Seller Finance Gets Tougher No Thanks to Dodd-Frank

Let’s say you own a home free and clear and you want to sell. You’re approached by a buyer willing to put 30% down, and then pay you the balance with seller financing. The buyer is self employed, has tons of cash, but he can’t qualify for a conventional loan until he has one more year of self-employment under his belt. The plan is that he will refinance within 2 years and pay off your seller finance loan. You’ve checked out the buyer’s income, you like the 30% down, but you don’t want to finance over 30 years. Instead, you will agree to finance on a 3 year balloon note so that you’re done with this property in 3 years. So far so good, right? Now you turn to your real estate broker and say “make it so.” Your real estate broker replies with “I can’t” and explains to you that the Colorado Real Estate Commission no longer permits real estate brokers to provide seller financing documents for these transactions. Instead you have to go to your lawyer (shameless self promotion: or just use me in the first place since I’m a broker and attorney!).

The Colorado Real Estate Commission took away the standard seller finance documents from brokers because two new laws, the SAFE Act and Dodd-Frank, have rendered seller financing quite complex. The SAFE Act regulates the licensing of mortgage originators and Dodd-Frank contains all sorts of restrictions on lending, including loans provided by sellers. Under Colorado’s version of the SAFE Act, people acting as mortgage brokers and lenders must be licensed and registered — including sellers offering seller finance.

Fortunately, the Colorado legislation exempts sellers who offer seller finance on no more than 3 properties in any 12 month period. So, if you’re selling one, two or three houses in a year, and you offer seller financing, you don’t have to be a licensed mortgage broker. That’s the easy part. The trickier part involves the final regulations that implement Dodd-Frank, which went into effect in January of this year.

The Dodd-Frank regulations are aimed at making sure the loans extended to borrowers are not predatory loans, and that the borrowers have the ability to re-pay those loans. The regulated loans include seller finance loans, like the one you would be willing to make on your free and clear property in the above scenario. The problem with Dodd-Frank — besides that subtle problem of dictating the terms upon which private parties can contract with one another — is the incredible complexity of the regulations. When any loan is covered by the regulations, the loan must meet stringent criteria. Seller finance loans fall into a couple of exceptions, but the exceptions are very limited. Below is my best attempt at clarity in the context of seller finance loans.

PRELIMINARY STEP 1. EXAMINE THE BUYER’S PURPOSE.
Dodd-Frank and the SAFE Act are concerned with loans provided to buyers who will live in the property. So, if you’re buyer is an investor and it’s a commercial purpose loan, you can pass GO and move straight toward creating the promissory note and deed of trust that your heart desires, without having to worry about these federal laws and regulations.

PRELIMINARY STEP 2. WHO IS THE SELLER.
The requirements and exceptions are quite different for sellers who are individuals and sellers who are companies or other entities. Individuals, trusts and estates have more latitude in the types of loans they can offer. Also, if the seller is a builder, neither of the two seller finance exceptions will apply.

THE LESS STRINGENT, SINGLE HOME EXCEPTION
This exception only applies when the seller is an individual, trust, or estate, and offers seller financing on only 1 home in a 12 month period. Also, the seller cannot have constructed the home or acted as the contractor in the seller’s normal course of business (no Builders).  Restrictions:

• If an adjustable rate loan the interest rate must be fixed for the first five years.
• If an adjustable rate loan the rate needs to be tied to a known index, like LIBOR.
• The seller does not have to show that the borrower has the “ability to repay.”
• The seller can use a balloon note.

THE MORE STRINGENT, THREE HOME EXCEPTION
This exception is available to individuals, trusts, estates, and also companies who offer seller finance no more than 3 times per year. Again, the seller cannot have constructed the home or acted as the contractor in the seller’s normal course of business (no Builders).  Restrictions:

• No Balloon notes. The note must be fully amortized.
• The Buyer must demonstrate “ability to re-pay.”
• If an adjustable rate loan the interest rate must be fixed for the 1st five years.
• If an adjustable rate loan the rate needs to be tied to a known index, like LIBOR.

Keep in mind there is also an overriding situation called a “high cost mortgage” that will disqualify any seller finance loan from fitting into either of the two exceptions. The “high cost mortgage” analysis considers a bunch of different things, but the easiest to determine is the interest rate. If your loan APR is more than 6.5% above the prime rate you need to fully examine the loan to determine whether it’s a high cost mortgage.

Clear as mud? Just remember, seller finance is still available. If you’re thinking of offering seller financing contact me so that I can help you navigate the requirements and exceptions so you don’t get in trouble.