The Dodd Frank Wall Street Reform and Consumer Protection Act took full effect in January 2014 – a wide-ranging piece of legislation that affects how sales of residential real estate are managed. In an age when more property sales than ever before are conducted strictly between buyer and seller, it’s important for investors as well as home buyers to know what Dodd Frank has to say about seller financed property transactions.
The Dodd Frank Act, as it’s popularly known, came into being after the disastrous bursting of the housing “bubble” back in 2008. As foreclosures mounted, so did allegations and evidence of bad practices on the part of the biggest US banks responsible for making mortgages easy for even the least qualified buyers to get.
Dodd Frank became law in 2010, as a result of demands for greater accountability for banks and better oversight of the mortgage lending industry as a whole. And because so many of the homeowners who ended up defaulting outright on mortgages they couldn’t handle, or “underwater” with suddenly ballooning payments, the “consumer protection” part of the act was implemented to help protect those vulnerable buyers.
The provisions of Dodd Frank touch just about every aspect of real estate transactions large and small, with emphasis on “small” – the Act isn’t intended to address issues with commercial real estate or purchases by large investment groups.
We’ve talked in previous articles about the major provisions of Dodd Frank. These include the Qualified Mortgage Rule, which required banks to service “qualified” mortgages meeting a specific set of standards in order to avoid penalties, and Ability to Repay standards, which mortgage applicants must meet in order to qualify for a loan.
But other provisions in Dodd Frank also affect investors dealing in rental income property. And when those transactions involve private financing by the seller, it’s important to be aware of some important distinctions.
Opportunities to start building wealth through income property are everywhere – and the digital revolution makes it easier than ever to find them. Buyers and sellers can connect across country – or across the globe. And increasingly sophisticated digital tools make it easier than ever to close those deals without resorting to the services of a mortgage broker or other industry professionals.
Dodd Frank’s regulations on seller financing apply only to residential property transactions involving three or fewer properties; more than that, and the transaction becomes commercial = a cutoff that holds for most mortgage lending.
Dodd Frank’s seller financing rules also apply to sales to “owner occupants.” And while that might seem to exclude investors, it’s worth remembering that many investor-entrepreneurs live in one property they own and rent out the others, or occupy one unit of a multiplex whose other unites (four or fewer) are rented out.
As a recent article from the National Law Review points out, Dodd Frank’s broad regulations on seller financing require sellers who finance the sale of their own properties to be designated “mortgage originators.” That is, they must be a licensed mortgage originator themselves or use the services of one in the transaction. Buyers need to meet the usual standards for qualifying for a mortgage.
But those regulations don’t apply if sellers are financing three or fewer residential properties within a 12-month period. The seller must own the properties, and the seller must not have been involved as a business with the construction of any residence on the property.
Dodd Frank also puts limits on the kind of loan a private seller can finance. Mortgages handled by the seller can be either fixed or adjustable rate, but the seller needs to determine in good faith that the borrower can repay the loan. And if rates do adjust, they must be tied to a major index such as LIBOR.
If only one property per year is involved, the seller isn’t required to document the borrower’s ability to repay the way mortgages originated by bank lenders do. But if that seller finances more than three properties in a year, he or she is subject to the same documentation requirements as any other licensed mortgage originator.
As Jason Hartman always advises, successful investing depends on a diverse portfolio – and being open to good deals wherever they might be. And knowing how Dodd Frank’s new provisions affect both sellers and buyers is a key to making those transactions work for long term investing success. (Featured image:Flickr/gorogen)
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