Exceptions to Dodd Frank Seller Financing

From the code:

The Dodd-Frank Act provides certain exceptions for sellers who wish 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 certain criteria.

The two exceptions are as follows:

1. First, there is a one property exception. Under the first exception, a seller-financer who 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 a twelve month period;

(c) they own the property securing the financing;

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

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

(f) balloon payments are allowed (not less than 5 years recommended to be conservative;

however, there is apparently a two-year window, and after two years this allowance may terminate);

(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;

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

2. 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, or trust, or an entity;

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

(c) they own the property securing the financing;

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

(e) the financing must be fully amortizing 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 also lifetime caps.

(g) the seller must determine, in good faith, that the consumer has a reasonable ability to repay, and while the sellers are not required to formally document how they made their good faith determination that the buyer had the ability to repay, a prudent seller should keep records in case the analysis is ever called into question. This could include current or reasonably expected income or assets, income tax returns, employment, monthly payments, debt obligations, debt to income ratios, credit history, etc.

For both exceptions, adjustable interest rates must have reasonable annual and lifetime limits on rate

increases and provide for the rate to be determined by the addition of a margin to an index rate based on a widely available index such as indices for U.S. Treasury securities or LIBOR. CFPB’s Official Interpretations note that an annual rate increase of up to 2 percentage points is reasonable. A lifetime rate cap or ceiling of 6 percentage points, up to any applicable usury limit, subject to a minimum floor, is reasonable. These “safe harbors” are not mandatory, but sellers would be wise to adopt them.

It is important to note that a corporation, partnership, or LLC can never avail itself of the one property exception, and may only use the three property exception.

A potential loophole would allow for a corporation to convey the property in question to its individual members/owners, who could in turn provide seller-financing under the terms of the one property exception. However, taking advantage of such a loophole under the new laws is very risky, and not recommended at this point.

Additionally, no matter what, under either exception there can be no mandatory arbitration, and the parties cannot waive any of the Dodd-Frank requirements or restrictions.

3. There is an additional exception for lenders or sellers who finance less than six dwellings in a twelve-month period.

Under this exception, these lenders are not considered “creditors,”1 and are exempt from the ability-to-repay provisions under 12 CFR §1026.43.

However, they are still considered “loan originators” for purposes of the licensing and compensation requirements, and must still comply with other relevant provisions under Dodd-Frank.

Therefore, seller-financers should rely only on the first two exceptions described above.

As mentioned, the laws and definitions are very confusing and unclear.

4. Lastly, there are other exceptions for qualified mortgages, but they are very complicated and allow only for a presumption that the ability-to-repay requirements have been met. As a practical matter, these exceptions do not assist local seller-financers