Dodd Frank and Lease Option!

50 Replies

Sorry guys! I don't know WTH was up with BP, but I assure you I only responded once to Curt's post ;) When I got booted off BP the posting had not even completed and when I can finally get logged back in (about 3 hours later) I find not one but THREE posts of the same response...Go figure!

Well, slightly differences of opinions now.

The original SAFE Act adopted does mention Lease-Options specifically and gives an example of the Lonnie Deals to boot. The D/F Act, shall be the determining factor as to real estate transaction financing as determined by HUD. The Act also describes the matter as "any financing arrangement that provides for the transfer of title" and "any transaction that attempts to circumvent the intent" (of the Act) being included.

The determination of any agreement that is deemed to be a financing agreement under the IRS Code would certainly be the focal point in determining any related tax matter. To say that IRS Code would or could be a determining factor in a mortgage financing violation that is governed by specific law under another federal agency having jurisdiction is not going to be the guiding factor nor applicable as we'd be talking apples and oranges.

The reason I'm pointing this out is because we certainly don't need to commingle laws by different agencies that have two different regulatory goals, creating duplicate and perhaps contradicting definitions in compliance .

I'm pretty sure that if a lender is charged with a violation under the SAFE Act they will be judged under applicable law, under the SAFE Act as to the specific charges and those definitions Act shall govern.

Now, if you end up in tax court, those issues mentioned above by Bill W. will be the governing law and definitions to be used, without a doubt. The determination of any financing agreement is not to the compliance of that agreement but in determining the application of tax laws to determine tax liabilities applicable to the agreement or transaction.

You can have a violation under one area of jurisdiction and not another as well, or you can certainly have various violations under the laws or rules in the jurisdiction of multiple of agencies.

As to the SAFE Act and what determines a financing agreement the definition is broadly interpreted as to any method or arrangement that facilitates the transfer of title to any covered property (OO SFD or land allowing such dwelling to be built) where there is a security interest of any kind in the property being purchased. Such an agreement may not have interest, it may only finance 7% (3% under that viewed in taxable even, it may not be amortized it might be lump sums toward an option over any agreed term, thereby not meeting those aspects identified by the IRS.

I agree with Bill W. that what may be in the mind of a Circuit Judge could be influenced by almost anything, including not having breakfast that day, but there are long standing finance regulations referenced in the SAFE Act for determinations to be made under the umbrella of financing regulators. I have been in situations where a determination as to applicable law or regulation was a head scratcher when a matter is not specifically described. In those cases those making a determination may see how other rules may apply. Those most applicable for a CFPB examiner will be first within their agency domain, then in light of other agencies such as FDIC, Comptroller of Currency or Treasury Department regulations pertaining to lending, if an examiner can't peg the issue at that point, it's questionable if the examiner can determine an enforceable violation under their jurisdiction. :)

Go Mizzo!

Originally posted by Brian Gibbons:
Originally posted by @Curt Smith :
So far no one mentioned that Dodd Frank put a limit on the length to the option period of 3 years.
Little known perhaps is that the IRS has for some time considered longer than 3 yr options, like Ron LeGrand's 5-10yr options to be taxable events as if it's an installment sale.

@Curt Smith this is important.

If you are underrwater and want to sell on terms as a Seller, to a Owner Occupant Tenant Buyer, and use a disguised sale lease option, it is the same as selling on contract for deed or a wrap. There are a due on sale and other isssues. An RMLO for the underwriting of the Tenant Buyer should be considered.

Finding ways to comply with Dodd Frank and do these long term lease options I believe is a great strategy for underwater homes.

Brian, can you explain why you think a long term L/O is better for underwater homes vs other methods, without posting a video to watch? :)

Sure @Bill Gulley

Underwater homes - what works?

1. Sub2 acquisition - not a good idea on underwater homes, as the asset is a negatively valued asset.

2. Wrap acquisition - not a good idea on underwater homes, as stated above (1).

3. Sandwich lease - same as above (1)

4. Posible master lease, sub lease, if the quality is there and ample profit spread..

5. Possible lease option assignment, depending on quality and details of underlying note. Long term lease option (disguised installment sale).

