Here’s a special report on how the Dodd-Frank law affects note investments. It’s written by Ric Thom.
PAPER SOURCE JOURNAL subscribers were the first to receive this information on Dodd-Frank. This is an example of one of the benefits of receiving the JOURNAL each month. For information, see the Journal tab above at https://papersourceonline.com/
Ric Thom is one of the leading authorities on seller carryback
real estate contracts. He has been involved with real property
installment sales (“seller financing”) for over 30 years. He
owns Security Escrow in Albuquerque, the oldest and largest
escrow company in New Mexico https://www.securityescrownews.com/
The escrow company acts as a third party custodian of deeds and payments
for private party real property installment sales. He has had the privilege of
working with over 60,000 customers who have bought or sold real
property using installment sales.
Ric has also been a real estate broker for 30 years. He has
served on the board of directors of both the Greater Albuquerque
Association of Realtors (GAAR) and The Realtor’s Association of New
Mexico (RANM). GAAR named him Realtor of the Year in 2012 and
earlier presented him with the Mary Ann Fisher Volunteer Leadership
Award. These are the most prestigious awards you can receive in the
New Mexico real estate industry. These were given primarily for his
work with Realtors and consumers in the area of seller financing.
RANM also gave Ric the Peggy Comeau Leadership award for his work
at the state and federal level in the area of seller financing. He
is currently serving his third three year term as a trustee of New
Mexico’s REALTORS® Political Action Committee, a nonpartisan PAC.
He developed and instructs a four hour course on seller financing,
“Practical Application of Real Estate Contracts,” for the New
Mexico Real Estate Commission and has taught PAPER SOURCE seminars.
Ric is on the national steering committee of the Coalition to
Save Seller Financing: www.savesellerfinancing.org
DODD-FRANK AND NOTE INVESTMENTS
by Ric Thom
SETTING THE STAGE
The following applies to transactions that occurred on or after
January 10, 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 only
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.
Remember that these restrictions only apply to seller-carryback
transactions on properties that have a dwelling that the buyer will
use as theirprimary 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. 10, 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 10,
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: https://www.securityescrownews.com/
PAPER SOURCE JOURNAL subscribers were the first to receive this
information on Dodd-Frank. This is an example of one of the
benefits of receiving the JOURNAL each month. For information,
go to the Journal tab above.
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