DTI, verify income and debts, keep the paper work, no prepayment penalty, low / no points, < 9.5% interest rate.

    I'm looking for LMO's in GA.

    • Curt,

      If you do less than 3 you do not need to be a LMO provided you meet the lending requirements i.e., no balloon, 30 year am, did not build, etc..

      • Tnx Clint, I emailed the CFPB and they emailed this link to me:

        http://files.consumerfinance.gov/f/201311_cfpb_updated-sticker_lo-comp-implementation-guide.pdf [Page 22 discusses seller financiers.]
        Which I think is where your quote came from. I’m an investor, owner financer so I would be “using” an LMO not considering “being” one. So these CFPB docs intermix being the lender context with being the borrower, being an investor so keeping the context and rules straight is a problem. My question was from the context of being a real estate investor doing a few owner finance deals a year. My guess is that I have to use an LMO because my mortgage does not meet QM, it’s high cost due to interest rate in the 9% range which is within 6% of the floating prime.

        What’s the added requirements if you sell via owner financing and your interest rate is above 10% say?

  • I wish the reply audio link to Clint’s conf call would be posted?

  • What if I rehab houses, sell for appraised value, at 7.75% interest amortized 30 yrs. But my bank demands no more than a 5 yr mortgage from me. So I assume since I have a balloon – I cannot do so, if I work around that and have 5 different companies doing same thing – do I get 3 per company as the company actually holds title.

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  • Reblogged this on Roosevelt Goodman and commented:
    Interesting information. Comments anyone?

  • There are other opinions about this; some say you can hire a licensed mortgage loan originator to pull to take the apps, pull credit, and qualify the buyer’s ability to pay.

    Others say that a series LLC could be used to stay under the 3 house limit by forming a new series for every 3 homes sold…although I have my doubts about this theory.

    Still others put together a group of non-related “Self-Directed IRAs” and simply do 3 in each every 12 months.

    The fact is…the government is making it very hard for honest people to help renters own their own home. I thought the courts we’re suppose to punish the bad guys. Instead, our government is punishing everyone because of a few bad guys. Or perhaps our government has a another agenda all together? It’s starting to smell like they want the housing industry to ad to the newly acquired college loan, auto industry and Banking industry portfolio.

    A common socialistic plan is to over regulate an industry, and when it fails, blame the capitalistic owners. Then, send the government in to take over said industry because, “They can fix it.”
    Which they can’t and won’t.

  • I think you might have missed a requirement, which is that mortgages cannot be “High Cost”, which seems to be market rate with good credit (4.5%?) plus 6 percentage points or you trigger additional loan requirements.

    • Jeff,

      Any consumer loan secured by the consumer’s principal dwelling can be a high cost mortgage if it meets any one of three independent triggers: either a) the “fees and points” will exceed 5% of the total loan amount on loans of $20,0000 or more or b) the “APR” is greater than 6.5% greater than the average prime rate, or c) the lender can charge a prepayment penalty more than 36 months after the loan or a prepayment penalty exceeds 2% of the amount prepaid.

      • Got-it, “can” be high cost. Clint and other’s: if high cost what must we do to comply? My understanding is:
        – use a loan originator
        – 3rd party appraisal at no cost to the buyer.
        – DTI of 43% or better.
        The requirement of using a servicer I don’t think is triggered by high cost???
        Just to round out my understanding,,, if a loan is not high cost, and I can’t imagine an investor creating a mortgage that won’t be high cost because of the low trigger ceiling for interest rate of 4.5% + floating prime, but if by chance the mortgage is NOT high cost what steps might we not have to do? If we do more than 3 per year, VS if we are do less than 3 per year (per entity). I think this is the scenario we need to understand.

  • Typo: interest rate trigger is as Clint said: 6.5%+week’s average prime.

  • I understand that offering rent credit can subject a Lease-Option contract to Dodd Frank rules. But what about the money paid for the option? If, in the paperwork, that is credited to the purchase price, would that connection subject the transaction to Dodd-Frank rules?

