How Dodd Frank Law Changes Seller Financing for Investors

I was actually in the process of negotiating a seller finance with one of my tenants and was halted in my tracks. I was reminded that the new Dodd Frank legislation went into full effect on January 10th of this year and will have a huge impact on investors who use seller financing as an exit strategy. While much of the Dodd Frank discussion has been centered around more stringent debt to income requirements for conventional borrowers, I thought it would be helpful to discuss new guidelines surrounding seller financing.

While the seller financing portion of the 900 page Dodd Frank bill is a relatively small fraction of the legislation, it has huge implications for many investors around the country. For many investors, using short-term seller financing plays a major role in their investment business. Going forward, most of these investors will have to re-think how to structure these types of deals (if at all).

At a high level, the new rules break down sellers into 3 distinct buckets:

1.) Individuals and Trusts that seller finance one property or less per year (to an owner occupant)
2.) Individuals and Trusts that seller finance one to three properties per year (to owner occupants) AND and LLC, partnership or Corporation that seller finances less than three properties per year (to owner occupants)
3.) Basically any person or entity that seller finances more than three properties per year (to owner occupants)

As a point of clarification, these rules apply when seller financing to an owner occupant. This is not the same as lending on a commercial property or to another investor who does not intend to occupy the property.

1.) INDIVIDUALS/TRUSTS – ONE PER YEAR

Under this bucket, the following rules are worth noting:
*The Note can contain a balloon (A balloon payment mortgage is a mortgage which does not fully amortize over the term of the note, thus leaving a balance due at maturity.)
*Seller does not have to prove borrowers “ability to pay” (for more information on what this actually means – http://www.dodd-frank-act.us/Dodd_Frank_Act_Text_Section_1411.html)
* Interest rate must be based on index (ex. prime, T-bill, etc) and must be fixed for first 5 years. After 5 years, the rate can only adjust 2 points per year to a max of 6 points above original interest rate.

2.) INDIVIDUALS/TRUSTS – ONE TO THREE and BUSINESS ENTITIES LESS THAN THREE

Under this bucket, the following rules are worth noting:
* The Note cannot contain a balloon payment (this is big deal for investors who typically don’t want to hold a note over the entire amortization schedule)
* Seller does have to prove borrowers “ability to pay”
* Interest rate must be based on index (ex. prime, T-bill, etc) and must be fixed for first 5 years. After 5 years, the rate can only adjust 2 points per year to a max of 6 points above original interest rate.

3.) ALL ENTITIES MORE THAN THREE PER YEAR

For any individuals or entities that make more than 3 loans per year, the new law requires that a Mortgage Loan Originator be involved to complete the transaction. Loan requiremenst are the same as bucket 2 (ie. no balloon payments, prove ability to pay, interest rate restriction)

There you have it – probably clear as mud. This is by no means a comprehensive look at the new law, but probably the most pertinent guidelines for investors who use seller financing.

My advice would be to find a good attorney to help write the note on your first deal under this new law …. and for those investors who do more than three a year, I’d find a good MLO (mortgage loan originator) to help oversee your deals.

Photo: Jenni C

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.