Dodd-Frank And The Note Business Explained

 Ric Thom is one of the leading authorities in seller carryback real estate contracts. He owns Security Escrow in Albuquerque, New Mexico. He has served as a director and the president of Valencia County Board of Realtors. He also served as a director of the Albuquerque Board of Realtors as well as a director of the Realtors Association of New Mexico. Ric was recently named Affiliate Of The Year to the Albuquerque Board of Realtors.

He is a certified instructor for the New Mexico Real Estate Commission’s continuing education program. He teaches the course “Practical Application of Real Estate Contracts,” which he created.

Ric will be teaching at The Paper Source Note Symposium in Las Vegas April 24-26.  For information visit http://papersourceseminars.com/seminars/the-paper-source-note-symposium-cash-flow-profits/ or call 800-542-2270.

This article first appeared in THE PAPER SOURCE JOURNAL (http://papersourceonline.com/paper-source-journal/infosubscribe/).

SETTING THE STAGE
The following applies to transactions on or after January 1, 2014.

None of it applies to any seller-carryback transactions where the buyer will not use the property as their personal residence.

When Dodd-Frank (“The Dodd–Frank Wall Street Reform and Consumer Protection Act”) was enacted into law on July 21, 2010, it said that you could only do three seller carryback transactions a year, and those transactions had to meet certain requirements:

(1) The note could not have a balloon.

(2) It had to have a fixed interest rate for five years, then it could adjust.

(3) You had to prove and document the buyer’s “ability to repay” in accordance with the Qualified Mortgage Rule (QM), which is quite restrictive. That’s the same rule that banks have to use if they want a safe harbor and not get sued for making a loan that didn’t fit the QM.

The Consumer Financial Protection Bureau (CFPB), which was writing the regulations to implement Dodd-Frank, asked for public comments. I told Bill Mencarow about this, and he immediately (and repeatedly) alerted PAPER SOURCE JOURNAL subscribers and everyone else he could think of, urging them to submit their comments.

I also alerted members of Congress and got the National Association of Realtors on board and helped them write their comments to the CFPB.

Because so many people wrote comments to the CFPB —- and THE PAPER SOURCE took the lead — the bureau relaxed the seller financing restrictions. They came out with something that was a lot more relaxed than the Dodd-Frank law was originally.

The CFPB subsequently issued the following regulations. They apply to seller carryback notes created on or after January 1, 2014.

THE ONE PER YEAR CATEGORY
The CFPB broke seller financing into two different categories. One category is for those individuals, trusts or estates who do just one seller carryback transaction a year on a property that has a dwelling that the buyer will use as their primary residence.

Let me repeat that, because there has been so much misinformation circulated about it: this category is for those individuals, trusts or estates who do just one seller carryback transaction a year on a property that has a dwelling that the buyer will use as their primary residence. For them:

* You can have a balloon in your note with the buyer.

* You do not have to prove or document their ability to repay.

* The note must have a fixed interest rate for five years, and at the end of five years the interest rate can increase no more than two points per year with a cap of six points above whatever you started at. You have to tie it to an index like a T-bill or the prime rate in the beginning.

That’s probably going to affect all but three to five percent of individuals who carry back notes.

Remember that these restrictions only apply to seller-carryback transactions on properties that have a dwelling that the buyer will use as their primary residence. A transaction on a lot or vacant land is exempt, even if the buyers plan to build a primary residence.

If the property has a dwelling, but the buyer is not going to use it as their primary residence — say they’re going to rent it or use it as a second home — then none of this applies, and you can offer seller financing with no restrictions.

Commercial property and multifamily that is five units or larger is also exempt from the restrictions.

Again, the one seller carryback transaction per year category applies to individuals, trusts and estates. It does NOT apply to corporations, LLCs, partnerships or other legal entities. In that case the second category applies (below).

Again, these rules only apply to what the CFPB refers to as a residential mortgage loan where the note is secured by a dwelling or residential real property that includes a dwelling.

Most people only carry back a note once in their lifetime, when they sell the big house, retire and move somewhere else. Some might do it a few more times. Even many real estate investors only do it once a year. These regulations are not a huge change for most people.

THE MORE THAN ONE PER YEAR CATEGORY
The second category applies to individuals, trusts and estates that do more than one seller carryback transaction per year when the buyers will use the dwelling as their primary residence.

It also applies to any seller-carryback transaction — even one — where the seller is a corporation, LLC, partnership or other legal entity and when the buyers will use the dwelling as their primary residence.

* The note cannot have a balloon.