6. Straight option - poor choice for underwater homes.

7. Short Sale - Maybe, maybe not, depends on BPO, specific lender, etc.

:)

Bill I know you have thoughts on this.

Originally posted by Bill Walston:
Dodd Frank doesn't address lease options specifically. UNLESS you are referring to the fact that an improperly drawn lease option that is determined to be "disguised sale" is, in fact, a financing instrument. And while a lease and option transaction in excess of three years IS a contributing factor in that determination, it is not the only factor.

To determine whether an arrangement is a lease-option or a sale,

This is great!

Here is a video on Lease Options and Disguised Installment Sales...

http://www.youtube.com/watch?v=SqnviWNBnSM

Thanks, generally I agree, but I'd prefer title over any L/O, giving me more options to dump it in the event things go south.

HORSEFEATHERS! Game over, Auburn wins! Next year Mizzou! :(

I'm back, sorry....

One thing I'd explore with an underwater home would be a Sub-2 with notice (and a wink and a nod of consent) to the lender. Especially if the owner has had issues or has been a slow pay, the lender doesn't want the property and they don't want a short sale, so a good strong buyer paying may save their tail, even if I leased it. Lenders aren't stupid. So, my first choice would be a Sub-2 holding title subject to the mortgage.

Saying "underwater" means there is no equity in the current market, I try not to pay more for anything than it's worth, but there can be exceptions. We don't really have cash flow machines for rentals, but that could happen. I'd say it would be hard to find an older mortgage that had been paid on having equity that has been lost. Or a note with lower payments (PITI) that would clear enough to be worthwhile for the brain damage of working between a seller and a tenant type buyer and staying compliant under the new laws.

I'd say that underwater properties are best left to cash or financed transaction in a short sale. If the seller owner were my sister, I'd work something else out to save her credit and get her out of the problem, buy and hold it, second thought, I might not too.

Really depends on the situation, if being underwater and swim out with a snorkel or if you need a submarine. :)

Okay, I'm over it, kids at Auburn are happy and they played a heck of a game, congrats to their Tigers!

Only slight differences, @Bill Gulley

But to your points...

First, we're not talking about lease options under the SAFE Act, we're talking about lease options under Dodd Frank..and, as I said, it doesn't mention them...at least not in the 2400+ pages that I've read..But then, I admit I may have missed it, so if you can point me to the appropriate section I'll stand corrected. Until then, I stand by my statement :)

Second, I'm not saying that the the IRS code is going to be the determining factor in a mortgage financing violation. What I AM saying is that the only way that a lease option is going to fall under Dodd Frank is for there to be a judicial ruling that what has been purported to be a lease and option transaction is, in substance, a "disguised sale" thus making the contract a financing instrument. A judge will need some basis (other than not having breakfast that morning) for reclassifying that transaction, and at this point, the only guidelines that I've seen that distinguish a lease from an installment sale, or an operating lease from a capital lease, are those used by the Internal Revenue Service and FASB 13. There is no "commingling of laws" between agencies involved.

I still believe that the bulk of the enforcement is NOT going to come from the CFPB who most likely will not know who, or who is not, selling property using owner financing. The enforcement is going to come when your PO'd tenant buyer takes you to court and attempts to prove that you did not "consider [his] ability to repay."

But that's just my opinion.

Brian, I agree both are very good, only one got there, there are no Mulligan's, MU is better than they played, second year in the conference the record got them there.

Bill, yes we do, slight point. I understand your point of view.

Disguised sale definitions apply in tax matters only, was my point. Financial regulators (CFBP, HUD, State Banking, etc) never need to go to IRS Code to identify any agreement as a financing arrangement, they will first go to the SAFE Act (an Act under their jurisdiction) as it is broadly defined and other regulations in their domain. The S/A and Dodd-Frank are siblings. These regulators don't need to refer to the Code to call a duck a duck, they simply see if there as any type of ongoing consideration paid to facilitate the conveyance of title to RE and use the definitions of security interest, title and equitable interest and payments basically to identify any financing arrangement.

