Owner Financing Dodd-Frank and the SAFE Act

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By Attorney William Bronchick

 Owner Financing, Dodd-Frank and the SAFE Act… If you are selling properties to owner occupants and doing selling financing, you ought to be aware of some comprehensive new regulations that have been in effect for a few years, and a real zinger that goes into effect on January 10, 2014.

A few years ago, the “SAFE Act” was passed on the federal level, then was implemented on a state-by-state basis.  The SAFE Act basically required that you be a mortgage loan originator, or use a mortgage loan originator to sell properties with owner financing.  This means getting a loan application like a FNMA 1003, comply with Truth in Lending, and have the buyer sign the ½” thick pile of other lender disclosures.

People panicked when the SAFE Act came out, and declared that seller financing was all but dead.  I simply walked down the hall of my office building and asked a mortgage guy if he could “originate” my seller financing loans.  He printed the stack of documents from his lender software and charged the buyer $400 as a loan origination fee.  No big deal, just a waste of good trees in my opinion.

The SAFE Act was later amended in my state (and many others) to allow you to do three or so deals a year without having to do all this nonsense.  The Act did not address using different entities every three deals, so, as a practical matter, the issue was put to bed for us in Colorado.  In other states, however, there were NO exemptions, meaning unless you were selling your own principal residence, you had to be a mortgage loan originator, or use one in the transaction, even for one deal.  Technically, you can’t even ADVERTISE the seller-financing feature – the mortgage loan originator has to do so.  But, again, as a practical matter I don’t think the powers that be are searching through craigslist or looking for “owner will finance” signs on houses, and the likely scenario is a “cases and desist” letter from your state agency, giving you a chance to get licensed.  No fines, no jail time.

Enter two corrupt, knucklehead politicians named Dodd and Frank.  They managed to pass the Dodd-Frank regulations that go into effect January 10, 2014.  This one is a bit more complex and difficult to deal with, largely because it is confusing and has regulations that have yet to be clarified.

We’ll start with who is exempt and who is not.  If you are selling raw land, commercial property, or to a person who is not going to a live in the property, you have nothing to worry about. If you are a person or a trust, you can do one deal a year, so long as it’s not a “funky” loan, like a reverse amortization, etc .  I know, you’re thinking, “I’ll use different land trusts for each property”, but that may end up blowing up in your face if you get caught.  Admittedly, however, nothing clearly in the Dodd-Frank regulations address this.  We certainly are anticipating a “controlled group” definition to come out soon.  One federal regulator commented that the rule was 25% common ownership, but nothing in the regs back that up.

If you are a corporate entity, then you can do up to three deals a year, if the deals meet the following three criteria:

  1. There’s no balloon in the note (meaning it must be fully-amortizing)
  2. The interest rate is fixed for at least five years, and
  3. You “qualify” your buyer.

Of course, these geniuses did not lay out what the qualifications are supposed to be, except for the debt-to-income ratio (43%)  In my opinion,  you’d be a fool if you sold a property and did not check the buyer’s credit, verify their income (with tax returns and employment), and make sure their gross income is at least THREE times their total monthly debt payments, including the mortgage.  Personally, I’ve always done this and I don’t object to making this a rule, other than the fact that there are already too many regulations in this Country.  On a practical note, if you are selling to a tenant or lease/option tenant, you can use their rental history as strong proof of their ability to repay.

Again, it is not clear if you form a new LLC or corporation for every three deals you can get around all of this, but nobody wants to be the “test case”.  Also, if you want to have a balloon after five years, simply pop the interest rate up so it hurts the buyer enough for him to want to refinance and pay you off anyway (note: you can only increase the rate 2% a year for a maximum of 6% above the original rate).