    • A lease option is subject to Dodd Frank if any part of the option or agreement helps the tenant build equity in the property. If the payment of the payment of the option is not credited toward the purchase price you are in safe territory. If the option payment is credited toward the purchase price the issue is less clear. I would argue that this is not subject to Dodd Frank because the nature of the transaction does not build equity for the tenant during the term of the lease. Great question.

  • I think if a natural person, estate or trust engages in only one such transaction in any 12-month period, you do not have to comply with the fully amortizing requirement. There just cannot be negative amortization, and the interest rate must be fixed or 5-year adjustable. And you do not need to reasonably determine buyer’s ability to pay. So an individual who wants to sell one residential property to renters on contract can have an 18-month balloon via refinance if interest rate is fixed.

    See link at pages 22-23: http://files.consumerfinance.gov/f/201311_cfpb_updated-sticker_lo-comp-implementation-guide.pdf

    Full amortization and assessment of buyer’s ability to pay seem to be required only with respect to those engaging in up to three such transactions per year. Interesting area here . . . thank you for your assistance and please do correct me if I am wrong.

  • Can you please tell me what the restrictions are for owner financing when the owner occupier sells and finances to another owner intending to occupy the property. Is the minimum term really 30 years? What are other restriction one needs to look out for in this scenario?

    • Wilson,

      If all you are doing is seller financing and you only engage in one transaction then the only requirements you must abide by are as follows:
      The loan must not result in a negative amortization loan; and
      the interest rates fixed or adjustable after 5 years

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  • I have been researching alternative financing to purchase my first home and came across this article. Let me first say my knowledge is little on Dodd Frank and other fine details please bare with me! I do not have the credit to obtain a typical bank mortgage and I have found a house that is currently being rented that the owner wants to sell (lease is up in Oct. 2014) I had not yet asked if she would be willing to seller finance, I wanted to educated myself on the benefits that would make her say yes. I pretty much had it all worked out until I seen this article ($95k sale price 5k down 5%interest for 8yr loan earning her almost $20k in interest) but based on this article she would not even be able to say yes because its only an 8yr loan? If that is correct if I were to have something like a private lender (or a rich uncle haha) just by the house from her and I pay them back more like personal loan would that still be subject to the new rules or is that closer to fraudulent transaction? Thanks for anyones help!!!

    • Michelle,

      If this is the only property the seller is going to seller finance then the loan can have a balloon and/or be adjustable after five years. The loan does not have to be for 30 years.

  • Dodd Frank describes high cost mortgage with several measures, one being the interest rate being > 1.5% over floating prime. Then it mentions 6.5% over floating prime but what context and to what effect on the investor lender? IE if I want to charge 11%, on a $80k loan on a owner occupied house, 30 yr amortizing, what does that mean for my ATR, LMLO etc requirements? If DTI is <= 43% then is ATR satisfied? What does being over 6.5% over floating prime really mean?

    • Hi Clint can you comment on my question about: so what about mortgages to owner occupants with interest rates over 6.5% over floating prime. Does DF say interest rates over 6.5% over floating prime are not permissable or just some other steps are needed? IE low dollar amount loans (<$45k) are in this camp.

    • Curt,

      I am only aware of the 6.5% over floating prime. If you charge more then it is considered a high cost mortgage and you will need to abide the restrictions contained in Dodd-Frank when offering this type of loan.

      • Thanks Clint. Which my understanding re high cost mortgate is until I read otherwise: is that I must use a LMLO to verify ATR. Recent CFPB (I believe) clarifications have said that 43% can be exceeded as long as the lender verifies ATR. Which to me is too fuzzy to understand what it is I have to do besides use a LMLO and pick some DTI per my lending standards.
        Ok my take is to ideally qualify via a LMLO to 43% or not much higher, keep all doc for 5 yr. Set interest rate ideally at 9.5% (6.5% over floating prime). I don’t plan on going over 9.5% even for low dollar amount loans (<$45k) just to play it safe.