The basis for my opinion is three fold. I've met and worked with banking regulators and state finance department types and HUD investigators, while I'd say we were all more aware of the Code than most off the street, none were tax experts and we (they) don't have the Code in the tool box, not in the vocabulary of these regulators. The other reason is that these examiners are not schooled in tax matters at all, the Code isn't an area that they are trained in. Those aspects of a disguised sale in the Code mentioned above I'd bet couldn't be recited by one out of 20 examiners, probably more. Lastly, illegal contracts (like usury for example) or predatory contracts have been taken to court and tax matters were never used at all that I'm aware of, they were nailed on the violation as charged.

If there were tax issues, financial regulators don't go there, it's turned over to the IRS for their determination. Federal agencies have their turf, one does not cross over the line. As you know, your neighbor could inform the IRS everyday and the tax payer would probably never hear a thing, such tips are not accepted, but a matter turned over to them by another agency is a different matter.

I totally agree, Bill, you're on target with how financing arrangements will be exposed and brought to light, many will arise from a ticked off buyer. But they will also surface from "life events". There will be instances with a satisfied buyer (initially) and a happy seller. Something will happen where the purchase arrangement is exposed to some third party, an attorney, court action, estate or state official, it's impossible or at least extreme to say you can hide such contracts over time. People die, become incapacitated, get divorced, get sued, take bankruptcy, qualify for medical benefits, go to jail, try to obtain financing or speak to Realtors or their tax advisor who may inform them of the issues. That third party can take action or advise that actions be taken.

Actually, any financing arrangement requiring to be paid off with refinancing will eventually surface, that should be obvious.

I've had many buyers come to me to be refinanced out of some contract. I'd need a copy to do the financing and had to read it. Guess what happened if there were problems, if the buyer couldn't perform under a predatory and/or illegal contract? Right, it was brought to light, modified and we carried on. Yes, I'd used a big stick to motivate, if necessary, an underhanded seller and yes, some thought they knew better and I'd see to it the hammer came down. I can't imagine any mortgage loan officer having a crying mother of three who thought she was really buying a home under some screwy deal and being reamed and cheated that would not at least advise that customer to see an attorney, or call some agency and get the contract faxed to them in order to save the home or be indemnified.

So, it's not just the ticked off buyer that exposes bad contracts, they can come to surface under a wide range of events. Now, with Dodd-Frank and the SAFE Act, curing issues of illegal contracts or predatory contracts just got much easier for a buyer. Wait and see. :)

PS. As to L/O, while I know sellers devise all kinds of disclosures thinking they can't be touched or to save their tail but I'd like to see a booklet similar to "Know before you owe" for these contracts, spelling out how end financing will be addressed and how equity is established. Just a check list for compliance. Including tax implications!

@Bill Gulley

>>I'd like to see a booklet similar to "Know before you owe" for these contracts

Sounds like you've just announced your next ebook Bill. :) Honest you could make your beer money selling ebooks on all the topics you post on here. Amazon has turned out to be a great ebook market place.

Bill you'd be helping alot more people if you'd just mine your recent posts and put them into a few titled ebooks and put them up on amazon.

Originally posted by Curt Smith:
@Bill Gulley

>>I'd like to see a booklet similar to "Know before you owe" for these contracts

Sounds like you've just announced your next ebook Bill. :) Honest you could make your beer money selling ebooks on all the topics you post on here. Amazon has turned out to be a great ebook market place.

Bill you'd be helping alot more people if you'd just mine your recent posts and put them into a few titled ebooks and put them up on amazon.

You have no idea how many people are bugging me about that. My GF is almost disgusted about it, my family shakes their head, my attorney friend says I'm nuts and some friends just ask if I've written anything yet.

I would have to work at that, I'm 2/3rds of the way through one rough draft, more work than I thought. It's not like knocking out comments, there is, in my mind, a great deal of due diligence required to ensure it's good stuff.

This is enjoyable for me. Keeps me investigating matters, considering a very wide swath of RE issues that keeps me more current than if I set in an office with some specialty.

