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The SAFE Act and the Dodd-Frank Act

By: Charles E. (Chuck) Sutherland

You should be aware that seller financing is not as simple as it used to be. There are new restrictions imposed by enactment of both the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (“SAFE Act”) and the Dodd-Frank Act. But there is “light at the end of the tunnel” as I will show in this chapter. [Please understand that I am not an attorney, CPA, or Certified Financial Planner. Please consult with your own professional advisors in any use of this information.]

The SAFE Act

The SAFE Act requires state-licensed mortgage loan originators (MLOs) to meet certain licensing, compliance, and underwriting requirements. Furthermore, the act requires that all state-licensed MLOs register with the Nationwide Mortgage Licensing System & Registry (NMLS). The individual states have enacted their own regulations to regulate mortgage lending to comply with the act.

One key thing to remember about the SAFE Act: anyone who engage in the activities of a loan originator” could be determined to be one. The SAFE Act defines an MLO as an individual who takes a residential mortgage application and offers or negotiates the terms for compensation. The Regulation Z rule defines “loan originator” slightly differently as a person who performs any of the following activities for compensation: takes an application; or offers, arranges, or assists a consumer in obtaining, applying, or negotiating an extension of consumer credit; or advertises that they’ll perform the activities described above. (Source: http://news.cuna.org)

Those definition of a mortgage loan administrator leave owners vulnerable in providing seller- financing. Under the SAFE Act, there is exclusion for up to five seller-financed transactions in every 12-month period under certain criteria. A seller financing the sale of his or her own property could also completely avoid the issue of licensing by retaining the services of an independent licensed loan originator.

For the most part, the Nationwide Mortgage Licensing System & Registry and the state-enacted legislation which followed fulfills the original intent of the SAFE Act. Some of the restrictions the SAFE Act created have been superseded by the Dodd Frank Act, including the criteria for seller financing of residential properties. But the idea of an exclusion for seller financing under certain conditions still remains as a part of the Dodd-Frank Act as we will next discuss.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) is a broad financial reform package affecting virtually every corner of the financial services industry. Since its inception, the act has come under continuing criticism, legal setbacks, calls for reform or outright repeal. The entire act is way beyond the scope of this chapter. We will focus only on the effect the act has on seller-financed, real estate transactions.

For the real estate market, Dodd-Frank provides that creditors wishing to make residential mortgage loans to owner-occupants must first determine that the borrowers have the ability to repay, based on specific statutory criteria:

current income or assets current employment status credit history
monthly mortgage payment
other monthly mortgage payments arising from the same purchase
monthly payment for other-mortgage-related expenses (e.g., property taxes) the borrower’s other debts
borrower’s debt-to-income ratio

The act does not apply to commercial or investment real estate transactions. However, it does apply to “any residential dwelling that contains 1-4 units, including houses, apartments, townhouses, condominium units, cooperative units, mobile homes, and trailers or boats used as residences. The rules apply whether the individual is purchasing a primary residence, second home, or vacation residence.” [From an article by Michael A. Smeenk entitled “Dodd-Frank, Consumer Financial Protection & Owner Financing” located at http://frascona.com ]

Additionally, an owner-financed note must have a fixed rate or, if adjustable, may adjust only after five or more years and be subject to reasonable annual and lifetime limitations on interest

rate increases. Negative amortization loans (always risky) must be accompanied by disclosure and counseling for first-time buyers. And prepayment penalties are banned.

There exist two exclusions for sellers making sales to residential owner-occupants. The first exclusion is the “Three Properties Exclusion” where sellers who finance the purchase of three (3) or fewer properties in a 12-month period. The second exclusion is the “One-Property Exclusion” where the seller must be a “natural person” and can only finance the sale of a single property in any 12-month period. These are discussed in the following Excerpt from the 2013 Loan Originator Rule Small Entity Compliance Guide issued by the Consumer Financial Protection Bureau

Excerpt from the 2013 Loan Originator Rule Small Entity Compliance Guide issued by the Consumer Financial Protection Bureau (pages 22-23)

“When is a seller financer a loan originator?

(§ 1026.36(a)(4) and (5)) Seller financers that engage in a minimum number of transactions are considered creditors under the Truth in Lending Act (TILA) and Regulation Z. Specifically, seller financers would be considered creditors under Regulation Z if they extend credit secured by a dwelling (other than high-cost mortgages subject to § 1026.32) six or more times in the preceding calendar year, or extend more than one high-cost mortgage in any 12-month period. Accordingly, such seller financers are excluded from the definition of loan originators for purposes of the compensation provisions unless they use table funding. In addition, the rule contains two additional special exclusions from the compensation, steering, qualification, and identification provisions for certain seller financers. These exceptions are:

You are a natural person, estate, or trust and you provide seller financing 1. for only one property in any 12-month period.
You are any type of seller financing entity and you finance the sales of three 2. or fewer properties in any 12-month period.

Specifically, under the first special exclusion, if you are a seller financer that is a natural person, estate, or trust, you are not a loan originator if:

You provide seller financing for only one property in any 12-month period.
You owned the property securing the financing.
You did not construct, or act as a contractor for the construction of, a residence on the property in your ordinary course of business.
The financing meets the requirements below. The financing must:
Have a repayment schedule that does not result in negative amortization.
Have a fixed rate or an adjustable rate that resets after five or more years. These rate adjustments may be subject to reasonable annual and lifetime limits

If the financing agreement has an adjustable rate, you must determine the rate by adding a margin to an index rate. The index you use must be widely available, such as the U.S. Treasury securities indices or LIBOR.