  • HI can someone answer my question please i do owner fianance 4 to 5 propertys a year with my LLC ( bond for title ) and all my houses are under 50k each with a 2k down and a 15 year term fix rate at 10% . i have sold 1 house owner fianance in january , so i want to sell the second one today my attorney said that i can not do it anymore . i have been helping low income people for 13 years to own theire house with no credit . Is my attorney wrong? can i still owner fianance 3 propertys a year? or just rent them. Or sometimes i started thinking why buy them at the first place.
    Thanks in advance.

    • Hakim,

      He is correct. Further, your loans would be considered high cost mortgages because of the interest rate you are charging. To fall within the 3 property exception you must not charge more than 6.5% over the floating prime rate. The current rate is 3.25% thus your maximum interest rate for you loan is 9.75%.

      Solution. Use a licensed mortgage originator to handle your loans or perform 3 loans per LLC and do not charge over the acceptable interest rate.

      • Thank you so much that helps a lot can i raise the prize of the property and drop the rate to under 6% . because all my propertys are under $400/ month for 15 years fix rate with 5% down .
        Thank you again you are a lotoff help.
        Hakim.

  • Also i forget to mention my attorney will have a answer this monday about a intrest free with no ballon .
    Thanks Hakim.

    • Hakim, Heres my understanding for you do research. I believe interest free loans are a fiction. The IRS will assign what’s called emputed interest which today is around 3.2% to such a loan and tax accordingly (admitadly only if you are audited). It’s still a loan to an owner occupant and is covered by DF if this is your scenario.

      • Thank you so much you are the best i understand everything after your radio talk you should run for our President iwill vote for you.

  • HI just cameback from my attorneys office and he said that in SC anybody cane owner fian 5 propertys / year . but not LLC .
    Thats in South Carolina.
    Thank you.

  • Clint, in Oregon the only entity form they will recognize to do a SC without a MLO is a trust that was formed for your family. I guess I really don’t get why you wouldn’t hire a MLO and do a dozen sales a year. The buyers are always ready to pay fee’s to buy a house, it is no different than getting a loan at a bank or thru a mortgage broker.

  • My understanding is that a loan originators license IS required on vacant land if the consumer buyer intends to build a 1-4 family residential structure (includes mobile homes) on the property.
    So, if they are buying that land for hunting or four wheeling – the originator doesn’t need a license. However, if the borrower is a consumer and even intends to build that dream home a license is required.
    DISCLOSURE: I am not an attorney and don’t pretend I know this for sure. It is just my understanding. Please consult your attorney for confirmation.

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  • I am a CA real estate broker selling a CA BUSINESS with seller financing secured by a trust deed on buyer’s CA home, with the note & TD prepared by the escrow.
    Note is fully amortized 5 year, 10% note (slightly higher APR, because buyer is paying for appraisal, title insurance & buyer’s-side escrow costs).
    Trust deed will include prepayment for the entire 5-year life of the note @ 80% x 6 months interest on the balance at payoff.
    Trust deed will include a due-on-alienation clause.
    My understanding is that outside Dodd-Frank and the SAFE Act, and that no loan disclosures (APR, etc.) is required.
    Nevertheless, I still want to hire a CA broker with an NMLS # to handle the loan because of my lack of knowledge about owner financing.
    Can anyone direct me to someone licensed in CA willing to do this?
    Thanks!
    Terry

  • Hi Clint or others who have an opinion.

    2 nationally known LMLO’a assert that use of an LMLO on an investors seller financing allows under dodd Frank and CFPB an unlimited number of financings per year.

    Can anyone comment? With Links To Statute or CFPB guidelines or clarifications?

    There’s investors patterning with these LMLO’s and selling their courses on no banks unlimited number of deals per year financing properties to occupants.

    I’ve not found support for investors as a mater of course of doing business of serial seller financing being within the current regulatory realities. Any facts?

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