So, effectively you can do three deals in an entity, and one deal in a trust or your own name if you are strictly following the law. A second entity owned by your IRA and a third owned by your spouse would add six more deals, in theory.  If you buy and sell with owner financing more than 10 times a year, you will likely need to become a licensed mortgage loan originator or hire one on staff, which may not be a bad idea, just a bit of a hassle because the slew of other nit-picky regulations that come with it.  Also, when you are beyond the 4 deal limit, you must not only prove ability to repay, you must DOCUMENT it.  Tax returns, W-2′s, bank statements – the works.  Thus, if you have a self-employed person who looks broke on paper but has 30% cash to put down, you really can’t document his ability to repay (suggestion – lease/option for 2 years, then convert to a owner-carry sale).

Are the Feds going to be chasing down real estate investors for this?  No, the SAFE Act already covers that at the state level. What the Dodd-Frank Act does is provide a buyer who is being foreclosed or evicted with a counterclaim recouping all their interest paid, plus their down payment, attorney’s fees, and court costs.  I always recommend that people settle out of court when a buyer defaults, using the “cash for keys” method.  But on the off chance that they aren’t paying you and can still afford a lawyer, then you will be facing a fight.  One investor I met in Houston recently commented, “If that happens, I’ll just give them the property”.  Since he was dealing in $60k homes, that would be a simple solution.  It’s really rare that you’d end up in court over this Dodd Frank issue anyway, but what keeps me up at night is the slimy “consumer protection” lawyer who puts out an ad that says, “Have you bought a house with owner financing?  Call 1-800-BAD-LOAN”.  Yikes!  Even so, if you do every deal in a separate LLC, then you are limited in exposure to the value of the equity in the home.  If you bought the property subject-to the existing loan with little or no equity, then all you really risk losing is the cash flow from the deal.

So, to sum it up:

You can do one deal per year as a natural person or trust, three deals per year in an entity without being licensed under Dodd-Frank. HOWEVER… if your state has no exemption under the SAFE Act, you still have to use a licensed mortgage loan originator on EVERY deal.

In theory, if you are married and you both have IRAs, then that’s 4 + 4 + 3 + 3 = 14 deals a year in various entities.  That’s a lot of leeway without having to get licensed.

Remember, too, this is only a summary of the Dodd-Frank and SAFE Acts.  You should consult with a qualified attorney in your state before proceeding.  Remember there’s state law disclosures, RESPA, Truth-in-Lending, and servicing rules to worry about, too!!

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70 comments

  1. Bill,

    Super interesting!

    It appears, at least on the surface, that a homeowner’s vesting its property in a non-profit charitable corporation (i.e., one acting solely for the benefit of its members…i.e., the beneficiaries of all the trusts for which it holds title), that there should be no compromise of any of the Dodd-Frank brain-fart.

    In truth, in such a scenario, there really is no real estate being sold, transferred or acquired by a buyer (as we’re dealing only with personalty); and there is no interest-rate consideration and no loan being made or applied for. As well, currently existing and solid, IRS guidelines give both the relinquishing party (settlor) and the acquiring party (co-bene.) all the same benefits of any title transfer and sale, without either one actually taking place…and, as well, nearly perfect asset protection in so much as personalty is non-partition-able by outside judgement creditors, and charging orders are disallowed due to the 3rd-party ownership arrangement (re. Kenoe and others: and we’ve had our share of time in court proving those points over the last 25 years of doing our thing…’without a single failure, successful litigation challenge, or successful due-on-sale call).

    Best regards,

    The other “Bill” (Gatten)

  2. William Bronchick

    Theoretically, Bill, yes, but the Act applies to any loan primarily secured by a mortgage, deed of trust, or “other customary security instrument”. Certainly your Trust is not customary!

    • Good point Bill, however, when there is nothing in the public record but a deed to a charitable, non profit corporation with no mention of a trust, and the corporation holds legal and equitable title purely at the behest of a former owner…’who is to say that the trust’s director couldn’t lease the property to anyone he/she would choose? The resident’s ability to access the “benefits” of ownership (including income tax deductions for interest and property tax) is sanctioned by the IRS and none of our business, doesn’t mean that he/she has ownership, or has purchased ownership, or that ownership has been relinquished, bought or sold (i.e., ‘in as much as the personal property beneficial interest has not been relinquished, nor has any power of direction been relinquished…until after the trust is set and the trustee’s deed recorded.

