The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank”) was enacted on July 21, 2010, in the aftermath of the Great Recession. While most of Dodd Frank focuses on the US’s financial services industry, a lesser-known part of the legislation regulates who is able to issue a loan that is secured by residential property, and the terms of the loan (“Regulation Z”).
With certain exceptions discussed in more detail below, Regulation Z prohibits the issuance of residential loans secured by real property by anyone other than a “Loan Originator,” or a person who is licensed to issue residential loans (the “Loan Originator Rule”). Loan Originators are typically bankers and don’t often include real estate developers or private individuals.
The rationale behind Regulation Z generally makes sense when taken in the context of the stock market and housing crash of 2008, which had its origins in the unprecedented growth of the subprime mortgage market beginning in 1999. Banks made a lot of questionable loans to people who could not afford them. Dodd Frank was the federal government’s attempt to remedy the problem by limiting the persons able to issue residential loans. Those who are allowed to issue residential loans — Loan Originators — in turn must follow strict guidelines on proving the borrower’s ability to repay.
There are two special exclusions from the requirements of the Loan Originator Rule:
- The one-property exclusion, in which a natural person, estate, or trust provides seller financing for only one property in any 12-month period.
- The three-property exclusion in which any type of seller financing entity finances the sales of three or fewer properties in any 12-month period.
Certain limitations also apply depending on which type of exclusion you qualify for. For example, under the one-property exclusion, the loan cannot have negative amortization. Under the three-property exclusion, the seller must determine in good faith that the borrower has a reasonable ability to repay the loan. Neither exclusion applies if the person issuing the loan is the same person who constructed the home. In other words, contractors are generally prohibited from providing seller financing.
The consequences for violation of Regulation Z are harsh. In addition to penalties up to $5,000 per day at a minimum, there could also be actions against the violator such as recession of contract, refund of borrower costs, return of interest paid, return of real property, restitution, disgorgement or compensation for unjust enrichment, private damages, and other monetary relief.
If you or someone you know has questions about seller financing, contact a real estate lawyer, like a real estate lawyer in Belgrade, MT, for more information.
Thanks to Silverman Law Office, PLLC for their insight into seller financing.