Federal Borrower Protections Limit Seller Financing Choices

written by Attorney Kirk G. Siegel

As of January 10, 2014, banks face new federal regulations requiring them to assess the borrower’s ability to repay most residential mortgage loans, intended in part to protect the public from overreaching lenders. An unintended consequence, however, is that many new (but not existing) seller-financing arrangements will become illegal; and, even if sellers are exempt, they may need to become licensed mortgage loan originators. Seller-financed and privately financed mortgages (and potentially land installment contracts) are implicated. Vacant land, commercial property and multiple units (5 or more) are not included in the rule, meaning there are no restrictions on seller financing for these types of properties. The rules are being implemented by the Consumer Financial Protection Bureau (“CFPB”) under the Dodd-Frank act.

 The rules state that a person who “takes, offers, arranges, negotiates or obtains financing for a residential mortgage borrower is subject to the Loan Originator Qualification rules.” There are exceptions, but the exceptions need to be read carefully. The purpose of the exceptions is to spare those who qualify from having to comply with the many rules set forth for “loan originators.” For example, a seller-financing entity taking back financing for 3 or fewer properties per year doesn’t need to be licensed as a loan originator but does need to conduct an ability to repay analysis of the borrower–but the seller cannot have constructed the residence; and the financing must be fully amortizing, cannot have unacceptable adjustable rate terms, and the seller must determine in good faith that the consumer has a reasonable ability to repay the loan.

Similarly, a person, estate or trust who sells only one property in a 12-month period doesn’t need to be licensed if he or she owned the property securing the financing, did not construct a residence on the property in the ordinary course of business, and the loan does not result in negative amortization or have unacceptable adjustable rate terms.

 The above comments are a best effort at summarizing a complex regulatory scheme and should not be taken as legal advice.  The upshot of all of this is that proposed seller-financed and other privately financed transactions should be reviewed by competent legal advisors before they are finalized to avoid running afoul of the regulations.