If you are actively involved in the real estate industry, then you are probably aware of the so-called Dodd-Frank Act (DFA) that went into effect shortly after the 2008 financial crisis. The primary goal of this legislation was to protect consumers from predatory loan practices. However, it has also impacted the way real estate seller financing deals are used and structured.
Seller financing plays an important role in the real estate market, especially when access to credit is limited. If you are not familiar with the term “seller financing,” it is basically an agreement in which the seller of a piece of real estate handles the mortgage process in place of a financial institution, like a bank.
In a seller financing arrangement, the buyer and seller make up the loan terms themselves. They write up a promissory note which details the interest rate, the schedule of payments, and the consequences in the event that the buyer defaults on the loan. This type of arrangement is particularly attractive to real estate investors for a number of reasons, including faster closings, lower closing costs, and flexible down payments.
Under the Dodd-Frank Act, there are several significant limitations and requirements for seller financing arrangements that are of particular importance to real estate investors. For example, the DFA states that no mortgage originator may extend a mortgage loan without making a reasonable or good faith determination that the borrower has the means to repay the debt.
The DFA exempts an individual or an entity, such as a real estate trust, from the designation of mortgage originator provided that the person or entity extends mortgage financing to no more than three properties in any twelve month period. If more than three mortgages have been offered, then an official Mortgage Loan Originator must be involved in the transaction.
There are several other requirements including:
- The seller can not be the builder of the property
- The mortgage is amortized with regular monthly payments
- The mortgage has either a fixed interest rate or is adjustable after five or more years
- The mortgage fulfills other criteria establish by the Federal Reserve Board
To help ensure you are complying with the Dodd Frank regulations, it’s a good idea to consult an experienced lawyer and/or mortgage loan originator to oversee any seller financing arrangements.