I'm technologically deficient too, it would be a nightmare for me to mine thousands of posts, just can't imagine that.

But, thanks for the thought and support. :)

@Brian Gibbons

@Bill Gulley

Hi guys, I've got a problem I think. I have a wholly owned property in my IRA that I'm lease - option to a renter / buyer in a few days. I'll rent to own for 12 months then will owner finance.

An aside, if this property was in my cash account, the 12 months would move the sale into long term capital gains land. I know owner financing is taxed (least I think it is) as an installment sale so amount of principal returned would be long term gain... The primary reason for 12 months of rent to own is to shake out the buyer before doing a mortgage. IE 12 months of no late rent.

I had her fill out a 1003 as a part of my renter application, which is the ONLY time I can take a 1003 under DF. She has high income but puts alot away into a 401k dropping her net. She has just a car payment and the perspective $1000/mo mortgage payment.

Her DTI calcs to be only 46% because of her dropped net due to 401k contributions. Darn!!!! 3% off. Since we will be the lender, or my IRA will be the lender I'm ok with a DTI of 46%. What about DF compliance?

Now I remember that there's tiers of requirements. IE I can (and will) have a high cost mortgage. IE over 1.5% over floating prime, but exactly at the upper limit of 6.5% over floating prime or just under: 9.5%. I've always meant to ask what happens if the interest rate is OVER 6.5% over prime? I read and recall that nothing happens, just a higher cost mortgage. A technical question: Is this TRUE that I can owner finance a mortgage to owner occupied at above 6.5% over floating prime??

So what about being over 43% DTI? I will use a LMO and 3rd party appraisal and of course a servicer but the later is not in play re the affordability, ATR, considerations.

@Brian Gibbons

I opened too many issues in that post. The only one that maters immediately is the DTI over 43% issue. There are no DF authoritative authorities for compliance so Bill's admonitions to not take advice off the internet, I don't know how to NOT take advice off the internet.

My understanding as the lender I can take an over 43% DTI and create the mortgage if I choose to per my lending standards. This paper obviously won't be sold to the fannie buyers so who cares. Is ATR compliance at risk when I choose to go with 46% DTI, with mitigating circumstances that the borrower is putting alot away into savings (401k).

We all knew it would come to this kind of baby or wash water problem.

Now that I see a real borrower's app who is squeeky clean has high income and still doesn't meet 43% DTI I don't see how this reg is going to fly.

The answer is under my nose. I just have to push out the term from 15 yr to 20 yr and the DTI drops... So I have the tools to make this loan fit.

Originally posted by @Brian Gibbons :
@Curt Smith

Are u an engineer? Ouch!

Go take the 1003 and the client to the RMLO, get an opinion, AND see a tax GA Property CPA guy that gets installment sales.

Or ask @Steven Hamilton II

If I am selling on terms, that is what I would do. :)

@Bill Gulley u'll have fun w this.

Brian,

What is the question?

Originally posted by @Steven Hamilton II :
Originally posted by @Brian Gibbons:
@Curt Smith
Are u an engineer? Ouch!

Go take the 1003 and the client to the RMLO, get an opinion, AND see a tax GA Property CPA guy that gets installment sales.

Or ask @Steven Hamilton II

If I am selling on terms, that is what I would do. :)

@Bill Gulley u'll have fun w this.

Brian,

What is the question?

Sorry,

Curt Smith a couple of posts back was asking " Hi guys, I've got a problem I think. I have a wholly owned property in my IRA that I'm lease - option to a renter / buyer in a few days. I'll rent to own for 12 months then will owner finance.

An aside, if this property was in my cash account, the 12 months would move the sale into long term capital gains land. I know owner financing is taxed (least I think it is) as an installment sale so amount of principal returned would be long term gain... The primary reason for 12 months of rent to own is to shake out the buyer before doing a mortgage. IE 12 months of no late rent.

long term capital gains q.