* The note must have a fixed interest rate for five years, and at the end of five years the interest rate can increase no more than two points per year after the fifth year with a cap of six points above whatever you started at. You have to tie it to an index like a T-bill or the prime rate in the beginning. This is the same restriction as the first category.

* You must determine the buyer’s ability to repay.

* If you do no more than three seller-financed transactions per year you do not have to become a Mortgage Loan Originator (MLO).

* If you do more than three you must become an MLO — or find an MLO who is willing to be the go-between.

Just as in the “one per year” category, these restrictions only apply to seller-carryback transactions on properties that have a dwelling that the buyer will use as their primary residence.

If you have a rental house and the renters want to buy the house to use as their primary residence, and you want to carry back a note with a balloon (and you don’t do more than one seller carryback transaction per year), and that rental property is in a corporation, LLC, partnership or other legal entity, you’re going to have to move the property into a trust or into your personal name. Otherwise, you’re going to fall into the second category which says you cannot have a balloon unless you are an individual, trust or estate.

If you think about it, not having a balloon but being able to do an adjustable rate almost serves the same purpose. Let’s say you start out with an interest rate of 6% on the note and then after five years it goes to 8%, then it goes to 10% and then it goes to 12%. That’s a huge incentive for the buyer to refinance out of the property and pay you off. If they don’t, then you’re rewarded for your risk in carrying that paper; you’re now getting 12% for holding that paper, and there is no balloon.


ABILITY TO REPAY
The second category requires you to determine the buyer’s ability to repay, but the rules and the regs don’t specify any standards for doing it (such as the qualified mortgage standard, a 43% debt to income ratio, etc.). You don’t have to do any of that; you can just ask them if they have a job, can you see a paystub, can you see their tax return (which they may or may not give to you). All you are required to do is to make some good-faith determination that they’re able to afford that payment, and you do not have to document it.

It would be prudent to have some documentation in case there’s a default and the buyer’s attorney says “where’s the documentation?” and tries to create a legal defense against paying you. But there is no requirement that you have to document. All it says is that you should determine the buyer’s ability to repay.

I asked an attorney at the CFPB about how one should determine the buyer’s ability to repay. He said that if you fall under category two you have to determine the ability to repay, but he admitted that there are no set guidelines. You just have to show that you used good faith in determining, for example, that the buyer has a job, his rent was $1,000 per month, but the payment on the note is $900 a month and you think in good faith he can afford this property because he could afford the rental house he was in before.

WHEN YOU’RE BUYING A NOTE CREATED ON OR AFTER JAN. 1, 2014
You’re going to be able to tell from the note if the mortgagee is a private individual or an entity. If it is a private individual, trust, or estate, then ask them to sign an affidavit saying that they have not done more than three of these in a 12-month period and how many of them had balloons. If it’s an entity, an LLC, or a corporation, etc., ask for an affidavit saying how many it has done and how many of them had balloons.

If there is a balloon in that note that you’re buying from an LLC, corporation or partnership, etc., you know there’s not supposed to be one (again, if that note was created on or after January 1, 2014). You’ll have to have the note modified to remove the balloon before you buy it. Otherwise at some point the mortgagor could use the fact that the note was not in compliance when it was written as a defense against paying the debt or foreclosure.

One more thing — I want to thank Bill Mencarow and PAPER SOURCE JOURNAL subscribers for getting the word out there, because, honest to God, without those comments we would be stuck with the original statute — which would have killed seller carrybacks.

In the Federal Register the CFPB wrote that they relaxed the rules on seller financing because of the numerous comments they received.

Ric Thom’ s website is www/securityescrow.com and his blog is www.securityescrownews.com

This article was originally published in THE PAPER SOURCE JOURNAL. Visit  www.PaperSourceOnline.com
www.PaperSourceUniversity.com
and www.PaperSourceSeminars.com or call 1-800-542-2270 for information.

Ric will be teaching at The Paper Source Note Symposium in Las Vegas April 24-26.  For information visit http://papersourceseminars.com/seminars/the-paper-source-note-symposium-cash-flow-profits/ or call 800-542-2270.
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13 thoughts on “Dodd-Frank And The Note Business Explained”

  1. Excellent information for investors, and very timely!

    Thank you so much, Bill, for bringing this to our attention.

  2. is there a market for notes on rental properties? (non owner occupied).
    we originate rental property mortgages in florida 40-70% LTV 8-10%, 5-10 year term, good areas, good borrowers.

