Some real estate investors and lenders have been sounding the alarm on the upcoming Dodd-Frank changes to seller financing, but most investors will have little to worry over.
As of January 10, 2014, the Dodd-Frank Wall Street Reform and Consumer Protection Act (commonly referred to as Dodd-Frank) went into full effect. The bill was actually signed into law by President Obama in 2010, and since then there has been plenty of buzz around investor circles about its impact and what the Dodd-Frank Act really means. Some real estate investors are worried about some of their seller financing practices and ultimately their assets.
The nearly nine-hundred page bill was drafted, in part, to try and address the many shortcomings of the financial industry, and relevant here is how it modifies mortgage lending practices (including seller-financiers) to try and protect borrowers in the wake of the last housing and financial collapse. Here's what you will need to know to be in compliance, if you make any mortgage loans or do any seller-financing.
Dodd-Frank Act Explained For Real Estate Investors
Residential and Owner Occupied Only – First and foremost, the new law only applies to homebuyers who intend to occupy the home. If you sell strictly to other investors, the remainder of this article is purely informational and does not apply to you. Similarly, the new law does not apply to commercial deals.
Category 1 – Dodd-Frank distinguishes between individuals, trusts or estates who sell to only one owner-occupant buyer per 1 year and those who sell to more than one buyer per year. For purpose of this article, “Category 1” refers to circumstances where the seller (individual, trust, or estate only) finances one property per year to an owner-occupant. Category 1 does not apply to LLC’s, partnerships, corporations or other legal entities.
Under Category 1, the following applies:
- Balloon payments are allowed
- No proof of ability to pay is required
- Note must be fixed for first (5) years, then may adjust no more than 2 points per year with a cap at no more than 6 points above the original rate (the original rate must be based on prime or an index such as T-bill or something similar).
Category 2 – This category references any individual, trust, or estate who sells to more than one owner-occupant buyer per year, but no more than three (3). It also refers to any LLC, corporation, partnership or other legal entity that sells to 1-3 owner-occupant buyers. To be clear, all legal entities are subject to the law in the same way as an individual seller who sells more than 1 property per year. Sellers in this category must abide by the following:
- No balloon payments allowed
- Must determine and show proof of buyer’s ability to pay
- Allowed to do up to 3 transactions without becoming a MLO (mortgage loan originator) or hiring one (an MLO is the shiny new term for a licensed loan officer).
- Note must be fixed for first (5) years, then may adjust no more than 2 points per year with a cap at no more than 6 points above the original rate (again, the original rate must be based on the prime rate or a an index like a T-bill or something similar).
Category 3 – For sellers who make more than three home loans (including seller-financed transactions) in one year, the new law requires MLO status or mandates that an MLO be hired to complete all transactions. Sellers in this category, whether individual or legal entities, follow all of the same rules as Category 2 sellers otherwise.
The law does not apply to commercial, multi-family properties with 5 or more units, or vacant lots/land, even if the buyer intends to occupy it as a residence.
Investors who take the time to understand the new changes know there is no need for panic and may, for the most part, continue to operate as they have been. The thing to keep in mind, which has always been the case for scrupulous investors, is professional and fair treatment at all times. Dodd-Frank is simply another approach to consumer protection. Investors can protect themselves and the consumer by simply knowing and following the new rules.