      Bill, if you’d prefer not having this discussion on your site, I understand and will at once cease and desist (‘though, we would use your trust in the process). But we, at the advice of our overly pecuniarily imbued legal beagles will go balls-out with this program, and we now see Mssrs. Dodd and Frank as our best buddies (‘as we did with the legislators in Texas when lease options became illegal…making us basically the only viable rodeo in town.

      My very best,

      bg

  3. And… you can sell instead with a higher interest.. starting out… (I’ve normally always sold with a starting interest rate of 7.9% – rising 1% per year till it reached 11.9% .. which usually got my people to refi within 2 – 3 years) but, instead start with say… 9 – 10% interest only.. and after year one or two.. it converts to an amortizing loan for 30 years.. after another year it drops to a 25 year loan.. and again the next year to a 20 year loan.. and again the next to a 15 year loan.. and that will cause an increase in payment as well in order to “tickle” them to refi…

  4. Augustus Geeser (aka Gus Geezer)

    Methinks the simple solution is: As a matter of policy I simply will not sell a residence to anyone who is going to reside in that property. I might even put a “DUMMI” clause in the note and deed of trust – “Due Upon Mortgagor Move-In” by the purchaser (if a note can have a DOS clause, why not a DUMMI clause?). The buyer will have to give me a sworn and notarized affidavit to that effect, “so help me God”, that they are not going to occupy the property. What they choose to do with the property after they buy it from me is their own business except for one thing…..the payments on the note better keep flowing into my account like a mighty river. And if they decide after the fact to move into the house, well that’s between them and God. If I’m getting timely payments, I’m not going to enforce the DUMMI clause. Just because the legislators are DUMMIs does not mean that we have to be…….

  5. Augustus Geeser (aka Gus Geezer)

    Problem with selling to the uncle is that the person/couple./family who wants to actually live in the property will then be renters and have no tax benefits, even though they (probably) have made the entire required down payment and are making the monthlies. Maybe I was being too sublte in explaining the DUMMI clause strategy. The DUMMI clause and the signed, sworn, notarized affidavit are CYA. Once someone buys the house from me, even if he lied to me about how it was going to be used (rental vs. owner-occ), there’s nothing I can do about it legally without interfering with his right to enjoyment, except to call the DUMMI note. And why would I do that if the payments are being made on time? Therre’s no DUMMI jail just like there’s no DOS jail. Aside from not making any sense, I’m not even sure it would be legal to say to a potential buyer,” I refuse to sell you this single family home if you intend to live in it.” That would be tantamount to “owner-occupant discrimination”, and THAT would give some consumer protection lawyers a field day.

    BTW, since the new law apparently says the rate needs to be fixed for 5 years, a rate which is fixed to an index is a “fixed rate”; it is the index fluctuation that is variable. Unless the law more specifically defines what is a fixed rate, I’m thinking that my fixed rate will be something like “prime + 12%” with lots of discounts for early rent payments – say pay on the 25th of the previous month instead of on the 1st of the month for which rent is due.

    • William Bronchick

      Catch – as a first lien it cannot be more than 1.5% above the average rate for A credit people, and not more than 3.5% on second liens.

    • It sounds almost like what has been set up is a “rent to own” program of sorts. I certainly agree with your points highlighting the negative aspect of this, the lack of tax credits and real home ownership, but I suppose depending on how the actual rental agreement was set up, it may not be all that bad of a thing for the buyer. Indeed, I’ve always been a fan of renting as opposed to buying. Maybe it is just the poor guy in me walking the poverty line on a daily basis that is saying this, but there is something comforting about being able to escape a lease if need be at the end of the contract term. It may be easier for a real estate broker to be able to gauge if the buyer will be capable of making payments on a mortgage when it comes to buying the house forthright if they rent for a year or two prior. Unless it was a really shoddy property I just wanted to offload, I’d imagine starting it as a rental and moving towards a sale would be ideal. In the least, the house is getting some use and some payments are coming your way until the final deal is made.

