Purchase money financing or seller financing has been a
traditional tool of investors and owners to expand the pool of buyers for their
residential owner occupied real property. Many buyers have the ability to put
money down or the ability to make monthly payments, but not the ability to
qualify for institutional bank financing. This includes recently foreclosed
homeowners who have now gotten back on their feet and desire to purchase a new
home or those whose existing debt pushes them slightly above the “quality
mortgage” requirement of a 43% debt to income ratio. If these buyers still want
to buy a home their only option is borrowing money from either the seller or a
“hard money” lender. Since “hard money”
lenders frequently charge interest in the double digits, many buyers look for
seller financing as a way to acquire a home, build credit and eventually pay
off that loan by obtaining bank financing.
In Florida,
when a seller finances the purchase of a property, the mortgage is labeled a
“true purchase money mortgage.” This is to distinguish between financing
provided by any third party, which is simply a “purchase money mortgage.” These seller loans are also sometimes
referred to as “Vendor’s Lien.”
Traditionally, seller financing usually has the following terms:
1. Short term of 2 to 5 years;
2. A balloon payment at the end of the loan
period;
3. No review of the borrower’s ability to
repay the loan, instead relying on the borrower’s down payment;
4. Monthly payments of interest only or a
loan amortized for less than 30 years;
5. Higher interest rate than market and
frequently an adjustable rate loan.
As a result
of the recent real estate collapse, Congress adopted a new law known as the “Dodd-Frank
Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). One of the consequences of Dodd-Frank is that
now all seller financing is regulated by, and subject to, strict new rules
adopted under the Act. Depending on certain factors, it may be impossible for a
seller to provide true purchase money financing to borrowers because of the
restrictive requirements.
These
requirements include that (i) the note cannot contain a balloon payment; (ii)
the seller as lender must qualify the borrower in the same manner that an
institutional lender qualifies a borrower for a loan; (iii) the interest rate
must be fixed for at least five years and thereafter may only adjust two
percentage points a year with a maximum of six percentage points; and (iv) the loan
must have a term of 30 years. Given these restrictions, very few, if any,
sellers will provide financing, which will either reduce the pool of potential
buyers or drive the few buyers who can get financing only into the arms of
institutional lenders. This will also result in sellers losing a secured loan
paying 5 to 10% interest and instead be forced to deposit their sale proceeds
in a money market account earning less than 1% with an institutional lender.
In
recognizing the problems with these restrictions the Consumer Financial
Protection Bureau adopted certain rules which loosened the restrictions on
individual seller financing for one property in a 12 month period. These rules
allow for a balloon payment and the seller does not have to qualify the
borrower for the financing. The other rules still remain in effect. This means all seller financing that
qualifies under these exceptions must still be amortized over 30 years and must
still contain a fixed interest rate for the first five years with limitations
on adjustments thereafter.
In adopting
these new rules, sellers must keep in mind that they do not apply to sellers
who constructed the home or if the seller is not an individual or trust. Many
investors purchase property in a limited liability company. If that company is
going to finance the sale, even if it is the only sale in a 12 month period, the
rules described above apply without the exception.
These new
rules will act to put a severe damper on private financing of residential owner
occupied property. It will result in fewer sales, drive otherwise eligible
borrowers to institutional financing, and cause hardship borrowers to lose
their homes because many small time “hard money” lenders make only a few loans
to residential borrowers in a year, and will no longer be willing to lend with
these restrictions.
The
Dodd-Frank restrictions are onerous and unwarranted and act as a substantial
intrusion on private transactions. This is clearly the law of unintended
consequences. While most of the Dodd-Frank rules relate to institutional
lenders, the inclusion of the private seller financing restrictions is likely
to cause substantial damage and expose those who finance owner-occupied
residential property to claims by defaulting borrowers who are looking for any
angle to avoid foreclosure.
Michael J Posner,
Esq., is a partner in Ward Damon a mid-sized real estate and business oriented
law firm serving all of South Florida, with offices in Palm Beach County. They specialize in real estate law and can
assist private lenders and sellers in all legal matters. They can be reached at 561.594.1452, or at
mjposner@warddamon.com
