Seller Financing: Still an Option?

By John St. Lawrence, Esq, Legal Education Attorney, The Fund

The Consumer Financial Protection Bureau's (CFPB) Loan Originator Compensation Rule went into full effect in 2014 bringing a subset of small mortgage lenders under a previously unknown level of federal regulation.  As a result some types of private mortgage financing are now too risky or cumbersome for many to contemplate.  This is unfortunate since seller and private financing are very popular and legitimate financing sources for intra-family loans, underserved communities and rural or non-conforming properties.

The rule applies only to closed-ended consumer loans secured by a one to four unit dwelling or property including such a dwelling. It does not apply to reverse mortgages, home equity lines of credit, or loans made for business, commercial, or agricultural purposes.

So what is all the fuss about?  The CFPB created a broader definition of 'Loan Originator” to basically describe anyone making an extension of credit, offering or negotiating credit terms, or in some cases, even assisting with an application for credit.

In other words, private parties looking to finance "family mortgages" between family members who only engage in a few loans per year, and some seller financers, are now "loan originators," who must either comply with the new rule, or work directly with a licensed, compliant loan originator such as a mortgage broker.

However, there are two exclusions for seller financers. Seller financers may qualify for exclusion from the new rule under one of two specific provisions defined in 12 C.F.R., Sec. 1026.36(a)(4) and (a)(5).

One-property exclusion under Sec. 1026.36(a)(5):

  • The lender is a natural person, estate, or trust and provides seller financing for only one property in any 12-month period; and
  • The lender owned the property securing the financing; and
  • The lender did not construct, or act as a contractor for the construction of, a residence on the property in the ordinary course of business; and
  • The financing must:
    • Have a repayment schedule that does not result in negative amortization; and
    • Have a fixed interest rate or an adjustable interest rate that resets after five or more years, subject to reasonable annual and lifetime limits.

Three-property exclusion under Sec. 1026.36(a)(4):

  • The lender is any type of entity and provides seller financing for three or fewer properties in any 12-month period; and
  • The lender owned the property securing the financing; and
  • The lender did not construct, or act as a contractor for the construction of, a residence on the property in the ordinary course of business; and
  • The financing must:
    • Be fully amortizing; and
    • Be financing the lender has determined in good faith the consumer has a reasonable ability to repay; and
    • Have a fixed interest rate or an adjustable interest rate that resets after five or more years, subject to reasonable annual and lifetime limits.

High-cost lenders beware. Regardless of the exclusions, lenders who engage in "high-cost loans" as defined in Sec. 1026.32, secured by a consumer's principal dwelling, may be "creditors" under Regulation Z and subject to additional regulation that effectively nullifies the exclusion.

A small lender or seller financer who does not qualify for the exclusions to the Loan Originator Rule may choose to work with a licensed, Regulation Z – compliant loan originator such as a mortgage broker.

It is the responsibility of the seller to determine if they qualify for the exemptions provided for in the Rule.  However to protect themselves, agents should always use the Comprehensive Rider to the Residential Contract for Sale and Purchase C. Seller Financing with any residential contracts written on either the FRBAR Standard or AS-IS forms that contemplate seller financing.  Rider C provides a disclosure to both parties of the issues involved with privately financed transactions.  It also includes a warning that buyers and sellers should seek legal counsel to help them determine if the financing plan they want to use complies with the Rule. 

Transactions involving seller or private financing are still an option but the seller will first need competent legal advice to determine whether they meet one of the two specific exemptions, and will likely need help with custom legal documents.  Sellers, who do not fall under the exemptions, as well as all private lenders, will need to comply with the entirety of the Loan Originator Rule, and likewise need legal advice to determine whether and how this may be accomplished.

Because of these unique issues, agents should refer seller and privately financed transactions to real estate attorneys or attorney-owned title companies who are equipped and legally permitted to provide the needed services. 

The opinions of any particular author are not necessarily the opinions of Attorneys' Real Estate Councils of Florida, Inc., any of the local Real Estate Councils or Attorneys’ Title Fund Services, LLC.