Seller Financing Pitfalls under Dodd-Frank and Consumer Financial Protection Bureau Regulations

By: William S. Kramer

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) created new regulations designed to protect consumers of mortgage loans.  In 2013, the Consumer Financial Protection Bureau (“CFPB”) was established to implement and enforce the Dodd-Frank rules in the mortgage industry.  The CFPB regulations went into effect January 10, 2014.  Several possibly unintended compliance issues have been created for seller financers who are not regularly in the business of making loans.

Historically, sellers of real property have, on occasion, offered to provide seller financing or take back mortgages in order to incentivize buyers to purchase their property where traditional institutional financing might not be otherwise available or convenient.

We are now moving into an era where many so-called investors (real estate dabblers) who were fortunate or opportunistic enough to have purchased real estate during the recession are in a position to sell those properties at a profit.  Combined with the continued difficulty buyers face in obtaining financing (notwithstanding the improved economy) many sellers wish to offer seller financing.  However, the Dodd-Frank and CFPB rules and regulations require sellers who wish to provide owner financing in even a single transaction to comply with Dodd-Frank.  The “catch” under Dodd-Frank is that a “mortgage originator” includes anyone who performs activities related to the origination of a residential mortgage loan, including offering or negotiating terms of a residential mortgage loan.  A “residential mortgage loan” means any consumer credit transaction that is secured by a mortgage on a dwelling or on a residential property that includes a dwelling.  A “dwelling” is a residential structure that contains 1-4 units.  This picks up virtually all individual residential transactions.  This means that seller financers must be licensed mortgage originators unless they qualify for an exclusion.  Unless a seller qualifies for one of the seller financing exclusions, the seller or buyer will need to engage a licensed loan originator to facilitate the financing.  Of course, licensed loan originators are typically only able to offer financing on more restrictive terms than could be offered under the seller-financing exclusions.  There are two primary exclusions:

One Property Exclusion

If the seller is only financing the purchase of a single property in any 12-month period, the following qualifications must be met:

  1. The seller must be an individual, trust or estate – corporations, LLCs, partnerships or other entities do not qualify.  The property must have been owned by the seller and must serve as security for the loan.
  2. The seller must not have constructed or acted as a contractor in the construction of the residence.
  3. The terms of the loan must meet the following requirements:
    • The financing must have a repayment schedule that does not result in negative amortization – this does not require the loan to be fully amortizing, meaning that a balloon payment can be a component of a one property exclusion loan.  This is a significant difference from the three property exclusion.
    • The loan must have a fixed interest rate or an adjustable interest rate that remains fixed for the first 5 years.

Three Property Exclusion

This exclusion is for sellers who finance the purchase of 3 or fewer properties in any 12-month period.  In order to qualify:

  1. The property must have been owned by the seller and serve as security for the loan, however, the seller may be an individual, trust, estate or other entity.
  2. The same restriction regarding construction and/or acting as contractor applies.
  3. The terms of the loan must meet the following requirements:
    • The loan must be fully amortizing.  Balloon payments are not permitted.  Accordingly, unless the seller is willing to hold a mortgage for the traditional loan term of 25-30 years, the payments under a 5 or 10 year amortization schedule are usually too high to make this a feasible financing option.
    • The seller must determine in good faith that the consumer (buyer/borrower) has a reasonable ability to repay – this essentially means that the seller needs to take into account the typical “ability to repay” factors similar to the exercise undertaken by traditional mortgage originators.
    • The loan must have a fixed interest rate or an adjustable rate that remains fixed for at least 5 years, must be tied to a widely available index such as U.S. Treasuries or LIBOR and may not have annual or lifetime increases in interest rate more than 2% points and 6% points, respectively.

Accordingly, occasional sellers of residential property who seek to provide seller financing, whether for convenience of the buyer or to provide an ongoing income stream, need to be cognizant of and very careful with respect to the Dodd-Frank and CFPB regulations governing seller financing in residential transactions.

The material appearing on this blog is meant to provide general information only and is not a substitute for nor is it legal advice to you.  With regard to specific law issues, readers of this article should seek specific advice from legal counsel of their choice.  Articles may not be reprinted without the express permission of Brinkley Morgan. 

Remember that the hiring of a lawyer is an important decision that should not be based solely upon advertisements.  Before you decide, ask us to send you free written information about our qualifications and experience.

By |2017-03-13T13:31:09-04:00March 5th, 2015|Blog, Real Estate|