There has been a lot of doomsday talk from real estate investors about this scary new legislation known as the Dodd-Frank Act (shortened from: Dodd-Frank Wall Street Reform and Consumer Protection Act).
First and foremost, if you do not deal with owner-financing, you don’t need to worry about it. If you do sell with owner-financing, you will want to pay close attention to what this new legislation requires you to do now.
Don’t worry. It’s not really that scary. We just need to follow more guidelines (that are admittedly a little blurry – as is most government legislation) to make sure we comply.
In a very small nutshell, you need to make sure you follow certain steps and meet certain criteria when qualifying someone for a home loan.
For this post, I’ve asked my good friend, Erik Saengerhausen to provide some insight. Erik owner-finances a lot of houses and has spent a lot of time and energy making sure he is compliant. In this post, he shares the key points of what he’s learned.
Thanks for providing this valuable information, Erik!
Hi, My name is Erik Saengerhausen and I am with Alamo Home Source in San Antonio Texas. We buy, rehab, and sell a high volume of homes every year with owner financing. We do our best to stay on top of the laws and regulations. I want to offer some insight into what we’ve learned about the Dodd-Frank law changes.
Effective January 10th, 2014, The “Qualified Mortgage” and the “Ability to Repay” provisions of the Dodd Frank Law go into effect. This provision will affect all mortgages that are secured by a first lien on a “principle dwelling”.
Here are the basics of the new regulation according to the CFPB:
Now, if the loan you originate meets the above requirement your loan is considered a “Qualified Mortgage”. This designation affords the creditor either a “Safe Harbor” or a Rebuttable Presumption of compliance depending upon the interest rate and the type of creditor you are considered.
Some other rule changes have to do with interest rate: If you are above a certain interest rate, then your buyer will have to go to “credit counseling” prior to closing and after they have received the disclosures. This is a big deal for us, as we have two options:
Lower interests rates: This will cause a problem when we go to discount the note, as we will have to discount it more to give our note buyers the same return or we will have to offer our note buyers a lower return.
Send clients to “credit counseling”: This becomes a problem, as it slows down or “throws a wrench” in our timeline before closing. I am sure it will also cause us to lose a couple deals a year. It is an hour and a half long meeting they have to attend. The credit counselors will go over all documents and disclosures and speak to the buyers about their finances to see if they are able to afford the house you are trying to sell them…Gotta love the Government!! This of course is free to your buyers.
I believe the numbers are 6.5 points above the daily prime offer rate. If you are at or above this then you will need to send your clients to credit counseling. Now, one thing to consider is it is not the interest you charge but the “total interest” or “annual percentage rate” that is shown on your disclosures. So, for example, if you are charging 11.9% interest, after you factor in closing costs etc. your annual percentage rate is really 12.2%. This of course all depends on what your client is paying for closing costs. This APR can go up or down. In this scenario we would have to send our clients to credit counseling to stay compliant with the new laws. In order to stay out of the credit counseling you will need to be charging under 6.5% of the daily prime offer rate.
The good news is that if you are considered a “Small Creditor” (less than 2 billion in assets or originating less that 500 loans per year) you are given more flexibility than a large creditor to meet the new requirements.
You will find a flow chart here http://www.consumerfinance.gov/f/201309_cfpb_smallcreditorflowchart_final.pdf
that will help you to better understand the ins and outs of which category you fall in and what it will mean to you. If you are like me when you start reading laws and regulations your eyes bleed. I like simple things like this chart to better help me understand the ramifications of the new laws.
For more information on Dodd Frank, please visit http://www.consumerfinance.gov/mortgage-rules-at-a-glance/
For more specific information on rules for small lenders (most of us that do owner-financing) see this document (specifically ‘i. Type 1: Small Creditor QM (§ 1026.43(e)(5))’ around page 33 of the PDF Document): http://files.consumerfinance.gov/f/201310_cfpb_atr-qm-small-entity_compliance-guide.pdf
sounds like an opportunity to start a credit counseling business and include that 1 1/2 hour course as part of the closing? Wonder if that would be “legit” enough for government.
It’s hard to say exactly what would be ‘legit’ at this point. That’s what everyone is scratching their heads about…the interpretation. There are so many opinions floating around.
Your idea might be a good one.
Well that’s just one more annoying thing we have to deal with. I can see why that legislation was passed though, there were tons of tenant buyers who screwed themselves over by accepting buy terms on a property that they could never afford.
It really just boils down to making sure you properly qualify your buyers when offering financing.
Good stuff, Danny. This SAFE Act and Dodd-Frank stuff never ceases to confuse the heck out of me. Would you be willing to do a sample case study using Erik’s setup as an example? I would love to see the start to finish of how a owner financing transaction now looks (not necessarily with every detail–that could fill a book I’m sure!).
Great idea, Brandon.
I will definitely consider doing that in the near future. I’m sure there would need to be a big disclaimer though saying you should check with a capable real estate attorney about how you should follow the laws.
Not sure if I missed something, but Does this apply to lease options as we’ll?
I never did do lease options and they are now illegal in Texas, so I won’t be doing them. Disclaimer: Definitely check with a local attorney.
From what I understand, if you allow any sort of principal paydown, you will have to follow Dodd-Frank. If you do not offer ANY sort of principal paydown, it’s really just a lease and you do not have to follow it. Hope that helps.
And if someone else has more insight into this, I love to hear it.
Not completely true… I bought and rehabbed a house that was supposed to close to my end buyer a couple weeks ago. since Dodd Frank went into affect my buyer could not close. they had a foreclosure 2 1/2 years ago. Before Dodd Frank the FHA would allow them to get a loan 2 years after their foreclosure. After Dodd Frank they have to wait 3 years to get an FHA loan.
Thanks for the input, Jeff.
Yes, buyers will have to meet more stringent qualifications to get loans and that could affect how quickly you sell a house and for how much you sell it.