I cannot take credit for putting this together, but I didn't see it on here and thought it would be of benefit for any investor thinking about Seller Financing:
Dodd/Frank Act Summary for Real Estate Investors
Overview—(Note: The following information is a summary of the Dodd/Frank Act, (Reference: http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/pdf/PLAW-111publ203.pdf ), a U.S. Regulation that is in initial implementation as of this writing. Note that there is no case law precedent to reference, so investors are encouraged to be cautious and thorough in dealing with the tenets of these regulations.
Passed in 2008 as the impact of the U.S. Financial collapse was affecting the entire world, this bill was well-intentioned in attempting to prevent a recurrence, but probably deals more with some symptoms than the actual causes. Nevertheless, it is designed as a consumer protection in the issuance of mortgages (by institutions or private lending) that tightens qualifications for borrowers and gives power of enforcement to borrowers who were not carefully screened regarding their ability to repay the loan.
The Dodd Frank legislation will affect investors in two areas: 1) The ability of consumer buyers to obtain qualified conventional mortgages will be more difficult, and this can make it more challenging to find an end buyer (owner-occupant) for properties; 2) Investors engaging in private lending (including offering properties using any seller finance method) will need to require more buyer qualification procedures, and add specific disclosures to their owner-occupant buyers or borrowers.
Penalties for not complying with Dodd Frank regulations will primarily not be enforced by government, but instead will result in lawsuits initiated by unhappy buyers and borrowers, who will claim that their lender did not properly screen their ability to repay the loan, and the court can award three years of previous payments on the loan plus down payments back to the borrower. It is very likely that predatory attorneys will exploit this opportunity.
Like many things in life, we can bemoan the inconvenience of these new statutes, or look for opportunity. There are potential huge opportunities to be found in learning how to work with these new standards as an investor, solving problems for buyers and sellers.
The Seven Ways Dodd/Frank Affects Investors
1) Loan Requirements for consumer (owner-occupant) conventional loans will have additional requirements for qualification and added restrictions—less people will be able to qualify for these loans. Wholesalers will not have to make modifications, but their cash buyers may have more difficulty finding qualified buyers for their properties.
2) Investors who offer private lending to consumer borrowers will be required to do more buyer qualification and disclosures.
3) Loans offering balloon payments, variable interest rates, prepayment penalties, negative amortizations, or in excess of 30 years are not “qualified” loans, and are not protected against litigation from a borrower.
4) All seller finance transactions to consumer borrowers (unless you only do one per year) require additional underwriting and pre-prequalification of buyer as well as additional disclosures.
5) Doing more than three transactions with consumer borrowers in a year’s time may require becoming or hiring a Mortgage Loan Originator (MLO).
6) The enforcement of these standards is generally left to borrowers and their attorneys who can sue for damages based on non-compliance. Awards can be up to three years of payments plus down payments, plus attorney’s fees and court costs.
7) Note Buyers will assume responsibilities on notes/mortgages initiated after the January 10, 2014 implementation of Dodd/Frank. If the note exposes the buyer to excessive liability potential, that would be a good note to avoid.
The Big Issue—Buyer’s Ability to Repay
Dodd/Frank essentially makes it the responsibility of the lender to determine if the borrower has the ability to repay, and gives the borrower the right to sue the lender if they did not adequately assess the buyer’s ability. If the lender offers a “qualified” loan, and can show that they made adequate efforts to determine the borrower’s ability, they should be relatively safe from lawsuits.
“Qualified Loan” Requirements—if you have complied with the qualified loan provisions below, the burden of proof rests with the borrower.
1) No Negative Amortization
2) No Balloon Payments
3) Cannot Exceed 30 Years
4) No Prepayment Penalties
5) Variable Interest Rate—can be included but underwriting must be based on the highest rate that will occur in the first five years. This point also implies that credit and Debt to Income ratio must be verified (43% DTI limit)
6) Must Verify Income
“Non-Qualified Loan” Exemptions—If you offer a loan that is non-qualified, the burden of proof for exemption rests with the lender. (Recommendation: For any loan that falls under the exemptions below, disclose to the borrower in the actual loan agreement in large print: “NOTICE—THIS LOAN FALLS UNDER A DODD/FRANK EXCLUSION AND PENALTIES WILL NOT APPLY.”
1) Meets 8 Loan Underwriting Requirements Exemption
a. Current Income Verification (All Sources)
b. Employment Status Verification
c. Monthly Loan Payments Verified
d. Other Loan Payments Verified
e. Other Mortgage Obligations Verified
f. Alimony and Child Support Payments Verified
g. Debt to Income Ratio (Including Subject Loan) not to exceed 43% of income
h. Credit History Reviewed
2) One Seller Finance Per Year Exemption
a. A private party or trust (not a business entity) is allowed to do one seller finance transaction per year without having to meet “qualified loan” or other requirements. It is still recommended to do background credit, income and employment verification.
3) Non-Consumer Loan Exemption
a. Dodd/Frank requirements are for protection of consumers, if the borrower is not receiving owner-occupant financing, the restrictions do not apply. Loans to an investor who will not occupy the property are exempt.
4) De-Minimus Provision Exemption
a. If you issue a consumer real estate loan 3 times or less within a year, you will not need to become or hire a Mortgage Loan Originator (MLO), over that number will require professional underwriting. (Another source says 5 transactions)
5) All Cash Transactions Exemption
a. If the transaction is an all-cash transaction, there will be no loan issued, and it does not fall under Dodd/Frank regulations.
Special Notes on Lease Options:
1) A lease option between a seller and an investor (non-owner occupant) is not restricted under Dodd/Frank;
2) Technically, since a Lease Option between an owner and a tenant/buyer does not convey title, it is not a sale, which means it does not fall under the regulations of Dodd/Frank; however, if either the IRS or a court determines that it is an installment sale to a consumer borrower, it would be deemed a loan. To avoid such designation, and avoid lawsuits:
a. Use Separate Documents for lease and option, executed on different dates, and with no reference to each other. You can charge option consideration with the option agreement as it is a legal requirement of an option, but do not accept option consideration in installments;
b. Keep Term of lease to tenant buyer under 3 years;
c. Offer No Purchase Credit/Rent Credit on monthly or periodic payments
d. Major repairs and maintenance are the responsibility of the owner—do not assign these to the tenant/buyer;
e. Complete some basic lease option underwriting and pre-qualification
i. Conduct a Credit Check;
ii. Confirm Employment;
iii. Confirm Income;
iv. Recommended: Request information on all Monthly Loan Payments, Other Loan Payments, Other Mortgage Obligations, and Alimony and Child Support Payments;
v. Run a Debt to Income Calculation, including their monthly Lease Payment.
3) Suggested: For any arrangement that could fall within Dodd/Frank legislation, have borrower complete a Uniform Residential Loan Application, such as the FNMA 1003, (Reference: https://www.fanniemae.com/content/guide_form/1003rev.pdf ) or modify such a form for your own usage—then use that information to research borrower’s repayment capability per the instructions above.
If you would like the chance to work with me or one of my fellow real estate investor coaches and our advanced training programs, give us a call anytime to see if Dean's Real Estate Success Academy and our customized curriculum is a fit for you. Call us at 1-877-219-1474 ext. 125