As indicated above, the Dodd-Frank Act applies only to residential mortgage loans.
1. Therefore, Dodd-Frank does not apply to loans secured by vacant land, commercial properties, rental properties or properties used for investment purposes. The rules also do not apply to residential properties on which the buyer does not intend to reside.


2. Further, Dodd-Frank does not apply to non-consumer buyers, even if the property being purchased is a residential property. Examples of non-consumer buyers are: corporations, limited liability companies, partnerships, etc.


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




Even if the transaction involves property being purchased by a consumer for their residence, 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,” 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.




A lease option contract where an owner rents out residential property to a tenant and gives the tenant an option to purchase the property after a specified period may also be subject to the new Dodd-Frank Act, if any of the rental payments are used as a credit toward the purchase price or create ownership equity in the property.




There may be some restrictions on a person who purchases a property, fixes it up, flips it quickly, and takes back financing from the buyer, in that the seller may be considered a contractor. Such a seller should still adhere to one of the above exceptions, particularly if the renovations required the seller to obtain building permits. The rules do not apply, however, to a seller who extends financing to an investor-buyer who does not intend to reside on the property.




One way to possibly make closings happen with an individual owner/lender is to have two closings in which the seller-financer first buys the property, so then he or she can immediately sell it to, and finance it for, the borrower, subject to the limitations contained in the exceptions. However, you have to deal with two closing costs and other risks. The contract would have to be assignable as well.


This potential loophole carries a risk, however. There is a general rule of law that one cannot do indirectly what is prohibited directly, especially if one acts repeatedly in the same way, creating a pattern.




So, what if Dodd-Frank applies to a seller-financer or an individual lender, and that seller-financer, the individual lender, or the transaction does not meet the requirements of either the one-property exception or the three-property exception? Do you abandon the deal? No. It will cost the seller and/or the buyer some money, but the seller (or the individual lender, if not the seller) or buyer can contact a licensed, independent loan originator who we all know as a mortgage broker. Dodd-Frank allows a seller-financer or individual lender who does not otherwise comply with Dodd-Frank to still provide mortgage loans if they provide the loans through a mortgage broker, provided further that the mortgage broker complies with all of the various lending laws and regulations, including but not limited to, the Dodd-Frank Act, the SAFE Act, RESPA, the Truth In Lending Act, and Regulation Z. Since the mortgage broker will be lending the seller-financer’s or individual lender’s money, the broker may be considered the agent of the seller-financer or individual lender, in which case, the latter will be potentially liable if the former fails to comply with all of the lending laws and regulations. Therefore, the seller-financer or individual lender should use only a competent and knowledgeable mortgage broker.




What happens if there is a violation of the Dodd-Frank Act and other related laws? The penalties are very harsh if there is a violation of the various federal requirements, including the Dodd-Frank Act, the SAFE Act, RESPA, and the Truth In Lending Act, in that there could be a private right to sue for violations and to be reimbursed attorneys’ fees and costs, penalties of up to $4,000.00 to $5,000.00 per day at a minimum, $25,000.00 for reckless violations, and $1,000,000.00 per day for knowing violations. There could also be actions against the violator such as rescission or reformation of contract, refund of borrower costs, return of interest paid, return of real property, restitution, disgorgement or compensation for unjust enrichment, private damages, other monetary relief, and other relief currently undefined.


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