  6. Uuumm..
    What I was describing was a fixed rate loan… but the term.. changed

  7. Bill B-
    I listened to a webinar by Mark Torok, a San Antonio real estate attorney. Here is some of what he discussed:
    Part of Dodd-Frank allows a homeowner to claim that the lender failed to verify that the homeowner could reasonably afford the mortgage when it was originated – even though his circumstances may have changed for the worse many years (ten years?) later.

    As I understand it, Dodd-Frank allows the deadbeat to go back and reclaim up to three years of mortgage payments and other costs from the lender, just because the lender didn’t foresee him defaulting when the loan was originated. The increased risks imposed by this little bomb will certainly deal the death knell to many seller carry-back loans and could quite possibly limit the cost and number of new conventional loans when the law takes effect. This look-back law could become a legal and financial calamity waiting to happen for any homeowners and investors who finance the sale of their properties with a mortgage. Just wait until the contingency lawyers start advertising for clients who are in foreclosure or can no longer afford their homes. . .

    Where there is chaos there is opportunity ;o)

    Dan Nicholson

  8. Are the new owner financing laws and regulations included in the owner financing course?

    • William Bronchick

      I will be covering this in my Owner Financing Boot Camp next week, and recording it. So anyone who purchased the course in the last year or so will get a link to a download of the recording of this section.

  9. Hi Bill,

    I love the idea of selling to the uncle on terms and having them lease out to family (rent to own too.)

    Great times for creative real estate!

    Brian Gibbons
    REISkills.com

  10. Thanks for the info. I am doing some research to help a client with a couple of properties, and this gives us a good starting point. In fact, I am sending her the link to your site the moment I finish typing this!

  11. From a consumer’s standpoint, I can thoroughly understand the value of the added regulations placed on people attempting to sell homes. There is something more comforting about dealing with someone with a title like “mortgage loan originator,” especially when we are dealing with a high value product like real estate; but from the other side, the side of those trying to sell houses for profit, I also see the real downside of the Safe Act and this Dodd-Frank addendum of sorts. It seems to strip away the ability for private individuals to really make sales. If someone out there is just buying and flipping houses for profit, it will become much less attractive to do this if you are now entitled to pay a loan originator a share. It’s just a fundamentally unnecessary hurdle to have to jump over, and even worst in states that don’t leave room to exempt people who are just flipping a house or two a year for some extra pocket money. Really, at the end of the day, I’m no expert on this topic, but I’m trying to learn the ropes. I just find it so absurd that buying and selling real estate can be such a complex thing, made even more complex by government regulations. While I suppose things like this are a “protective measure” in some ways, it’s overly biased towards the buyers; and ignores the sellers out there in a whole lot of ways.

    • I think this is a great point, Chris, about people who want to flip houses and keep their overhead as low as possible. It really complicates the idea of wanting to grow your investments in this area.

      Likewise, I understand the desire to protect consumers by having them deal with “mortgage loan administrators.”

      It sounds to me like the SAFE act is coming from the motivation to protect homeowners, but it sounds like it could take a serious bite out of a seller if you are not careful with evaluating someone’s ability and intent to make good on paying a mortgage.

      • While it is, in some respects, protective of the buyer; on the other hand it will likely undermine the purchasing power of some consumers out there who don’t have documentation of their ability to pay. It gets into a sort of grey area, and I believe the actual article touched on this, with what sort of documentation we should rely on as proof of an ability to pay. Indeed, a simple credit score (or an aggregate of scores, which would be better); would be a good starting point. But even then, I can only imagine more emotional judgments coming into play as well as simply financial ones. Does the seller like the buyers personality? How about their race? Seeing as how the SAFE Act is a political issue, these sub-sets of issues should also be addressed. If it is so worrisome to be a seller in this day and age on the real estate market, I’d imagine many judgments like the aforementioned ones would come to light as we evaluate who is fit to rent or own a home. It’s really a slipper slope in its own right.