:)

Originally posted by @Brian Gibbons :
Originally posted by @Steven Hamilton II:
Originally posted by @Brian Gibbons:
@Curt Smith
Are u an engineer? Ouch!
Go take the 1003 and the client to the RMLO, get an opinion, AND see a tax GA Property CPA guy that gets installment sales.

Or ask @Steven Hamilton II

If I am selling on terms, that is what I would do. :)

@Bill Gulley u'll have fun w this.

Brian,

What is the question?

Sorry,

Curt Smith a couple of posts back was asking " Hi guys, I've got a problem I think. I have a wholly owned property in my IRA that I'm lease - option to a renter / buyer in a few days. I'll rent to own for 12 months then will owner finance.

An aside, if this property was in my cash account, the 12 months would move the sale into long term capital gains land. I know owner financing is taxed (least I think it is) as an installment sale so amount of principal returned would be long term gain... The primary reason for 12 months of rent to own is to shake out the buyer before doing a mortgage. IE 12 months of no late rent.

long term capital gains q.

:)

As long as the property was held for at least a year plus one day it would be long term capital gains; however, in an IRA I would not worried about unless he actively flips properties in his account as well

@Curt Smith My understanding is that you only need to worry about the 43%DTI if you are wanting your loan to be a Qualified Mortgage. You can still do a loan (even at 46%) if you are willing to consider all of the 8 underwriting factors and give up the ATR "safe harbor" of writing a QM.

Hope this helps.

@Brian Gibbons

Great insights and I enjoyed some of your youtube vids. A little dry - maybe you could include a song and dance number in the next one. ;-)

Great info though. Thanks for taking the time to flesh out the possible implications of poorly structured L/O in regards to DF.

My question is what did Curt mean "shake out the buyer" as the reason for the LO?

There are a few misconceptions floating around. DF is one Act, it modifies and/or incorporates about 40 other laws and regulations. Saying that you can ignore DF if you do less than 5 or 3 or follow 8 underwriting aspects is not the whole story nor are qualified mortgages necessarily embracing individual investors selling with seller financing, lumping them into the classification as a "Lender". A lender defined in the Act as well as other regulations are cash lenders making funds available for purchase transactions. A seller who enters into an installment contract or financing arrangement that finances equity based on a sale price may not be a "lender" as the definition and requirements to be met go much deeper than assuming equity and cash are treated the same, as they are not.

I'm still looking into this aspect, if any of you investigative guys out there has come across the specification of equity funded installment contracts being considered under the same umbrella as cash advances, please post it up.

That mentioned, I'd suggest that every installment contract be treated and underwritten as a non-qualified loan, following the underwriting requirements.

Another issue is underwriting your own transaction, we can read in black and white the 8 aspects to be followed. These points described have been written for mortgage originators, institutional lenders, not for laypersons as there are other procedures, rules, practices and factors that apply to each of those 8 points that have not been disclosed fully. There is not going to be any attorney off the street or any RE agent or other person who has not had specific training in originations that can hit on those 8 points and be in compliance. DF only skims over these matters, what they are referring to is prudent lending practices, not really step one, step two, step three and so on.

I've also heard suggestions as to processing, underwriting and documentation "ideas" or "suggestions" that 1. are not customary practice, 2. not required, 3. generalized lack detail and 4. just bad advice to the extent of really causing serious issues. I'm including everything mentioned about DF and lending requirements on BP, not just this thread.

Not sure if I mentioned it in this thread, but no one is an expert on DF, I don't know every slight detail and I know no one else does as a BP contributor. I can only think of 9 members on BP that have sufficient managerial lending and compliance experience to be giving advice on lending now, they are all institutional type lenders, regulators or compliance specialists.

Back more on topic. The SAFE Act defines contracts that are included with compliance requirements as being any method or arrangement where credit is given toward a purchase price, basically, mentioning specifically "Lonnie Deals", "Rent-To-Own" or "Lease-Option" arrangements. The SAFE Act doesn't specifically refer to these sellers as "Lenders".

Last caution is saying only a lender is liable. The SAFE Act states that any "Lender" "Originator" or "Maker" of any financing arrangement can be subject to requirements. The "lender" will be as we all know, the guy loaning the money, the "originator" is the one processing and underwriting, the "maker" is the borrower (not the lender or the one writing the contract). DF encompasses the SAFE Act and gives enforcement aspects to the CFPB as well as HUD.

