How the Dodd Frank Act Will Impact Your Real Estate Business

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Most real estate investors are somewhat familiar with the Dodd Frank Act that goes into effect at the first of the year.  One thing that I know for sure is that a whole lot of folks aren’t taking it seriously. The most frequent comment that I hear is, “The government will never enforce this Act”.  And to those folks that say that, I would have to agree.

However, it is not the government that you will need to be concerned with in most cases… it will be your tenants.  Did you know that you might be faced with reimbursing your tenants up to 3 years of payments under certain circumstances?  Everyone needs to understand how the Dodd Frank Act has the potential to impact your business.

The Interview

I did an interview recently with my colleague and fellow real estate investor Bill Walston who is expert on this subject.  Some of the things we covered in this interview were:

  • When the Dodd Frank Act goes into effect
  • How it is different from the SAFE Act of 2008
  • What effect it has on investors doing lease options
  • The new requirement that the seller must verify the buyer’s ability to repay the debt and the procedures they are required to follow
  • Buyer remedies and the stiff penalties for real estate investors that don’t comply with these requirements

I hope you will take about 30 minutes and listen to this interview. It has the potential to impact just about every real estate investor’s business, but there’s no doubt that the ones that will be the most affected are those investors that use seller financing as an exit strategy.

Are you familiar with the Dodd Frank Act and how it will potentially impact the way you do business?

Photo: Mr. T in DC

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About Author

Sharon has been investing in real estate since 1998. She owned and operated a successful home inspection company for 17 years. In January of 2008 she took the leap of closing her business to become a full time real estate investor.

47 Comments

      • Hi Sharon, I’m considering using a hard money lender to pull some cash out of one my rental properties in NC. However, he was concerned about the Dodd-Frank Act. Are there any caveats in the Dodd-Frank Act that disallow hard money lenders to lend to commercial investors.

        Rodney

        • Sharon Vornholt

          Hi Rodney – There is never a problem with investor to investor financing. It’s only when it is investor to retail buyer. However, are you sure you want a long term finance agreement with a hard money lender?

          Why not try to raise some private money? Bill and I are having a 2 day seminar on that topic probably in May of 2015. Be sure you are subscribed to my blog so you get the notification.
          Louisville Gals Real Estate Blog

          Sharon

  1. I would be suspicious of the comment that under 5 owner financed loans per year you are free to screw borrowers (extreem wording meaning you do not need to follow Dodd Frank).

    My view is that even if less than 5 you use a Licensed Mortgage Loan Originator in your state, qualify to <= 43% DTI, use a servicer after closing and make your loan term look "normal": 30 yr term, interest rate less than 6% over floating prime, no prepayment penalty.

    I think their advise re Lease Options is spot on. Just think they are potentially giving bad advice re less than 5 owner financings a year and you are exempt is not exactly true. Addition I've read in the regs a mention of 3 deals, not 5. Safe Act (per state) had 5 as the limit so I think this guy is mixing Safe Act with Dodd Frank which supercedes..

    Here's a lawyers blog on Dodd Frank:

    http://clintcoons.wordpress.com/

    CFPB (the horses mouth) links:
    Search on: Small entity compliance guides

    Small entity compliance helps:
    http://search.consumerfinance.gov/search?utf8=%E2%9C%93&affiliate=cfpb&query=small+entity+compliance

    http://www.consumerfinance.gov/regulations/ability-to-repay-and-qualified-mortgage-standards-under-the-truth-in-lending-act-regulation-z/#compliance

    http://files.consumerfinance.gov/f/201308_cfpb_TILA-HPML-Appraisal-Implementation-Guide-Updated-Sticker.pdf

    • Let me clarify and embellish the best tip I heard in this interview:

      1) DF does not make investor created owner financed mortgages impossible or illegal. Hardly. We just have to create mortgages in compliance following the now codified steps that should have been in use all along (loan affordability): use a licensed mortgage loan originator who qualifies affordability, verifies income, debt and DTI to <= 43%, and you use a servicer. I use trustfci.com they are the biggest and cheapest.
      2) Keep a detailed file on the progress of this borrower, what was said and what was promissed, all financial docs from the LMLO (tax returns, pay stubs and calc showing 43% DTI).
      3) This is the biggest takeaway for me: Give this text to the closing autorney to put at the beginning of the Security Deed: Go into insane detail about the steps you followed qualifying the borrower, that this loan is DF compliant, mention if you feel this loan is exempt because of under 5 (or is it 3) loans per year. List that the borrower may have signed a DF waiver. Put the name and contact info for the LMLO. It's not yet understood in the DF discussions, that it's the LMLO has his neck on the line re being DF compliant. The investor/lender follows steps that I feel are pretty clear, but it's the LMLO that actually DOES the borrower affordability verification and this is the meat of what we are being burdened with, besides using a servicer which any sane lender would do anyway.

