Article by Michelle R. Rodriguez Woodland Hills Mortgage
After the Consumer Financial Protection Bureau (“CFPB”) released the final Loan Originator Compensation Rule in early 2013, there has been a lot of confusion surrounding the Seller Financer Rule or Seller Carry- Back Rule. It is important for brokers and lenders to understand these rules. Seller financing will become more important as interest rates rise, and it becomes increasingly difficult for borrowers to obtain conventional financing due to the new ability-to-repay guidelines. Also, with FHA lowering its loan limits, more sellers will need to carry paper in order to sell their properties because FHA borrowers will not be able to get financing for expensive properties. If you are a mortgage broker or a lender, chances are that Realtors make up some portion of your customer base. They will likely have questions about seller carry- back loans, and it would certainly help your reputation and standing with Realtors to have the answers to the questions they have regarding those loans. Lastly, some lenders may have REO properties that they will sell in the future, and those lenders should understand the implications of the Seller Financer Rule.
I. Roadmap to the Rule and Related Issues
Here is a summary of the basic determinations that a seller financer must make in light of the Seller Financer Rule.
1. Seller financers first need to determine if they will be considered a loan originator (“LO”) under the Loan Originator Compensation Rule (“LO Comp Rule”).1
2. If the seller financer will be an LO, then they need to decide if they want to be exempt from being an LO under the LO Comp Rule.
3. If they want to be exempt, then they will have to fulfill the requirements under either the one of the seller financer exemptions: the one-property exemption or the three-property exemption (explained in more detail below).2
4. If the seller financer only qualifies for, or otherwise chooses the three- property exemption, the seller financer must determine in good faith that the borrower can reasonably repay the loan.3
5. In making the ability-to-repay determination, the official interpretations state that the seller financerhas two choices: 1) the full §43 ability-to-repay rules, or 2) abbreviated ability-to-repay rules under comment
36(a)(4)-1, set forth later in this article.
6. If the seller financer decides not to be exempt, or for whatever reason is not exempt from the LO Comp Rule, then he or she must take into consideration the LO Comp Rule when making the seller carry-back loan.
7. Whether or not the seller financer is a mortgage loan originator under the SAFE Act is a separate question, with a separate definition, and different exemptions, none of which specifically mention seller financers.
The seller financer must look at the SAFE Act rules and determine whether they are performing acts for which an NMLS license is required, and if so, see if they qualify for one of the SAFE Act exemptions or get an NMLS license, or arrange the loan through someone who is properly licensed.
The rest of this article will go into more detail regarding each determination on the list above.
II. The Rule
The CFPB published regulations which relax and slightly change the seller carry-back rules as passed under Dodd-Frank.4 The CFPB rules are located as part of the LO Comp Rule5 Therefore, the Seller Financer Rule only applies to seller carry-back loans that are consumer loans secured by 1-4 unit residential properties.6 Business purpose loans are not affected by the Seller Financer Rule. The Seller Financer Rule is an exemption from the definition of an LO for purposes of the LO Comp Rule.7 If a seller financer fulfills the Seller Financer Rule, then he/she is not an LO under the LO Comp Rule. If a seller financer does not fulfill the Seller Financer Rule, then the seller financer is an LO, and must follow the LO Comp Rule, and is subject to its liability. The Seller Financer Rule has two different exemptions: the three-property exclusion and the one-property exclusion.
a. Three-Property Exemption Under the three-property exemption, “A person … that meets all of the following criteria is not a loan originator [under the LO Comp Rule]…:
(i) The person provides seller financing for the sale of three or fewer properties in any 12-month period to purchasers of such properties, each of which is owned by the person and serves as security for the financing.
(ii) The person has not constructed, or acted as a contractor for the construction of, a residence on the property in the ordinary course of business of the person.
(iii) The person provides seller financing that meets the following requirements:
(A) The financing is fully amortizing.
(B) The financing is one that the person determines in good faith the consumer has a reasonable ability to repay.
(C) The financing has a fixed rate or an adjustable rate that is adjustable after five or more years, subject to reasonable annual and lifetime limitations on interest rate increases. If the financing agreement has an adjustable rate, the rate is determined by the addition of a margin to an index rate and is subject to reasonable rate adjustment limitations. The index the adjustable rate is based on is a widely available index such as indices for U.S. Treasury securities or LIBOR.8
b. One-Property Exemption Under the one-property exemption, “[a] natural person, estate, or trust that meets all of the following criteria is not a loan originator under [the LO Comp Rule]:
(i) The natural person, estate, or trust provides seller financing for the sale of only one-property in any 12-month period to purchasers of such property, which is owned by the natural person, estate, or trust and serves as security for the financing.
(ii) The natural person, estate, or trust has not constructed, or acted as a contractor for the construction of, a residence on the property in the ordinary course of business of the person.
(iii) The natural person, estate, or trust provides seller financing that meets the following requirements:
(A) The financing has a repayment schedule that does not result in negative amortization.