I didn't mean to write a book again, but just a few statements can require paragraphs to correct or explain in more depth or shed light on an issue.

Another comment was made concerning ambulance chasing attorneys learning that there can be a gold mine for tenants and borrowers, absolutely true and might as well expect them to pop up. As to regulators trolling deed conveyances to find violators, really doubt that very, very much. Regulators are far too busy in compliance issues with institutional lenders and dealers on a much grander scale than to beat the bushes for Ivan the Investor.

Investors need to understand what attorneys refer to as "life events" things that happen in life, death, bankruptcies, casualty losses, tenant suits or divorces where some deal will surface. You can not do a deal and keep it a secret unless you're lucky, if nothing else, your deal will surface when a buyer tries to refinance a deal. As these deals surface naturally and attention is drawn to them is when a regulator may get involved, they don't have to search for them. :)

@Bill Gulley

Hi Bill, I think this is the 2nd time I pressed that button and forgot my back peddling on the 1st time... :( "shake out" meaning the buyer has to prove themselves to be a reliable payer to earn the ability to have me write a mortgage with them. 12 months never late rent payments. Some nice talking folks, solid on paper, just aren't reliable payers. We know this from landlording so no need to hog tie one's self in a OF to a poor payer. ATR does not also mean pays on time or every month. LOL!

My DTI math issue goes away by making the note a 20 term, DTI is under 43%. If the buyer wants a 15 yr note, the question is am I able to offer the 15 yr term even though it means 46% DTI?

All of the DF threads have not talked about what if the OF is outside the stated lines in the sand? What do we do to comply? I tried to crack open the discussion of what about OF's outside the middle ground within DF? What is needed to be in compliance with DF if:

- greater than 43% DTI?

- greater than 6.5% interest rate over floating prime?

I see only the DTI discussion to be interesting to me.

The over 6.5% + prime is mainly for discussion sake. It's probably is in play for folks who sell real low priced properties IE $45k and down where risk is much higher and the amount of equity you take back so low that you are in the hole vs the un paid balance if there's a default/foreclosure. But I don't want this issue to hyjack talking about what if > 43% DTI.

Originally posted by @Douglas Larson :
@Brian Gibbons

Great insights and I enjoyed some of your youtube vids. A little dry - maybe you could include a song and dance number in the next one. ;-)

Great info though. Thanks for taking the time to flesh out the possible implications of poorly structured L/O in regards to DF.

Thanks Douglas. You be well too. :)

PS got any videos of you dancing singing? love to see that. :)

Are you considered a dealer, I suppose you will be.

My point up there was that underwriting is not cut and dry, it's a process that leads you to a justified decision to advance credit of fair and equitable terms that can be achieved by the borrower. 43%, 46%, 49% they can all be done, in compliance. Your issue is with them having poor credit. Credit can be poor but it must be out weighed with positive factors, the lease (without an credits) is a good idea. HUD provides structured classes for those with poor credit, requiring completion of a personal financial and homeowner's class will also be a significant compensating factor. Likelihood of income increasing or other debts falling off in 6 months or less are compensating factors. Total income is another factor, a borrower making $6K a month may have sufficient savings and the ability to pay 50% and live off the other $3K monthly. Ratios are guidelines, not meeting the guideline changes the classification of the loan, it doesn't deny the loan if there are other factors that show the loan was prudently made, not predatory, achievable under the terms and is otherwise in compliance, such as not containing a balloon payment.

Higher interest needs to reflect risk, not be made arbitrarily based on greed, shown as customary under the circumstances, not violate any usury aspects, must be affordable and the loan should be amortized no longer than 30 years. When you start going over 10% you may have issues and higher rates may be considered predatory.....and if they are higher, the loan probably is predatory for a homeowner.

If one were to sum up the DF Act in a few words, it would be; get rid of predatory lending and servicing practices and securitization of sub-prime loans. :)

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here