  12. Lots of great points here to mull over as I look at selling a property with owner financing.

    Figuring out an interest rate has been a bit of a challenge for me, but I think the idea about choosing a rate that’s a bit higher than market level could give my buyer more motivation to refi, which is preferable to me than waiting out the full course of a mortgage.

  13. I have read about this legislation elsewhere, and it’s still muddy. For me, it comes down to what you say above about nobody wanting to be the test case. For the time being, I’m working with a licensed loan originator just to stay on the safe side.

  14. It’s really interesting to discuss this topic as more and more practical information comes to light about the Dodd-Frank Act.

    In the media, the coverage about the legislation was so focused on the ideas of consumer protection that I cheered it on, not realizing at first how it would impact my professional life. Now I am doing a lot of research to be sure that I don’t find myself on the wrong side of the new legislation.

    Smaller-scale investors can get bowled over by stuff like this if we’re not careful. Thanks for posting about it.

  15. It seems to me that if you try to go the route of raising the interest rate a few yrs down the road to encourage buyer to refinance could subject you to the same legal penalties. Even if your 3 yrs past the origination of the loan, the seller may stop paying and cry foul because increased loan payments violate debt to income rules.

    • William Bronchick

      The statute specifically allows you to raise the interest rate after 5 years at 2% per year for a total of 6% above the original rate.

      • Thanks for clarifying this point as I had been wondering about the implications of raising the interest rate. Plus, five years gives the buyers ample time to get organized about doing a refi if they want to–and 2% feels like a reasonable increase.

  16. If I read these posts correctly, a 1st lien sale woud only be able to carry a rate of about 6.5% and a wrap or 2nd lien would only be about 8.5%. Is that correct? I know Texas law allows higher rates but that is only at the state level. Dodd-Frank apparently reduces that at the federal level.

    • William Bronchick

      That’s correct. If you own a property free and clear, then refi it for $10 to a friend, then wrap it.
      ;-)

      • Bill –
        Could you please explain / clarify this refi for $10 / wrap in more detail?
        You lost me in the brevity of this post.

        • William Bronchick

          A first lien has a max interest rate you can charge relative to going rates; a SECOND lien gives you more leeway on what you can charge. So if you sell a free and clear property and take back a first, you are stuck with the first lien interest rate limit. If you have a lien on it, even for $10, then sell on a WRAP (which is a second lien), then get to charge a higher interest rate.

          • That sounds ok. The section 32 loans sound like a problem? I work with investors who buy the houses and then finance them or I work with an entity that loans their own money. My understanding is that they aren’t considered a lender because it is their own money. Is that right? My investors usually charge 12% on 30 yr fixed. What will that do?

          • William Bronchick

            It only applies to loans that are to a buyer who is going to occupy the property as their primary residence. Whether you sell with owner financing or lend to people who live in their home, it’s covered under Dodd Frank.

  17. Fantastic post as always!

    But I am wondering if Dodd Frank applies in other scenarios too.

    For instance, what would happen if I were to purchase a home “Subject To” its existing financing, wherein no NEW mortgage is being created and there are no Seller Carrybacks being created. And then I resell that home to someone else, where they just pay me an amount “cash to mortgage” and then take over that same mortgage subject to.

    Would this be subjected to the Dodd Frank act? Even though the loan was originally created by a big bank say 5 years ago?

    Likewise, what if I purchased a home with seller financing (that does not include any due on sale clause) from a regular home owner. and he is just selling his primary residence. in other words, I buy a home with “seller financing”, that I myself did NOT originate, but then at a later date (perhaps even say tomorrow) I resell that home to someone else and let them take over that seller financing “subject to”?

    Would I now be subjected to the Dodd Frank act? even though I didn’t originate the loan? And what if I did say 20 of these a year, from 20 different sellers, and they were resold to 20 different buyers? would that be stepping over the line, or would I be safe since I never originated any of the loans, and I never re-modified any of them, rather, I just had my buyers pay cash to mortgage, and I didn’t create any second mortgages.

