Seller Beware: New Laws on Seller Financing have Broad Reach in Real Estate Sales
By Daniel Rice (Winter 2013-14)
In an effort to curb the mortgage lending abuses that contributed to the Great Recession, Congress and the Oregon legislature in recent years approved new laws imposing stricter controls on residential lending practices. Together, these laws: 1) broaden the type of real estate activities that require a mortgage broker or originator license; 2) require greater scrutiny of a buyer’s ability to make loan payments; and 3) generally limit a seller or professional advising a seller from steering a buyer into non-traditional loans with less favorable terms than a buyer could obtain through traditional bank financing.
The laws do not apply just to banks or professional mortgage brokers. Anyone involved in a residential real estate sale with so-called “seller-carry financing” can run afoul of the laws and face negative consequences. As this article highlights, both sellers and professionals advising them must proceed with caution in a seller-carry financing transaction.
I. Seller-Carry Financing Described
Seller-carry financing includes any arrangement in which the buyer does not borrow or use cash to pay the seller in full at closing. Instead, the seller “carries” the all or part of the purchase price.
The seller might deed the property to the buyer at closing and take back a promissory note for all or part of the purchase price, secured by a trust deed that the seller can foreclose in the event of default. Often in this type of arrangement, the loan will call for a balloon payment after several years, with the idea that the buyer will be able to refinance through a bank loan before the balloon date.
Alternatively, the seller and buyer might enter into a landsale contract. In a landsale contract, the seller keeps title to the property while the buyer makes installment payments. The seller deeds the property to the buyer only when all the payments have been made.
Most people involved in seller-carry financing transactions probably do not equate their actions with professional lending or mortgage broker activities. Nevertheless, their conduct can be regulated under Oregon’s Secure and Fair Enforcement for Mortgage Licensing Act (“S.A.F.E Act”) and the federal Dodd-Frank Act. Sellers and professionals advising them should become familiar with the licensing requirements under theS.A.F.E Actas well as the “ability to repay” and “anti-steering” provisions in the Dodd-Frank Act.
II. S.A.F.E Act Licensing Requirements
A. Basic Licensing Requirements
Congress enacted the S.A.F.E. Act in 2008, among other things, to establish a nationwide licensing registry of professionals engaged in residential mortgage origination or broker activities. The federal legislation required states to adopt minimum mortgage professional licensing requirements, and the Oregon legislature responded in 2009 by enacting the requirements in ORS chapter 86A.
The baseline requirement is that any individual who acts as a “mortgage loan originator” in connection with a residential sale must have a mortgage originator license. Obtaining and maintaining a license requires, among other things, submitting to a background check, completing education requirements, and posting a surety bond. Knowingly violating the license requirement can result in felony criminal liability.
While intended to regulate full-time mortgage professionals, the law has broad enough definitions to include sellers providing financing in a transaction and professionals advising them, such as Realtors, lawyers, or financial advisors. A “mortgage loan originator” is defined as anyone, “who, for compensation or gain: (A) Takes an application for a residential mortgage loan; or (B) Offers or negotiates terms for a residential mortgage loan.” A “residential mortgage loan” means a loan secured by a trust deed or other type of security interest in a residential property. Thus, sellers in a seller-carry financing situation and the professionals advising them may need to obtain an originator’s or broker’s license to comply with the law, unless one of the exemptions discussed next applies.
B. Exemptions from Licensing Requirements
One key exemption applies to individuals selling property that is or was at some point their primary residence. No license is needed to negotiate seller-carry finance terms for such a sale.
Under recent amendments, an individual may also, without a license, engage in up to three seller-carry transactions per rolling 12-month period (even if the transactions involve properties that have not served as their primary residence) as long as the individual does not hold more than eight loans at one time. Legislators added this exemption mainly to allow individuals to finance a vacation or rental property.
The law also exempts professionals from the licensing requirements in some circumstances. For instance, real estate professionals may engage in some activities considered “incidental” to their usual professional role such as promoting the seller’s willingness to provide financing in listing materials. Realtors, however, may not discuss or negotiate the terms of the financing with the buyer unless they are licensed.
A lawyer may directly negotiate or offer seller-carry financing terms on behalf of a client only if that activity is ancillary to the lawyer’s representation in an independent matter. A lawyer retained to represent a client in a divorce, for example, could negotiate a seller-carry finance transaction for a property sold in connection with the divorce proceedings.
Professionals should note that they cannot claim the benefit of a seller’s exemption. For example, even though an individual would not need a license to carry financing for the sale of the individual’s principal residence, a Realtor could not negotiate the terms of the financing on the seller’s behalf without a license. The bottom line is that, in most circumstances, if a Realtor or other third-party professional is involved in a seller-carry financing transaction, a licensed mortgage professional should negotiate the financing.
