BROKER RISK MANAGEMENT
WEEKLY PRACTICE TIP
Seller Financing after the Dodd-Frank Act
Effective January 14, 2014, several provisions of the Dodd-Frank Act (“DFA”) go into effect that have an impact on seller financing. The DFA modified the Truth-in-Lending-Act (TILA) defining which persons are loan originators under TILA. Under these new rules, a seller financier can be a “loan originator” under TILA and, as a result, must comply with specific rules.
BOTTOM LINE: Most seller carry-back loans will not be affected by these new rules if they meet the criteria set forth in Paragraph III, below.
I. BACKGROUND
NOTE: THIS TIP ONLY APPLIES TO RESIDENTIAL 1-4 UNIT PROPERTIES.
On July 21, 2010, the President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act or “DFA”). The DFA substantially changes consumer financial regulation and oversight, and includes provisions governing seller financing of properties they are selling.
The DFA modified the Truth-In-Lending Act (“TILA”) which applies to lenders on 1-4 unit residences who regularly extend consumer credit for personal, family and household purposes. That law defines who is a “loan originator” which includes sellers who are carrying back a loan from a buyer on the sale of their property. The original TILA law, and Reg Z which implements that law, is now governed by the new Consumer Finance Protection Bureau (CFPB).
The CFPB issued its rules creating two categories of seller financing as exempt from being a “loan originator:”
1. Those sellers who sell 3 or fewer properties in any 12-month period; and,
2. Those sellers who sell only one property in any 12-month period.
II. THREE OR FEWER PROPERTIES IN ANY 12-MONTH PERIOD
The CFPB exempted from the definition of “loan originator” an individual (or an estate or trust) seller who provides mortgage financing for no more than 3 properties in any 12-month period from stricter requirements, but only if the financing meets certain rules:
- The seller did not construct the home.
- The loan is fully amortizing (no balloon mortgages allowed).
- The seller determines in good faith and documents that the buyer has a reasonable ability to re-pay the loan.
- The loan has a fixed rate or is adjustable after 5 or more years, subject to reasonable annual and lifetime caps.
- The loan meets other criteria set by the Federal Reserve Board.
III. ONLY ONE PROPERTY IN A 12-MONTH PERIOD
For a seller to qualify for this more flexible “one property in a 12-month period” rule:
1. The seller must be a natural person, estate, or trust. The “one property in 12 months” exclusion is not applicable to other organizations, such as corporations, partnerships, or proprietorships
2. The seller must sell only one property in a 12-month period.
3. The property must be owned by the seller and serve as security for the financing.
4. The seller has not constructed, or acted as construction contractor for, a residence on the property in the ordinary course of business of the seller.
5. The seller financing:
A. Is allowed to have a balloon payment.
B. May NOT have a negative amortization on the repayment schedule.
C. Can have a fixed interest rate or adjustable interest rate. But, if it has an adjustable rate, it must have reasonable annual and lifetime limits on rate increases. (See the NAR summary link below for details.)
IV. PROHIBITION ON ARBITRATION PROVISIONS:
There is now a prohibition on arbitration clauses in a contract where a lender, including seller financing, is advancing consumer credit. However, this prohibition only applies to a lender who regularly extends consumer credit for personal, family or household purposes. So, if a seller who is extending seller financing does not “regularly extend consumer credit” of this type, then a seller-carry financing contract may have an arbitration clause.
PRACTICE TIPS:
1. Be sure that your seller is an individual, trust or probate if they want to qualify for the “one property in 12 months” exclusion. All other seller entities (LLC’s, Corporations, Limited Partnerships, etc.) should be advised to consult with their legal advisors to comply with this law.
2. Verify that the seller has not originated another seller carry-back loan in the past 12 months. Sellers who carry back more than one loan in a 12-month period are subject to the more strict rules (see above).
3. Do not accept compensation for negotiating a seller carry-back loan in your, or any other, transaction, as that will trigger stricter Truth-in-Lending requirements.
4. If the seller who is providing seller financing regularly extends consumer credit for personal, family or household purposes, THE PURCHASE AGREEMENT WHICH PROVIDES FOR SELLER FINANCING MAY NOT HAVE AN ARBITRATION PROVISION. Of course, the parties may agree to arbitration between them after the sale is completed and a dispute arises if they desire to do so.
5. Remember that on all residential 1-4 unit sales, the Seller Financing Addendum (CAR zipForms form SFA or equivalent) must be used. The buyer agent, if there is one, is the “Arranger of Credit” charged with completing that form. If no buyer agent, then the listing agent is the “Arranger of Credit.”
6. The seller should not engage a third party to assist for a fee in negotiating the seller carry-back loan as this will also trigger stricter regulatory requirements.
7. If the seller sells one property using the less restrictive “one property in 12 months” exclusion rule, and then plans to sell a second property, send your seller to his/her legal advisor. The safest course would be for the seller to wait for the expiration of the 12-month period after the close of the first transaction before selling the second property.
For more information on seller financing see the CAR Legal Memo entitled “Seller Financing” at:
http://www.car.org/legal/financing-folder/SellerFinancing/
Also, for more information on loan originator compensation see the CAR Legal Memo entitled” Regulation Z – Loan Originator Compensation Requirements” at:
http://www.car.org/legal/financing-folder/RegZloanOriginatorCompensation/
For information on seller financing minimal interest rates see CAR Legal Memo entitled “Seller Financing of Real Property: Minimum Interest Rates” at:
http://www.car.org/legal/financing-folder/seller-financing-min-inter-rates/
For more information on the requirement of “Balloon Payment Notices and Restrictions” see CAR Legal Memo at:
http://www.car.org/legal/financing-folder/balloon-payment-notice/
Finally, for more information on the requirement for lenders who regularly extend credit to consumers to determine the borrower’s ability to repay the loan see the CAR Legal Memo entitled” Regulation Z – Ability to Repay Standard for Loans” at:
http://www.car.org/legal/financing-folder/RegZrepayLoans/
WEEKLY PRACTICE TIP: DO NOT FORWARD TO CLIENTS. This Weekly Practice Tip is for the exclusive use of clients of Broker Risk Management and their agents. It may not be reproduced or distributed without the express written consent of Broker Risk Management. The advice and recommendations contained herein are not necessarily indicative of standards of care in the industry, but rather are intended to suggest good risk management practices.
© Copyright Broker Risk Management 2014 01/03/14