    Ricky in Arizona

    • William Bronchick

      You are correct, in both cases, no new loan. However, if you are selling to a buddy with OF, then he sells to a consumer subject to that loan, it would clearly be within the law. The commentaries to the Act discussed that exact scenario as trying to circumvent the law.

  18. Ok thanks… but so I am clear, when it is subject to an old loan from before dodd frank started, or even a new loan that complied with dodd-frank, we are not subjected to the Dodd Frank Act. because we are not the one originating the financing. and I am referring to an arms length transaction.

    However, if there were a lot of equity in the deal and I were to try to carry my profit and add a carryback on top of the original loan, I would fall under the dodd frank act, because I am creating seller financing.

    but so long as we are just taking mortgages subject to their existing terms, and we aren’t altering them or adding any additional financing, we are not under any guidelines of the dodd frank act… correct?

    • I don’t really have a dog in this fight (‘not my site and I’m not the expert here), but in my experience a question is always better asked, than is a didactic statement.in the form of a questions. And though it’s up to Bill B to address your concerns, not me, I will none-the-less jump in for a second.

      As logical as your reasoning is (‘and it truly is), much of the real danger comes later-on when some opportunistic ambulance chasing bottom-feeder takes on a client who wants to resend your deal, or challenge your foreclosure or eviction and would like nothing more than to “rip you a new one (‘so to speak)” by using Dodd-Frank to nail you in court for being “essentially” an unlicensed mortgage lender or equitable-mortgage facilitator. The effort at that time (guilty or not) will be to run your legal bill up so high that you have to pay out-of-court just stop the (legal) extortion.

  19. I’ve read these new terms on many websites and it appears that these stips are geared towards sellers only. As a real estate investor looking to obtain properties through creative owner financing there is no limit? Provided we can still find sellers that are willing and able to sell under these conditions there are no limits on how may properties a buyer can purchase through these means in a year?

  20. Thank you Bill for putting this in easy to understand language. I tried to read about it on Wikipedia and fell asleep! I can see how this would be a problem is not addressed. Thank you again for making it simple.

  21. Bill, I have a question about the Dodd Frank & Safe Act

    Instead of using a Lease and Purchase Agreement, if we used a Lease agreement and Option agreement and the Option only give the Tenant Optionee the right to buy the property at the end of the lease and option term and did NOT provide for any seller financing would this exempt us from the Dodd Frank & Safe Act (except for vetting the Tenant Optionee to make sure he has a reasonable chance of being able to qualifying for a loan at the end of the lease and option term)?

  22. Hi Bill,

    If a lease and an option has rent credits, subtracted from the purchase price if and when the tenant buyer gets a mortgage, is that construed to be a financing contract, like a contract for deed?

    Would it be better to have a lease and an option without rent credits in this Dodd Frank underwriting environment?

  23. Bill, someone higher up the chain mentioned the webinar with Mark Torak and he had all the above information, but his stance in his webinar and that I have heard from others that if we were to sell a house to an owner occupant on a lease option (unless done perfectly correctly and to hire him to do it for you) that the lease option could in fact become subject to all the rules and regulations in Dodd Frank (of course he is in Texas I think, where Lease Options are a big problem to begin with)

    • William Bronchick

      A simple lease/option for 1-3 years with a very small option credit is clearly not a sale. If you do a loan disguised as a lease/option, then it could be problematic.

      • So if we do a try lease (as in rental) with a security deposit and an option with a non-refundable option fee, then it is two separate transactions. No Seller Financing, so no Dodd Frank?

        • William Bronchick

          So long as it’s not long term and have a declining balance like a loan amortization, then I think it’s fine. Most lease/opts are fine, if you try to get cute and do a 30 year lease/option with a $1 buyout at the end, of course it’s going to look like a loan.

  24. once again government comes in to save the day and ends up sinking the ship.

