Questions about Structuring a Seller Carryback in CA

[Mike S.]

I am in negotiations with a potential seller who owns a property free and clear and is willing to "entertain" the idea of a seller carryback. She is fixed on a certain number (sales price) and I have been playing around with the numbers trying to figure out a way to make this work for both of us. My strategy here is a mid to long term appreciation holding the property as a rental.

Are there specific rules I need to adhere too when structuring a seller financed deal in the state of CA?

are loan terms like these permitted:

balloon payments

longer than 30 yr loan terms

no prepayment penalties

[Bill Gulley]

Well, this is rare, Dion, in the seller financed world, I'd have to address each of those first three matters you mentioned.

Balloon payments, I think he's saying that the balloon payment can not be before half the principal has been paid. This is under Dodd-Frank for non-qualified mortgages. You may have said the same thing, but awkwardly as this is the basic language used in the Act.

If you are doing a commercial loan, there are no restrictions to a balloon payment except in view of predatory lending practices, doing so beyond the reasonable ability of a borrower's ability to pay or meet that obligation. While a seller may be exempt from Dodd-Frank and could do a balloon, it would be very advisable to approach that with a strong justification showing the ability to pay and attempt to comply with the Act as much as possible.

Amortizations: Dion got carried away, too much coffee maybe. Of the thousands of notes I've been through no seller financed note exceeded a 30 year amortization. Mentioning 100 years in Japan is silly, no loan of any kind is amortized like that in the U.S. that would be viewed as purely predatory lending here as there is no significant pay down. Increasing the amortization also just violates all kinds of prudent practices, your property could depreciate faster than the loan would be reduced placing the borrower underwater, tax issues would likely arise (deferring principal) an ongoing interest expense and in an installment sale, which is what seller financing is, probably wouldn't come close to being seeing at arm's length, valid or as a legit transaction. 50 years is just as silly.

There are conventional loans at 40 years and those are rare as hen's teeth and were more of an experiment to making homeownership affordable. That is absolutely no direction for an installment loan to go.

Loans are amortized up to 40 years, rarely, that would be the longest term and that note amount would need to be high to give a justification for going there. 40 years is an unqualified mortgage, it takes on additional liability in it's origination. The entire loan must be viewed as well, is there enough of a principal reduction to establish an equity amount to refinance?

Seller financed notes have a very long history of acceptable practice and a 30 year amortization is the standard for residential loans.

Let me come down from the ceiling. Common sense, if you needed a longer amortization than 30 years to make a deal cash flow at an acceptable level, that means you don't have a deal!

As an investor or dealer, you make the offer and everyone including any judge (outside of Colorado smoking something) is going to know that you not only made an offer but that you also engaged in some salesmanship in trying to get your offer accepted. You talk some unknowing type into doing something wildly unorthodox and totally unconventional you take on the liability and responsibility for what you get others into. If you hang a seller with a less marketable note, one that doesn't allow the reasonable collection of principal that does not make you a superstar RE investor, it makes you an idiot, doing stupid things to get $70 more in cash flow, it sets you up looking predatory. Search "predatory dealing"!!!!

Dodd-Frank sets the maximum loan amortization at 30 years for non-qualifying mortgages, again, which is what a seller financed note will be.

Prepayment penalties. To conform to Dodd-Frank, there may not be a PPP.

If compliance is not required, there are two areas where the PPP is used, unless prohibited by state law.

1. Where in consideration of providing financing the seller is to avoid the gain on sale and they may have a penalty equal to the tax liability arising from the early payoff, over a reasonable term, such as for the first 3 or 5 years.

2. Where, in consideration of the interest charged (meaning not sky high bit lower rates) the borrower may guarantee a certain amount of interest to be paid over a term, again like 3 or 5 years.

3. Commercial loans may and often do have a PPP as a guarantee of interest and servicing periods, 5 years is common and usually won't exceed 10 years or until half the original principal has been paid on shorter amortized loans.

We have two different issues here, residential notes with owner occupants that must conform to Dodd-Frank (DF) and exempt residential notes. I can't stress enough that those who may be exempt make every reasonable attempt to comply with the intent of DF as the restrictions are and will be seen, just as any other regulation, as a base line for fair dealing.

Then you have commercial loans, these won't be held strictly to DF but they will be to the Uniform Commercial Code (UCC) and acceptable commercial underwriting.

The days of two old farmers meeting over a fence post and selling land on terms, writing out an I.O.U. are long gone.

The acceptable play ground for investors as to an amortization on a SF deal is 1 to 30 years. The interest rate area is above the imputed tax rate that changes, guessing now around 3% and the ceiling of any state usury law, some being at 10%. Interest rates are`set to as to risk, an equity loan is not usually seen as a high risk issue that can be justified if there is the ability to pay which will always be required. The down payment is flexible, 10% down is common, it's not impossible to do 100% financing, but it needs to be reasonably secured and with a borrower that is capable of paying and that would really be to an investor, not a homeowner.

There are tons of posts here about seller financing, pre and post DF, read them and understand where the info is coming from and when the post was made in relation to DF.

I did mention in another post that one might be creative in extending an amortization to offset other matters, I should have said within limits and under prudent origination conditions, I feel that I may have set Dion's mind in motion, pushing him over the edge into a philosophical financing black hole. :)