      I assert that step #3 putting the doc on public view will be your biggest friend. There will be preditor lawyers who will do public records searches for Security Deeds and mail a package to the property address (the borrower) trying to get the borrower to take you to court for not following Dodd Frank. If there will be any suit shield us investors / lenders can create it is: put right out in the open in the public documents, the Security Deed that we are DF aware, followed the steps and that any opportunistic lawyer trolling for fees can skip over your mortgage since you made it public that you followed Dodd Frank. BTW the CFPB enforcers will be doing the same, trolling public records like small town cops looking to self fund their agency with fees and penalties. I've heard that the Gov/CFPB enforcers will troll from the servicer back to the lender (us) so we may put into the servicer setup doc any notes that this loan is Dodd Frank compliant. IE ask that a note be put in the setup file…

      curt

      • Interesting embellishment. I do question the view that the MLO is the only one on the hook, which may be why that isn’t talked about in the DF discussions. In reading Dodd Frank, all mentions of the penalties for violation indicate they are assessed against the LENDER, not the MLO. So while the MLO may have to bear some of the responsibility it appears that “the buck stops” at the lender.

    • Curt,

      As my sweet granny would say, “bless your heart.” Thanks for your comments. Let’s see if I can clear up your confusion.

      First, I don’t recall saying that you should feel free to “screw borrowers” whether you are doing five deals or 500 deals – but the fact remains that if you do five or fewer deals you are exempt from DODD FRANK. (Note that I did NOT say you were exempt from the SAFE Act, but that’s not what we were discussing.) 12 CFR 226.2 states, in relevant part, a person regularly extends consumer credit…MORE THAN 5 TIMES FOR TRANSACTIONS SECURED BY A DWELLING in a 12 month period (emphasis mine). And for purposes of our discussion (seller financing) that’s what Dodd Frank is about – consumer credit and the ability to repay.

      Second, I have no problem with your view to use a mortgage originator – and I don’t think you can point to an instance where I recommended against it. And I agree that in some states, but not all, the “magic number” is 3 transactions before you are REQUIRED to have a MLO. The interesting point (and one that you seem to have missed) is that you can be required to use an MLO under the SAFE Act because you are doing more than 3 transactions, but still be exempt from all of the horrendous underwriting requirements of Dodd Frank because you are doing 5 or fewer transactions. So I’m not mixing Dodd Frank and the SAFE Act at all. I am quite aware of the difference.

      And thanks for sharing the link to Clint’s blog. He writes good stuff too. And I don’t find a thing there that contradicts what Sharon and I discussed in our interview. If YOU do, please point it out with specificity and I will gladly stand corrected.

      • Hi Bill, Thanks. Do you have a link to the regs, paragraph etc state you do not need to follow DF if you do less than some number of deals per year?

        I have read in one of the docs on the CFPB site an isolated line saying to the effect you infer, an exemption to DF if under some number per year.
        Then near by following that line, the regs say that you loose that exemption if your mortgage does not meet the terms for a Qualified Mortgage (QM). To me that erases the comment about an exemption for <=5. Because in practicality no investor is going to write a mortgage at an interest rate <= 1.5pts over floating prime or today that would be 4.75%. Honest to have a QM you have to have a note interest rate at or less than 4.75%. That just isn't going to happen in my view. So no investor is going to write a QM thus no under 5 exemption in practicality. (is my understanding as I allow my slow brain cells to regurgitate 9000 pages of that crap. LOL )

        I feel it's key to qualify this <= 5 exemption when so much is on the line. I now feel it's having a QM and certainly for me I'll never have a QM. I charge 9% interest (6pts over floating prime… It’s too many layers of requirements.