    • Augie Geeser (aka Gus Geezer)

      “once again government comes in to save the day and ends up sinking the ship.”

      The nine most feared words in America:

      “We’re from the Government, and we’re here to help”

  25. I am very encouraged that lease options are not included in the law. I heard Mark Torok’s claim that they were. I really like the 30 year lease options like John Burley does them. Sounds like I should come up with another way to do them. Could I do a 3 year lease with option and renew every 3 years on the anniversary date with a lower strike price?

    • My fairly well-studied understanding is that any lease for more than 3 years, or one containing an option to purchase the lender’s security is considered a sale and/or seller financing by the lending community (see: 12 USC 1701 j-3). I personally feel that using a land trust transfer (vs. an LLC, option, CFD, etc.) is the only way to be complete safe (re. Dodd-Frank), in that transfer by land trust bene. Assignment is a transfer of personalty and not of realty and there is no sale. purchase or financing of real estate involved: although 100% of all BENEFITS of a sale or purchase cn be enjoyed by the acquiring and relinquishing parties..

      Hey! Ahm just sayin’…

      [Why the right hand alignment?? You got me...]

      • William Bronchick

        Three years is not the standard, that’s the Garn St. Germaine definition that was negotiated into the law. The IRS definition is more appropriate, which is laid out in some tax court decisions. Basically, if it looks and smells like a sale, it’s a sale. The typical 1-3 year lease/option that’s at market rate is fine. I agree with Torok only to the extent that a disguised sale would come under Dodd Frank if it’s not a short-term, simple lease/option.

    • William Bronchick

      A true lease with option is a 1 to 3 year lease at market rent with an option to buy it. The longer you take it, the more you give “rent credits”, the more the balance declines, the more it looks like a sale, not a lease.

      • From my tax research, preventing a disguised sale by the IRS

        STRATEGIES TO AVOID RECHARACTERIZATION OF A SALE:

        Where the parties want to avoid having the lease/option recharacterized as a sale, the overall planning strategy is to avoid or minimize the above indicators of a deemed sale as follows:

        1. The rent should be at or near fair rental value. Breece Veneer & Panel Co., 232 F .2d 319.
        Get a written opinion of the rental value from a qualified real estate professional.

        2. Keep rent credits toward the option price to a minimum.
        Generally, 20% or less is considered reasonable.

        3. The option price should be at or near fair market value.
        Get a written opinion of the market value from a qualified real estate professional.
        Breece Veneer & Panel Co., Ibid.

        4. Try not to tie-in substantial lessee improvements with the option exercise.

        5. Do not pass legal (or equitable) title to the optionee\lessee\buyer.

        6. Demonstrate that you intend to do a lease-option and that you believe the rent and option price to be reasonable. See Benton, 197 F.2d, 745; Lester, 32 TC, 711.

        Use arm’s length lease-option documents along with the counsel of qualified professionals.

  26. Great info Bill! Appreciate it. I am in Colorado and am starting a fix and flip business. The plan is to sell fixed up properties on the MLS with a realtor – no seller financing. I will not know the buyer so do I need to worry about this Dodd Frank law?

  27. Hello All,
    Did I see that the term has to be 30 years? Most seller financed are 10 or 20 year term. Has the length changed with these new laws? Thanks!

  28. Hi Bill,
    I buy subject to and then sell subject to without doing a wrap around mortgage. I collect a down payment and deed the property subject to with signed CYA letters. As part of my contract to sell to end buyer, I create a very small 2nd mortgage with small payments to me and intentionally disregard Dodd/Frank Act.
    What is the worst that can happen to me. Would I just be liable for up to 3 yrs of small payments received by me on 2nd mortgage?
    This is why I bring this up. I do not want original seller to be sorry they ever met me. Their credit could get trashed years later if end buyer defaults on payments on 1st mortgage. This scenario would allow me to stay in the loop. I would be notified of loan default as a 2nd mortgage holder and have chance to work something out with end buyer so I can regain title. This would be win/win for everyone, while giving me another profit center through any loan paydown, appreciation, and collecting another down payment from future buyer.
    Obviously if I could get end buyer qualified and compliant with Dodd/Frank, I would do so and only use this strategy as a backup plan.

