The New Seller Financing Reality (Living in a Dodd-Frank World)

      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