The Dodd-Frank Act took effect on January 10, 2014 and changes the rules for seller financing for those not qualifying as exempt.
The most relevant changes are:
- Requires every lender to consider the borrower’s ability to repay the loan.
- Requires that lenders consider at least 8 factors applied against reasonable underwriting guidelines.
- Lender must write a “qualified loan”.
- Requires lenders to wait at least 120 days of delinquency before foreclosing.
- Dodd-Frank combined with the SAFE Act in the various states, will require all owner finance transactions (except the exceptions) to be originated by a Residential Mortgage Loan Originator.
- Prohibits builders from selling with owner financing.
- Eliminates balloons and negative amortizing loans and requires fixed rates for 5 years with no prepayment penalties.
- Sellers who sell with owner financing more than 3 times a year will become mortgage originators and must comply with Dodd-Frank.
- No forced arbitration clause is allowed in the buyer’s note.
Questions & Answers
Q. What information am I required to get from buyer to prove their capability to pay? Subtitle B. Section 1411
A: At a minimum, creditors generally must consider eight underwriting factors:
- Current or reasonably expected income or assets
- Current employment status
- The monthly payment on the covered transaction
- The monthly payment on any simultaneous loan
- The monthly payment for mortgage-related obligations
- Current debt obligations, alimony and child support
- The monthly debt-to income ratio or residual income and
- Credit history
Creditors must generally use reasonable third-party records to verify the information they use to evaluate the factors.
Q. What is a qualified loan?
A: A qualified loan:
- Cannot have a negative amortization
- Cannot have a balloon payment
- Must be for 30 years or less
- Cannot have prepayment penalties in excess of a schedule set out in the regs
- Can be a variable rate, but the underwriting must be best on the highest interest rate it can be during the first five years.
- The creditor must verify income and assets and debts through 3rd party reports
- The creditor need not verify employment status per se, monthly payment per se, or simultaneous loans except as they fit into the debt to income ratio
- The creditor need not verify credit history, but as a practical matter will do so as part of determining the debt to income ratio.
Q. What is the 120 day rule?
A: Loan servicing regulations in Dodd-Frank require the loan be delinquent for 120 days before you can begin a foreclosure. You must engage in lost mitigation, loan modification, etc. and can’t do any kind of foreclosure action while the loan modification is pending.
Q. What makes me a mortgage originator? How do I become an exception as home seller?
A. The rules define a “loan originator” as a person who, for or in expectation of direct or indirect compensation or other monetary gain, performs any of the following activities:
- Takes an application, offers, arranges, assists a consumer in obtaining or applying to obtain, negotiates, or otherwise obtains or make extension of credit for another person” OR
- Represents to the public through advertising or other means that such a person can or will perform any of these activities. A “loan originator” includes individuals and organizations, as well as an employee, agent or contractor of the creditor or loan-originator organization. A loan originator may include an independent mortgage broker or a bank loan officer. Therefore, if you “make an extension of creditor for another person” you are a mortgage originator. As a selling homeowner who is going to do seller financing, you can be considered a mortgage originator. The only exception that applies to a home seller under the rules is someone who only “originates” 3 or fewer loans a year.
Under TILA, any person who originates 2 or more mortgage referred to in subsection (aa) of this section in any 12 month period or any person who originates 1 or more such mortgages through a mortgage broker shall be considered to be a creditor for the purposes of this subchapter. However, this is different than mortgage originator.
Q: Since balloon payments are not permitted, are there any provision allowing interest rate or rise each year? Must it be fixed for five years before increase? How much can it increase?
A: Those restrictions apply if you are trying to fit under the exclusion to the originator rule as a seller financer. Once you are doing more than 3 loans per year per person/entity, all the provision of Dodd-Frank apply. Therefore, once you want to be incompliance, you must comply with all the regulations.
The qualifying exclusion restriction on adjustable rates is that they can only adjust after five years, and must have the margin tied to an index such us LIBOR. Additionally, they must have “Reasonable” annual and over the life of the loan limits. It appears that number is a maximum 2% annual and 6% lifetime of the loan increase.
Q: How do I become exempt from Dodd-Frank?
A: Don’t originate more than 3 seller financed deals per year in any entity you control. Commercial deals are exempt, loan to non-owner occupied buyers are exempt, and if buyer and seller are entities, it’s exempt.
Q: If I become an exception, does any of the law apply?
A: Yes! You must still meet the following criteria:
- No balloon
- Interest rate fixed for 5 years
- You qualify your buyer
Q: What must I do or not do to buy and sell with owner financing?
A: Buyers are the ones receiving the protection, and therefore none of this applies. Sellers who sell with owner financing more than 3 times per year will become mortgage originators and must comply with the requirements of Dodd-Frank. So, if your entity sells more than 3 per year, you must comply with all the rules.
Q:Can I do 3 deals each in different entities if I control all? Subtitle A, Section 1401
A: The entity control question is more complex. If the same person controls multiple entities, then the rules may apply; however, there is no clear distinction in the Act as it does not address this issue. We believe you may own several entities doing up to 3 deals and comply with the exemption.
Q: What is the penalty if I don’t comply with Dodd-Frank and I’m not exempt?
A: Any borrower on a consumer loan secured by real property has 3 years to bring suit against a lender for failing to consider the borrower’s ability to repay the loan.
If they succeed, the borrower is entitled to EVERYTHING THEY PAID THE LENDER FOR THE PREVIOUS 3 YEARS plus attorney fees, costs, etc. At any time after the loan is made (3 years or not) the borrower may bring this as a defense in set off to any foreclosure action and recover the previous 3 years of payments!!
Q: We sometimes do 10 year lease options when homes are over-leveraged. Will this be considered as owner financing? If so, how can we fix it?
A: A 10 year lease option may fall under Dodd-Frank if it can be construed as a seller financed transaction. Lease options are considered loans if the “renter/borrower” is attempting to build equity in their primary residence. One has to be careful of how the lease options are structured to make sure there’s no equity buildup or other terms that would make it qualify as a sale. The IRS may consider a lease option with a 3 years term as a sale, but this should not be confused with Dodd-Frank.
Q: Is a private money loan considered a security under SEC rules?
A: Correct. In general, under the securities Acts, promissory notes are defined as securities, but notes with a maturity of 9 months or less are not securities. Securities Act § 2(1), 3(a)(3); Exchange Act § 3(a)(10). Likewise, the US Supreme Court sets a rebuttable presumption that a note with a maturity over 9 months is a security unless it resembles a type of note that commonly is not considered a security. Reves v. Ernst and Young, 110 S. Ct. 945 (1990).
The US Supreme Court in Reves recognizes that most notes are, in fact, not securities. The Court provides the following list of notes that are clearly not securities, irrespective of their maturity. Notes that fit into any of these categories are not securities:
- A note delivered in consumer financing.
- A note secured by a mortgage on a home.
- A note secured by a lien on a small business or some of its assets.
- A note relating to a “character” loan to a bank customer.
- A note which formalizes open-account indebtedness incurred in the ordinary course of business.
- Short-term notes secured by an assignment of accounts receivables.
- Notes given in connection with loan by a commercial bank to a business for current operations.
Disclaimer: It has not been proven, if in fact, a private money loan is or is not a security as there is a lot of dissention on the subject. Our interpretation is that it is not a considered a security based on the statutes above. No representations can be made on how any state or federal court will interpret the regulations or apply them. And that said interpretation or application may be different from this analysis of the law.