Tuesday, September 23, 2014

Thoughts on Dodd-Frank Seller Financing

A question that comes up often in my Dodd-Frank classes is: Can a seller carry financing on a house without getting in trouble?

There are a few components to consider in that question:
  • Is a license needed?
  • Does ATR apply?
  • Is the financing transparent to the buyer/borrower?
This is not meant to be legal advice, just educational observation of points one should probably consider. Always begin any discussion regarding this topic that sellers doing financing should have a conversation with the attorney who would represent them in the worst case scenario of being pursued under the Dodd-Frank Act, because from a legal analysis standpoint we are missing a major leg to the stool, which is legislative intent as decided by a court. We can only go with the words the law states, and interpretation by the Consumer Financial Protection Bureau (CFPB), along with how the CFPB chooses to enforce.

However, that doesn't mean the CFPB will always be correct in interpreting the application of Dodd-Frank, think back to your high school government class: checks and balances in federal government.

The executive and the legislative branches have been heard, but the judicial may have a say at some point. We are missing the case law needed for a complete legal analysis, the law is too new, but case law will slowly come.


For example, the Federal Trade Commission (FTC) has been on the wrong side of the court opinion in interpreting the Fair Credit Reporting Act. Just because the federal agency tasked with enforcement says "this is the way it is," sometimes a court says, "sorry federal agency, but you are mistaken." The FTC has been in that position occasionally, but not often. Recently the Equal Opportunity Employment Commission (EOEC) was shot down by a district court in a case against Kaplan Higher Learning, alleging the use of credit reports in employment background checks was a form of discrimination (Case: 1:10-cv-02882-PAG). The court sided with Kaplan over the EOEC. Case law will unfold on Dodd-Frank as it pertains to licensing and ATR, it will work its way through and up jurisdictions, and maybe one day we will see it as a case before the Supreme Court. Or maybe we won't and we are overthinking the seller carry issue, but it is always safer to analyze the worst case scenario when possible.

The CFPB may find itself experiencing the same judicial findings at some point. What we know is that courts have not weighed in yet on interpretation to the extent we are bound to see in the future.


That being said, the first question is whether the seller is even considered an originator:   12 CFR §§ 1026.36(a)(4) and (a)(5) suggests limited extension of financing probably excludes a seller if they doing less than 3, or only 1 loan a year.


See all of page 144 - 145, but CFPB response is ATR applies to creditors originating more than 5 loans in a year



From CFPB: The Bureau received numerous letters from individuals concerned that the rule would cover individual home sellers who finance the buyer’s purchase, either through a loan or an installment sale. However, because the definition of “creditor” for mortgages generally covers only persons who extend credit secured by a dwelling more than five times in a calendar year, the overwhelming majority of individual seller-financed transactions will not be covered by the rule. Those creditors who self-finance six or more transactions in a calendar year, whether through loans or installment sales, will need to comply with the ability-to-repay provisions of § 1026.43, just as they must comply with other relevant provisions of Regulation Z.


The points above give the appearance that this stuff may not apply to the individual seller acting within the published limits, but there is one more angle, and that is of the Small Creditor provision for a lender doing 500 or less loans a year, they can do balloons until 2016, at which time only rural small creditors will be able to do balloons, but in order to do balloons under this provision all other QM requirements have to be met, and the balloon could not be less than 5 years it appears, here is the chart:



On June 12, 2013, the Bureau published a final rule amending the Ability-to-Repay Rule (78 FR 35430). Among other things, the final rule adopted §1026.43(e)(6), which provides a two-year transition period during which small creditors as defined by § 1026.43(e)(5) can originate balloon-payment qualified mortgages even if they do not operate predominantly in rural or underserved areas.



I hope this helps, not completely clear, but the statement made by the CFPB in the ATR Preamble seems to support that there is no intent to go after sellers who do not meet the standard of a bonafide lender.


Personally if I were giving a loan as a seller, I would follow the ability to repay guidelines simply because they are basic ways to make sure this person can actually pay back the loan, but also it may prevent someone from trying to work an angle of predatory lending, which ultimately is what the Dodd-Frank Act is designed to prevent.


There are 8 underwriting factors to make a reasonable & good faith determination of the ability to repay:

  1. Borrower’s current or reasonable expected income or assets, except for value of dwelling that secures the loan.
  2. Borrower’s current employment status (assuming creditor relies on employment income in determining repayment ability).
  3. Borrower’s monthly payment on the covered transaction, calculated in accordance with Appendix Q in final rule, which closely follows the FHA 4155 guidelines.
  4. Borrower’s monthly payment on any simultaneous loan the creditor knows or has reason to know will be made, calculated in accordance with the Rule.
  5. Borrower’s monthly payment for mortgage-related obligations.
  6. Borrower’s current debt obligations, including alimony, child support or other liabilities due monthly or will have payments within 12 months from the closing date.
  7. Borrower’s monthly debt-to-income ratio (DTI), calculated according to the rule. Residual Income also taken into consideration on HPML loans.
  8. Borrower’s Credit History.


What transactions does this apply to?

  1. Primary residence
  2. Second/Vacation Home
  3. Only applies to investment properties is the borrower will live in the property for more than 14 days a year, otherwise investment properties are excluded


Exempt loan scenarios:

  1. HELOCs
  2. Reverse Mortgages
  3. Bridge Loans and Construction loans with a term of 12 months or less
  4. Timeshares
  5. Investment properties for business purposes (e.g. borrower doesn’t occupy the property more than 14 days out of the year)
  6. Loans made pursuant to Housing Finance Agency Programs (HARP/HAMP, etc.)
  7. Community Housing Authority issuing Down Payment Assistant Loans,
  8. FHA Streamline Refinance if meets HUD guidelines


QM and Temporary QM cannot have the following toxic features (there are exceptions for small creditors):

  1. Payments with deferred principal
  2. Negative Amortization
  3. Interest Only Payments
  4. Balloon payment
  5. Terms in excess of 30 years
  6. Irregular payments (except ARMs)
I hope this gives you some points to consider, go to www.CreditLiteracyProject.com to learn more about credit and mortgage financing, there are some cool webinars available on demand at no cost.

Patrick Ritchie

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