III. Ability to Repay and Anti-Steering Prohibitions Under the Dodd- Frank Act
As if the loan originator and broker license requirements were not technical enough, individual sellers and professionals also need to become familiar with the new “ability to repay” and anti-steering requirements under the Dodd-Frank Act, which can also affect seller-carry finance transactions.
A. Ability to Repay Requirements
The Dodd-Frank Act imposes a requirement that “creditors” verify a borrower’s “ability to repay.” A “creditor” is anyone who extends consumer credit more than five times in a calendar year. Many sellers financing a single real estate transaction probably do not qualify as creditors within the meaning of the Act. However, for those sellers who qualify as creditors because of involvement in multiple seller-carry transactions or extensions of consumer credit in other circumstances, the “ability to repay” requirements carry particular significance.
The Dodd-Frank Act provides eight factors to measure a buyer’s ability to repay: 1) current or reasonably expected income or assets; 2) current employment status; 3) the monthly payment on the covered transaction; 4) the monthly payment on any simultaneous loan; 5) the monthly payment for mortgage-related obligations (taxes, property insurance, etc.); 6) current debt obligations, alimony, and child support; 7) monthly debt-to-income ratio (residual income); and 8) credit history.
A creditor must verify the information supporting these factors through reliable third-party sources. Noncompliance can result in liability for the creditor and can also serve as a defense to foreclosure (i.e., the borrower can argue that it was the creditor’s fault for loaning more money than the borrower could afford).
The Act and implementing rules do specify a “qualified mortgage” standard, which if met may establish that the creditor has verified a borrower’s ability to repay. A “qualified mortgage” is one that does not result in a debt-to-income ratio for the borrower greater than 43%. Further, the loan must not have: a) fees or points greater than 3% of the loan amount; b) a balloon payment (except for loans originated and held by certain “small creditors”)c) negative amortization, interest-only payments, or other risky loan features; or d) a term of more than 30 years. The final rule defining a “qualified mortgage” took effect on January 10, 2014.
A loan can be either a safe-harbor qualified mortgage or a “higher-priced” qualified mortgage. A safe-harbor qualified mortgage is secured by a first-position lien on the residence and calls for an interest rate that does not exceed the prevailing (?) prime rate by more than 1.5%. If a safe-harbor loan meets the all these standards, the creditoras a matter of law has fully complied with the ability to repay requirements. By contrast, for a “higher-priced loan” – one, for example, with an interest rate greater than 1.5% above the available prime rate – meeting the qualified mortgage standard provides only a rebuttable presumption that the creditor has verified the borrower’s ability to repay. A borrower may still show that the creditor did not do enough to verify his ability to repay, even though the loan is a qualified mortgage.
B. Anti-Steering Prohibitions
The anti-steering provisions in the Dodd-Frank Act can also affect seller-carry transactions in some situations. The law prohibits “mortgage originators” from “steering” a consumer into a non-prime loan when a prime loan was otherwise available, unless the non-prime loan meets the nebulous standard of being in the “consumer’s best interest.”
A “mortgage originator” includes anyone who, with the expectation of direct or indirect compensation, assists a consumer in obtaining or applying for a residential loan or who offers or negotiates the terms of a residential mortgage loan. A seller offering financing or a professional advising that seller may qualify as a “mortgage originator” and fall subject to the anti-steering rules.
In a seller-carry finance transaction, a seller or Realtor or other professional may run afoul of the anti-steering rules by promoting seller-carry financing when the buyer could obtain traditional bank financing with a lower interest rate or more favorable terms.
For many sellers, the risk is mitigated by an exemption from the anti-steering rules. The rules do not apply to sellers who have provided financing on three or fewer properties in any 12-month period if the seller did not construct the home; the loan is fully amortized and has either a fixed interest rate or a rate that does not adjust for at least 5 years; and the seller reasonably determines and documents the buyer’s ability to repay. (In the context of the anti-steering rules, the buyer’s ability to repay is determined under a more flexible standard than the “ability to repay” standards that apply to sellers who qualify as “creditors” by virtue of extending consumer credit more than five times in a calendar year).
The bottom line is that sellers and especially Realtors and other professionals should generally avoid promoting seller-carry financing with a higher interest rate or less favorable terms than might be available through traditional bank financing.
Seller-carry financing real estate transactions now face heightened scrutiny under state and federal law. Sellers and professionals advising them should seek competent legal counsel about whether the transaction implicates the licensing requirements under the S.A.F.E Act and complies with the Dodd-Frank Act ability to repay and anti-steering requirements.