        • Sorry Curt, there is no part of the Act that says, unequivocally, “you do not have to comply if you do less than 5 transactions per year.” That would be WAY to easy. It’s as you said, a reading of the definitions, the act, the context, and following the logic (??) of the Act itself. DF states that it applies to those who “regularly extend” consumer credit. It then defines the regular extension of consumer credit in 12 CFR 226.2, which is where the 5 transactions secured by real estate is discussed. Writing a Qualified Mortgage is a Dodd Frank Safe Harbor. When you write a Qualified Mortgage you are “presumed” to have complied with the Act – the burden of proof would be on someone else to prove that you did not “consider the ability to repay.” If you do 5 or fewer transactions per year, QM or not, you are EXEMPT from the Act. If you are exempt from the Act you don’t have to worry about the interest rate ( you can charge what you want), the amortization period (you can still have a balloon), or any of the other horrendous underwriting requirements – it’s business as usual. At least, that’s my understanding. Could you send me a copy of the doc that you are referring to? Or perhaps a link? I’d like to trace it back to see to what it’s referring.

  2. This is timely. Bill Gully and I have some comments about Dodd Frank here http://www.biggerpockets.com/search?term=dodd+frank#topics

    It is scary to the REI community, and the penalties of 36 months of payments plus attorney’s fees plus court costs are absurd.

    My thoughts…

    -Using a RMLO on all seller financed buyers when selling seems like the prudent work around.

    -When selling to investors get an affidavit saying they will never be residing in the property as an Owner Occupant.

    -When buying it does not matter, as the onus is on the seller.

    -Keep to 3 properties per LLC.

    Thanks Sharon and Bill.

    Oh and the good news about Dodd Frank is sub2 sellers can get a break. After 12 payments (12 months) they can apply for another home loan and not have their loan considered in the DTI.
    See my blog here on BP
    http://www.biggerpockets.com/blogs/3/blog_posts/32715-dodd-frank—what-can-real-estate-investors-do-after-jan-10-2014

    Nice job, Sharon and Bill!

    • Great tip Brian re sub2 sellers not having that note on their record past 12 months. Do you have a link to those regs? Should be a big help to close sub2 deals. Your link to your blog you gave didn’t have any content, just a comment area.

  3. Rodney Williams on

    Hey Sharon,

    Great interview with Bill.
    I don’t like the government trying to set us up for problems any more that the next investor.
    However the eight requirements for non qualifying loans should be used anyway, it is just not that hard. I always want to know who I am financing and what their situation is.

    Knowledge is Power

    I thank both of you,

    Rodney Williams

    • Rodney –

      You are absolutely right about just following eight requirements for non-qualifying loans. It isn’t that hard, and if investors as a whole did this you would probably see a lot fewer people getting in over their head. Yes indeed; knowledge is power.

      Thanks for watching and leaving your comments.

      Sharon

  4. Bill / Sharon,

    Thanks for sharing. How does DF impact the purchase of owner finance notes you did not originate, especially notes that were created prior to 1/1/2014

  5. January 10th – Sub2, Lease Option, Contract for Deed, etc. just got a lot harder as an exit. Very good interview guys and timely. I’m working on a write-up for my site as we speak. You know how all of this makes me feel Sharon – Validated to be a slow, dumb, multifamily, creative finance guy. Never sell (only trade); just buy lol

    Thanks Bill and Sharon!

    • Ben –

      “You know how all of this makes me feel Sharon – Validated to be a slow, dumb, multifamily, creative finance guy. Never sell (only trade); just buy lol”.

      It’s obvious that you are anything but slow and dumb, but I’m glad you found the post helpful. You and Bill have a lot in common; multi-family, creative finance guys.

      Shron

      Sharon

    • Geoff –

      BP is a site that has a wealth of information on every topic imaginable. It’s a great place for all investors to learn whether they are brand new or happen to be seasoned investors. Thanks for reading.

      Sharon

  6. Hi Sharon and Bill, In regards to Dodd-Frank’s impact on Lease Options, how will the up fronnt Option Fee be treated? Can this trigger a violation of some sort? Thanks!

    • Hi Carl – There is no change in the treatment of the lease option fee. It can be be applied to the purchase price at the time the option is exercised, and can be non-refundable if the option is not exercised. That being said, if the lease option fee is very large in relation to the purchase price I think this would be indicative of a “disguised sale.” That though, only means that Dodd Frank rules and regs apply to the transaction. It doesn’t mean that there is a violation. The violation would be the failure to “consider the borrower’s ability to repay.”

  7. Hi Bill, Found the reference for the exemption for <=3 not 5. Google for file name:
    Loan Originator Rules 2013.pdf Small Entity compliance guide.
    Go to the very end pg 22 refers to investor financed deals:

    Under the second special exclusion, if you are a seller financer (regardless of whether you are a natural person, estate, or trust), you are not a loan originator if:

     You provide seller financing for three or fewer properties in any 12-month period

    The paragraph that follows:
    Further, you must determine in good faith that the consumer has a reasonable ability to repay the loan.

