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Seller Financing and the Dodd-Frank Act

by | Jun 5, 2024 | Firm News

Sellers who personally finance a transaction and allow the buyer to make payments directly to them over time can be impacted by certain aspects of the Dodd-Frank Act, particularly Title XIV, the Mortgage Reform and Anti-Predatory Lending Act.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as the Dodd-Frank Act, is a comprehensive piece of financial reform legislation enacted in 2010. The act was a response to the 2007-2008 financial crisis, which exposed significant weaknesses in the regulatory framework governing the financial industry.

The Dodd-Frank Act introduced a wide range of measures aimed at addressing various issues within the financial system and promoting stability, transparency, and consumer protection. These measures impact many services offered to consumers, such as mortgages, credit cards, and other financial products. The mortgage reforms included in the Act promote responsible lending and borrowing practices by implementing rules related to mortgage underwriting and the securitization of mortgages. Among other provisions, the Act establishes requirements for when a licensed loan officer must be involved in the transaction.

Sellers who provide financing are exempt from the requirements to involve a licensed loan officer if they do not meet the definition of a loan originator and the loan meets certain requirements. The Act provides a detailed definition of “loan originator,” but it generally applies to professional mortgage brokers or someone who negotiates credit terms.

These exemptions apply to sellers who are financing a sale to an owner-occupant in a property with between one and four units. They do not apply if the sale involves commercial property or to an owner who will not live on the property. In addition, builders are prohibited from using owner financing.

The Act creates two exempt categories of sellers who are providing financing based on the number of properties sold within a 12-month period, and applies different rules to each:

The One Property Exemption:

  • Under the first special exclusion, if you are a seller financer that is a person, estate, or trust, you are not a loan originator if:
  • Seller only provides seller financing for one property in any 12-month period;
  • Seller owned the property securing the financing;
  • Seller did not construct, or act as a contractor of a residence on the property in your ordinary course of business.

Additionally, the financing must:

  • Not result in negative amortization;
  • Have a fixed rate or an adjustable rate that resets after five or more years. Based on regulatory guidance, an annual rate increase of 2 percentage points or less is reasonable. A lifetime limitation of an increase of 6 percentage points or less is reasonable.

The Three Property Exclusion

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

  • Seller provides financing for three or fewer properties in any 12-month period;
  • Seller owned the properties securing the financings;
  • Seller 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 must meet the following requirements:
    • 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, the seller must determine in good faith that the consumer has a reasonable ability to repay the loan. If the financing agreement has an adjustable rate, the seller must determine the rate by adding a margin to an index rate. The index used must be widely available, such as the U.S. Treasury securities indices or LIBOR.

The main difference between these categories of sellers is that sellers who finance one property or less per year are not required to confirm the buyer’s ability to pay.

Sellers who finance more than three properties per year are not exempt from the Dodd-Frank requirements. This group of sellers must consider the borrower’s ability to repay the loan based on eight separate underwriting factors. In addition, the lender must write a “qualified loan.“ To be considered “qualified,” the loan must met multiple requirements such as not including terms resulting in negative amortization, interest-only payments, balloon payments, or a duration exceeding 30 years. “No-doc” loans where the lender relies solely on the borrower’s statements regarding income or assets without separate verification are not qualified mortgages. Finally, a loan generally cannot be a qualified mortgage if the points and fees paid by the consumer exceed three percent of the total loan amount.

Other provisions that apply to this group of sellers include a required 120-day period of delinquency prior to foreclosure, and a restriction on forced arbitration clauses. And, crucially, a mortgage loan originator is required to process the transaction.

Seller financers who extend credit secured by a dwelling six or more times in a 12-month period year are generally considered creditors as opposed to loan originators under the act and are subject to additional regulation.

Choosing to enter an owner-financed transaction can have benefits for both buyers and sellers. Buyers who have trouble qualifying for traditional loans due to self-employment or credit issues may find sellers more lenient in credit requirements than traditional loan originators, the closing costs related to traditional loans may be reduced or eliminated, the transaction process is often faster, and flexibility in the terms of the loan including interest rate, repayment period, and down payment can allow buyers to enter the property market without a large upfront investment.

Sellers who offer financing can also benefit in a number of ways: they can attract a larger pool of buyers, including the self-employed, they may be able to obtain a higher overall selling price for the property when offering financing as the terms can be customized to justify the higher value, receiving payments over  time as opposed to in a lump sum can provide tax benefits in some circumstances, and seller financing often results in a faster sale.

Given the potential benefits to both sellers and buyers, seller financing is a powerful tool to create value in a real estate deal. However, the applicable laws are complex and involve various sections of the United States Code, as well as regulations and commentary issued by various federal agencies. Involving an attorney who can assist with Dodd-Frank compliance will help ensure the transaction is successful and guard against civil liability.

-Zach Burr, J.D.
Burrwood Law Group, P.L.L.C.