    Any thoughts on this?

  29. Okay, so an LLC buys a property for cash, sells it to an owner occupant under the 1 to 3 deal rule (1 to 3 deals every 12 months). Loan has to be fixed rate for 5 years, but can adjust after year 5 by as much as 2%, using a defined index and premium over the index (like LIBOR+X%), for a total of no more than 6% over the initial rate, for the life of the loan, correct?

    And it can’t be a balloon note, so if you do a balloon, and your doing 1 to 3 deals a year, you’ve what? Violated federal law?

    So you could do a first mortgage amortized over 5 years, for a principle amount that would have a payment equal to the full purchase price fully amortized over 30 years, and then do a second mortgage for the remainder (purchase price minus principle balance of first mortgage) that has no payments in years 1 to 5, but is immediately due and payable on day 1 of year 6, correct?

    Example: $100K sale price at 8% over 30 years has a payment of $733.76. To achieve the balloon, setup a first mortgage of $35,750 at 8% amortized over 5 years, for a payment of $732.33, with a 2nd mortgage for $64,250, due in full on day 1 of year 6.

    But the interest rate for the first cannot be higher than 1.5% over competitive rates for A grade customers? That seems ludicrous. “A” grade rates today are around 4.375%, so I can’t charge more than 5.875%, and my likely owner occupants are going to have crappy credit, but I can prove ATR, and I’m stuck with a measly 5.875% rate?

    If I’m in the 1 to 3 rule, seems my first mortgage can be up to 3.5% above A grade rates, correct? Still a bit measly.

    What happens if I want to charge 10% on the first mortgage? Does that just mean I lose QM safe harbor? Is that an issue, if I have a rock solid ATR for the borrower?

    So does that also mean that hard money loans are dead?

    By the way, where is the specific wording that DF only applies to owner occupied homes? The QM rule documentation certainly indicates otherwise.

    Thanks,

  30. There is one thing that I have not seen in this thread and that relates to homeowner’s insurance (fire, windstorm and extended coverage). When the original mortgagor gets a loan he/she must have insurance to protect the mortgagee. When he/she sells subject to, and transfers title, the subject to buyer must get insurance in his name as the seller no longer has an insurable interest. The subject to buyer must have a policy so that personal property is covered. The policy will need to have a ‘loss payee’ showing the lender. If the insurance is left in the name of the original borrower so that the lender will not notice a change, and the payment is escrowed then the property is being insured twice and you can only collect once on casualty insurance. Any suggestions on how to only have one policy and keep everyone covered and happt?

    2. In MS the tax bill that is sent to the mortgagee shows the name of the titled owner. The employee at the lender/servicer may notice that the ownership has changed and potentially cause a ‘due on sale’ letter.

    • William Bronchick

      Yes, the lender usually catches on with the change of insurance payee. The buyer can leave the existing policy in place and purchase a second policy that just names the buyer. However, the additional cost of the second policy can be prohibitive in some states.

  31. If i had a owner financed “wrapped mortgage” in place in Texas from May 2012 that started at 9% and after 2 years ballooned to 18%, would it be affected by the new laws or is there some sort of grandfather clause.

    Thanks

  32. Bill: Thanks for the great article. I understand that that a balloon payment IS permitted under the one property exemption set forth in 12 CFR § 1026.36(a)(5) and IS NOT permitted under the three or fewer properties exemption set forth in 12 CFR § 1026.36(a)(4). However, you seem to suggest that even under the one property exemption a balloon cannot take place within the first five years. Is this your opinion? I know that the interest rate cannot adjust during the first five years, but I’m wondering if there is authority to support the position that no balloon payment can be required within the first five years of the loan even under 12 CFR 1026.36(a)(5)? Thanks!

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