  3. Looks like the bureaucrats want to prevent someone like me from ever starting into this business.
    I was hoping to become a note originator (seller finance), but this is really complicating things for me.
    So, I have 2 questions: (1) what’s required to become a MLO, and (2) does this garbage apply to only real property? Or does it also apply to anything seller finance with a note–like vehicles? mobile homes? land? …?

    1. 1) Each state has its own requirements. But it’s much easier to pay an MLO a few hundred $ to handle each transaction.

      2) It only applies to property that will be owner-occupied. That includes mobile homes, but not land, not commercial property, not boats, not multifamily that’s 5 or more units, not to investment property that is sold to another investor not living in the home.

      Dodd-Frank, the SAFE Act, TILA…it can be very confusing. Ric Thom, the author of the above article, will be answering all your questions at THE PAPER SOURCE NOTE SYMPOSIUM April 24-26 in Las Vegas: http://papersourceseminars.com/seminars/the-paper-source-note-symposium-cash-flow-profits/

      Also see http://www.mobilehomeinvesting.net/mobile-home-blog/2014-safe-act-and-dodd-frank-for-mobile-home-investors

  4. Have a mobile Home Park and process at least 5 sales per year. These are owner occupied homes but on leased space in the park. Does this apply to these transactions since they are owner occupied?

    Thank you for the information I look forward to hearing from you

    1. Connie, I asked Ric Thom, and he replied,

      “In Reg Z in TILA a “dwelling” is defined as a residential structure that contains one to four units, whether or not that structure is attached to real property. That includes mobile homes. If you use seller financing to sell mobile homes that are attached or not attached you fall under the same rules as selling a site built stick house using seller financing.”

      So being on leased land doesn’t matter.

  5. My question is if you purchase pools/tapes NPN or PFN from Lenders or Equity Funds does the Dodd Frank Rule apply?

    Thank you

    1. I asked Ric Thom, who is our expert on Dodd-Frank, and he says: “I am only familiar with seller financing/installment sale rules under Dodd Frank. If the property has a dwelling and the buyer is a natural person that is moving into that dwelling and the seller owns that dwelling then the rules under seller financing apply. They only apply if the notes were created after 1/10/14. If the “lender” did not own the property then I’m sure that other Dodd-Frank rules come into play.”

      Ric will be teaching on Dodd-Frank and answering all your questions at The Paper Source Note Symposium in Las
      Vegas April 24-26. This one opportunity could make the entire Symposium worthwhile for you. For information visit
      http://tinyurl.com/2014notesymposium or call 800-542-2270.

  6. Bill
    This is such great information, that you share with people…Over the years we developed mobile home land and sold it to many of our clients with owner financing….They would not have qualified for any other type financing, and in most circumstances they paid us off over the years….some of the property we sold only the land (which would not be effected by Frank-Dodd, however in other cases we sold a home and land to clients who again would not be able to qualify, but they wanted their homes and worked hard to make their payments. Most all have paid us off now as the time has gone by….we have a few homes on land left and will need to look seriously at the article advising of the Frank-Dodd as it applies to our corporation.
    We were hit with two Whammies! (1) the great recession (2) Frank-Dodd – and perhaps (3rd) is our age, my partner is 83 and I’ll be 79, – Old Vince Lombardi the coach of the Green Bay Packers once said “We never lost a game we just ran out of time” we can relate to that.

    I appreciate so much in receiving your articles, information and help when we have a note for sale…
    At one time I thought of getting in to the note business for other people, and I understand in discussing this that one probably would need a license for that too…. I still have my Real Estate License and perhaps will not renew it when the time comes…..I’m trying to Keep it Simple – and the harder it gets the more opportunity is going to be out there, but I’m running as fast as I can, but can’t keep up (ha ha)

    I also appreciate your Christian Witness Bill – wonder in this day and age to be not afraid to share the Gospel, of Jesus Christ – as he really is the Way and the Truth…. Many Blessing to you!

  7. Thanks for the timely information and the needed letter writing to the law makers concerning the rules for owner financing. I have created a note and mortgage to sell for cash. this is on a rental that I receive rent from. it is being created from equity in the property. I own the property free and clear. How does Dodd-Frank affect my note and mortgage.

  8. Hello fellow mobile home carryback sellers, For many years I have been selling mobile homes with land. I always carried the paper. Now I’m faced with a monster called Dodd-Frank law. My mobiles are affixed to the land, which always made sense, until now. My new plan is to unaffix the mobile from the land and to rent the mobile to the buyer of the land. Does this make sense? Object is to skirt the law. I welcome your comments. Thanks.

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