Restrictions you need to know about owner financing

By
Services for Real Estate Pros with RealEstateAgent.com

While searching for your dream house, you may face some challenges that make your dream seem untouchable. It could be a bad credit score, a low income, or the ordeal of going through the conventional lending process. There might be several reasons, but there’s a silver lining for those who face these issues.

 

A viable alternative might be owner financing. Are you wondering how does owner financing work and if it’s a good option for you? Known also as seller financing it’s a transaction in which a property’s seller finances the sale directly with the buyer, either entirely or in part. It is beneficial for both parties because it eliminates the costs of a bank intermediary.

 

Although it might seem like a perfect scenario, it has its drawbacks.

In 2010, the Dodd-Frank Act was signed into law to provide certain protections for buyers in owner-financing transactions. But only for those who occupy the property and only under specific conditions.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act created the Consumer Financial Protection Bureau. Other laws have extended previous regulations on the licensing, training, screening, and compensation practices of loan originators, mortgage brokers, bank officers, and lenders in consumer loan transactions.

 

On January 10, 2014, the Loan Originator Rule enacted the new Dodd-Frank requirements. This rule was extended to include certain restrictions on owner financing in residential real estate transactions. In this case, a mortgage secures the property unless the seller is entitled to specific exclusions.


What is a “loan originator” under Dodd-Frank act?

If a property secures the loan for residential purposes, the person who arranges the loan is defined as a loan originator. Seller-financers must be licensed mortgage originators.

 

The Dodd-Frank Act defines mortgage originators as “any person who for direct or indirect compensation or gain or in the expectation of direct or indirect compensation or gain takes a residential mortgage loan application or offers or negotiates terms of a residential mortgage loan.”

 

The loan originator rules under the Dodd-Frank Act, yet needs the person in question to be licensed. They need to follow ambiguous guidelines to prove the borrower’s ability to repay the loan. And also put through certain compensation restrictions.

 

Under the Dodd-Frank Act, any person who negotiates a residential mortgage loan is considered a “mortgage loan originator.” They must be licensed mortgage brokers in conformity with all laws and regulations. Unless one of the exceptions below.

 

It applies only to mortgages that secure loans on residential properties containing one to four units. It includes houses, apartments, townhouses, condominium units, cooperatives units, mobile homes, trailers, and boats used as residences.

 

The rules apply whether the person purchases a primary, secondary, or vacation house.


Non-applicability

As mentioned above, the Dodd-Frank Act refers only to residential mortgage loans.

  • Thus, Dodd-Frank does not apply to loans secured by vacant land, commercial properties, rental properties, or dwellings used for investment purposes. The rules also do not apply to residential properties where the buyer does not intend to stay.
  • Moreover, Dodd-Frank does not apply to non-consumer buyers, even if the purchased property is residential. Examples of non-consumer buyers are corporations, limited liability companies, partnerships, and so on.

 

So, if Dodd-Frank does not apply as stated above, you do not have to analyze whether the transaction meets one of the two exceptions discussed below.


Exceptions

The Dodd-Frank Act provides exceptions for sellers wishing to sell their property and take back a mortgage. Under these exceptions, the seller-financer will not fall under the definition of a “loan originator” if the seller and the financing terms meet specific criteria, even if a consumer purchases the property for their residence.

  1. First, there is a one-property exception. Under the first exception, a seller-financer extends credit to a buyer as defined above. Secured by a mortgage encumbering a residential dwelling is not considered a “loan originator” if:

(a) they are a natural person, estate, or trust;

(b) they provide financing for only one property in twelve months;

(c) they own the property securing the financing;

(d) they did not construct or act as the contractor for the construction of a house on the property;

(e) the financing must have a repayment schedule that does not result in negative amortization;

(f) balloon payments are allowed (not less than five years recommended to be conservative; but there is a two-year window, and after two years, this allowance may end);

(g) the financing must have a fixed rate or an adjustable rate that resets after five or more years, and there are restrictions, limitations, and caps on rate changes and lifetime caps of rates;

(h) the seller does not have to vet the borrowers or determine the borrower’s ability to repay.

  1. Second, there is a three-property exception. Under this exception, the seller-financer is not considered a “loan originator” if:

(a) they are a natural person, estate, trust, or entity;

(b) they provide financing for three properties or less in any twelve months;

(c) they own the property securing the financing;

(d) they did not construct or act as the contractor for the construction of a house on the property;

(e) the financing must be amortized, and there must be no balloon payments or structures allowed;

(f) the financing must have a fixed rate or an adjustable rate that resets after five or more years and must have caps on rate changes and lifetime caps.

(g) the seller must determine, in good faith, that the consumer can reasonably repay. The seller is not required to document their determination. Still, a prudent seller should keep records in case the analysis is called into question. It could include current or expected income or assets such as income tax returns, employment, monthly payments, debt obligations, etc.

 

Adjustable interest rates must have reasonable annual and lifetime limits on rate increases for both exceptions.

 

Before making any owner-financing arrangement, ensure you know all the laws and regulations to be aware of what it represents. Also, it would be best to address a real estate attorney to help you with the entire process and ensure you understand all the terms and conditions.

Comments (2)

Bill Salvatore - East Valley
Arizona Elite Properties - Chandler, AZ
Realtor - 602-999-0952 / em: golfArizona@cox.net

This is an excellent post with great information. Thanks for sharing it.

Have a super fantastic week! Bill

Jan 31, 2023 06:00 AM
Michael J. Perry
KW Elite - Lancaster, PA
Lancaster, PA Relo Specialist

I was not aware of these provisions in the Dodd-Frank Act . It does seem to be in conflict with the Fed Tax Code that allows Sellers to do an Installment Sale( owner financing to spread out your Capital Gains) ?

Jan 31, 2023 06:45 AM