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.