Under the second special exclusion, if you are a seller financer (regardless of whether you are a natural person, estate, or trust), you are not a loan originator if:

You provide seller financing for three or fewer properties in any 12-month period.
You owned the properties securing the financings.
You did not construct, or act as a contractor for the construction of, a residence on the property in your ordinary course of business.
The financing meets the requirements below. The financing must:
Be fully amortizing.
Have a fixed rate or an adjustable rate that resets after five or more years. These rate adjustments may be subject to reasonable annual and lifetime limits.

Further, you must determine in good faith that the consumer has a reasonable ability to repay the loan. If the financing agreement has an adjustable rate, you must determine the rate by adding a margin to an index rate. The index you use must be widely available, such as the U.S. Treasury securities indices or LIBOR.”

Takeaways

The Dodd-Frank Act does put some constraints upon seller-financing of residential properties. However, for most sellers this will not apply as long as they take care to follow the requirements for the exclusions.
For all of the above complexity of these regulations and transactions that are excluded from these regulations, I do recommend you work only with an attorney who is trained in the technicalities of owner-occupied seller financing and the exclusions under of the Dodd-Frank Act. (See the short advisory on Finding Knowledgeable Legal Counsel by James T. Wilson that follows)
Even given those new restrictions, understanding the creative seller financing options discussed in this book will give you an opportunity to build your income and net worth, solve problems that are not easily resolved, and be free of the constraints imposed by conventional financing.
The real seller financing opportunity for real estate investors still exists under a number of scenarios:

Seller financing under one of the Dodd-Frank exclusions
Lease to tenant with an option to purchase
Investor buying from home owner using seller financing
Investor selling to other investor using seller financing
Plus: Other creative financing strategies, some of which are contained in this book and in our other books on creative real estate.

While there are new restrictions for seller financing under the SAFE Act and under Dodd-Frankly, there will always be people who want to own their own home no matter what! And creative real estate owners, buyers and investors will find new ways to help those people do just that. While the federal government changes some of the rules we operate under, those who creatively adapt will profit the most!

FINDING KNOWLEDGEABLE LEGAL COUNSEL

By James T. Wilson

Asking friends and acquaintances is one way to identify “candidates” for legal counsel, but is often not a great source. Many people do not have the knowledge or expertise/experience to recognize competent legal counsel from an attorney they like. As with any area of advisory or any other service, we should be seeking a specialist in dealing with our specific area of need. In this case, a real estate attorney with current knowledge and experience in handling transactions with seller financing.

Today, we have Internet resources. Check the listings of attorneys in your area that specialize in real estate. Check multiple sites and lists. Many listings only include attorneys who pay a fee to be listed. Bar Associations often have online listings. Identify candidates and then go to their individual websites or maybe some social media sites for detailed information. Since the rules we are addressing are relatively new, any reference to real estate financing expertise on the individual website should get your attention. If the listings in your area, do not provide what appear to be good candidates, expand the geographic location to find an attorney. In this case, traveling a few mile or maybe many miles to get competent advice and services is a cheap price to prevent inadvertent violation of the rules and the penalties that come with such violations.

Another good resource is real estate investors groups and conferences. In many areas there are organizations with both websites and regular meetings. Check their websites and go to their meetings. Often, knowledgeable and experienced attorneys are sponsors or attendees at meetings. Such organization have members who are acquiring and selling multiple properties. Such active real estate investors and operators are a good source to identify the type of competent legal counsel needed. That is especially true of “house flipper.” House flippers are particularly subject to the subject seller financing restrictions.

After identifying candidates, how do I know which ones are knowledgeable and competent. The first thing is to clearly understand that you are interviewing the attorney and not that the attorney is allowing you to be their client. Ask questions! Even if you have to buy 30 minutes or an hour from the attorney to discover their competence, it is less expensive than expensive problems in the future. What questions?

“I am potentially going to be selling several properties in the future and want to carry seller financing for long-term income. I have read and heard that there are some new restrictions on seller financing. Could you explain those restrictions in layman’s terms?” You know the overview of the restriction as presented above. If the attorney cannot provide an overview at least as complete as the overview in this article off the top of their head, they are probably not your attorney.
I have heard that the restrictions are treated differently from state to state. How are the new restrictions being treated and enforced in this state?
What volume of your transactions in the past year have included seller financing?
How do you advise your real estate clients to monitor when they get close to being affected by the new regulations?

You can probably think of other questions that you need to have clearly answered so you can operate effectively. The key is that you need a competent, knowledgeable (up to date knowledge) and experienced legal counsel with whom you can work easily. Your need the best team you can assemble and competent legal counsel is critical.

Do not hesitate to ask the hard questions. If the attorney takes offense or becomes defensive, they are probably not your attorney. Remember it is your money and time that you are putting at risk when you do a transaction that might have some regulatory restrictions with penalties.

Chuck Sutherland is a commercial real estate developer and real estate consultant based in Dallas, Texas. He is also the author of 3 books entitled: Creative Seller Financing, Creative Down Payments, and Advanced Creative Real Estate Financing. Mr. Sutherland is NOT a legal or tax expert and does not represent himself to be. This article represents his opinion only as a real estate investor and instructor. Anyone engaging in seller-financing transaction or any type of real estate transaction should engage competent legal and tax advisors.