    I agree that this doesn't say you have to use a LMO. But why not? It's just makes sense to use a LMO from now on given the risks to the lender/investor.

    Also this doc says "any 12 month period" not per calendar year. So don't do a bunch all in a few month period spanning the new year that runs more than 3 in a running 12 months.. Just picked that out of this complicated wording.

    I view DF as an improvement over <=2013 Safe Act. In GA the Safe Act exemption only for a natural person. DF allows for a non-natural person doing 3 per 12 months. I was buying into my name so I could owner finance under GA Safe Act so this is a big improvement for me. :) Hey good news!! Which I feel this is all good news. Except the fines/punitive stuff that will feed the preditory Gov enforcers and fee generating lawyers.

    • Hey Curt – Thanks for the reference. And I think I see the confusion. Notice that your reference is to whether someone is considered a LOAN ORIGINATOR and needs to be licensed or use an MLO for the transaction. This is the situation where I mentioned that someone could fall under the SAFE Act by doing three or more transactions but be excluded from the specific underwriting requirements of Dodd Frank by doing five or fewer. And I agree, I think as an investor that using a MLO is the way to go with our seller financed transactions to owner occupants. An alternative is to just sell to other investors or deal strictly with commercial deals. Dodd Frank wouldn’t apply at all to those types of transactions.

      • Just thought of a bad situation, if you do 4 or 5 in a running 12 months you have to BE a licensed loan originator. I think the safest advice is to say <= 3 deals per 12 months. Saying 5 or fewer get that investor a fine from the state Banking agency for originating loans without being licensed if my parsing the tea leaves is correct.

        This gets to be just crazy. The solution is simple enough: create LLC's with EINs (important) that do only 3 owner financed loans per year and use an LMO and servicer, qualifiy to <= 43% DTI, amortizing and keep interest rate at or under 6% over floating prime. I might have left a point or two off but I think this is the bulk of what we need to do. Plus put all your DF doc on the Security Deed (thanks Bill!!!!).

      • Attn: BPers!!!

        Read this post (see above), it drills it down!

        “I think as an investor that using a MLO is the way to go with our seller financed transactions to owner occupants. An alternative is to just sell to other investors or deal strictly with commercial deals. Dodd Frank wouldn’t apply at all to those types of transactions.” Bill Walston

  8. Thank you very much Sharon & Bill,

    This is excellent coverage of this topic. I had it rambling around in my head that I needed to catch up on the repercussions of this DF Act—sometime soon. Since I don’t have Bill’s incredible brain I was somewhat avoiding sitting down to learn what I needed to know. I sent this off to a couple of my investor buddies because they were unclear also.

    Just what we don’t need >> more government . . . But I won’t get on a rant right now.

  9. Great interview Sharon and Bill, very insightful and informative!

    I’m so glad you tackled this very complicated subject. There’s so much confusion out there in the marketplace!

    When these new laws come into play, I think a lot of folks forget to remember why they came about. Usually, it’s a reaction and response — people were wronged during the mortgage crisis and this is the result.

    At it’s core, it’s all about knowing how to qualify folks. During the crisis, many were not even qualified to buy the homes that they did. Now the government has to step in and set rules due to all the irresponsibility.

    Even in the world of real estate investing, I see this happen all the time — seller financing being offered to folks who can’t make the payments over the long term. I’ll admit, I even see this in my own niche. I cringe when I hear folks (in my own niche) talking about how they have to fill another home as the people they put in defaulted after 6 months. To me, it sounds like these people were just not qualified to begin with.

    What this new law will do is weed people out who are or want to get into the game. No longer will there be overnight approvals and fast closings. It will cause those who continue to be in the game to think twice about the folks they put in these homes. Those who have and continue to qualify people the right way will be the ones to prosper and will be the least affected.

    I enjoyed the interview. Thanks so much for sharing your insight Bill, and Sharon for conducting the interview!

    • Hey Rachel –

      I think you have really hit upon the important points. Real estate investors will have to do what everyone should have been doing all along; make sure they have financially qualified tenants. The pro’s will just take those extra steps and go about business. The ones that don’t will likely be out of business.

      There are always rules to follow, and I think this will help investors over the long run get better tenants from the get go and by reducing vacancies. It’s good to hear from you.

      Sharon

  10. Thank you so much for this video. As a beginner and someone who depends almost entirely on owner financed deals this is going to be a scary time. I am a rehabber who’s exit strategy is always owner financing. I see this as a way for that army of lawyers out there to make lots of money from investors.

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