(B) The financing has a fixed rate or an adjustable rate that is adjustable after five or more years,subject to reasonable annual and lifetime limitations on interest rate increases. If the financing agreement has an adjustable rate, the rate is determined by the addition of a margin to an index rate and is subject to reasonable rate adjustment limitations. The index the adjustable rate is based on is a widely available index such as indices for U.S. Treasury securities or LIBOR.” 9
c. Analysis & Commentary If the seller financer meets one of the two exemptions, they are exempt from the definition of loan originator under the LO Comp Rules. Also note that sellers that are entities (limited liability companies, corporations, etc.) can only qualify for the three-property exemption. Only natural persons, estates & trusts can avail themselves of the one-property exemption. In California, it is unusual for a seller financer to receive or pay compensation for the seller carry-back loan. Therefore the question arises – if no compensation is being received by or paid by the seller financer, who cares if a seller financer is exempt from the LO Comp Rules?
Even if compensation is received or paid, as long as the payments comply with the LO Comp rules (i.e. no dual comp, no comp based on the terms of the loan, and no steering) there has been no violation of the
LO Comp rules due to the compensation. It is easy to fall into the trap of believing that the seller financer must find an exemption from the LO Comp rules. That is not necessarily the case – in fact, in California, it would appear that most seller financers would not run afoul of the LO Comp Rules, because normally no compensation is received by or paid to the seller financer. Therefore, seller financers should question the need to fit themselves under one of the seller financer exemptions – it might not be worth it. It might be better to operate outside of the exemption, and just comply with the LO Comp Rule when necessary (i.e. when paying or receiving compensation for the seller carry-back loan.)
The LO Comp Rule generally excludes creditors who meet the definition of a creditor under the Truth in Lending Act (“TILA”), otherwise known as being a “Reg. Z Creditor,” except for those that table und.10 TILA’s definition of creditor excludes a person that extended credit secured by a dwelling (other than high-cost mortgages) five or fewer times in the preceding calendar year; and (2) does not include a person who extends no more than one high-cost mortgage (subject to § 1026.32) in any 12-month period.11 Therefore many seller financers would not be considered a Reg. Z Creditor, and would not be
exempt from the definition of an LO under the LO Comp Rules, unless they meet one of the seller financer exemptions (or other exemptions outside of the scope of this article). Some seller financers will be Reg. Z Creditors – a lender who makes consumer loans (more than 5 per year) and sells REO’s using seller financing is likely a Reg. Z Creditor. They are already exempt from most of the LO Comp Rule – so the seller financer exemption is irrelevant to them. However, a Reg. Z Creditor is still subject to the rest of Reg. Z – including the disclosure and timing requirements, and the ability-to-repay rules.
IV. SAFE Act issues
The Seller Financer Rule is particularly confusing because it refers to the definition of a loan originator, which is a term used both in TILA and the SAFE Act. Remember, that the Seller Financer Rule is an exclusion from the LO Comp Rule under TILA – the Seller Financer Rule has nothing to do with being aloan originator for purposes of the SAFE Act. A person could be exempt from being a loan originator under the LO Comp Rule, but still be a loan originator under the SAFE Act, and still need a SAFE Act license to make the seller carry-back loan.
a. TILA Definition of Loan Originator
The LO Comp Rule defines a loan originator as, “a person who, in expectation of direct or indirect compensation or other monetary gain or for direct or indirect compensation or other monetary gain, performs any of the following activities: takes an application, offers, arranges, assists a consumer in obtaining or applying to obtain, negotiates, or otherwise obtains or makes an extension of consumer credit for another person; or through advertising or other means of communication represents to the public that such person can or will perform any of these activities.”12
b. SAFE Act Definition of Loan Originator
The SAFE Act defines a loan originator as: an individual who—
(i) takes a residential mortgage loan application; and
(ii) offers or negotiates terms of a residential mortgage loan for compensation or gain.13
As you can see, the definition under TILA is a lot more broad and all-encompassing compared to the SAFE Act definition. The seller financer should consider these issues separately.
V. Ability-to-Repay Issues
Another source of confusion with the Seller Financer Rule is how this rule interacts with the Ability-to- Repay Rule under TILA.14 Bear in mind that the Seller Financer Rule is an exemption to the LO Comp Rule, not an exemption to the Ability-to-Repay Rule. If a seller financer does not fulfill the requirements of one of the seller financer exemptions, then the seller financer may be an LO under the LO Comp Rules, and have to follow all the requirements of the LO Comp Rule. The Seller Financer Rule does not mandate that the seller financer prove ability to repay. However, under the new Ability-to-Repay Rules, Reg. Z Creditors must prove ability-to-repay for consumer loans secured by single family, 1-4 unit dwellings. A seller financer must determine 1.) if they are a Reg. Z Creditor, in which case they will be subject to the Ability-to-Repay Rule for some loans, or 2.) if they are not a Reg. Z Creditor, in which case they are not subject to the Ability-to-Repay Rule. But if a seller financer wishes to avail him/herself of the three-property exemption, they will have to determine in good faith that the consumer has a reasonable ability to repay the seller carry-back loan. The preamble and official comments to the rule give some guidance as to how a seller financer can go about making this determination. Basically, the seller financer can comply with the full Ability-to-Repay Rule in 1026.43(c), or do the following:
If the consumer intends to make payments from income, the person considers evidence of the consumer’s current or reasonably expected income. If the consumer intends to make payments with income from employment, the person considers the consumer’s earnings, which may be reflected in payroll statements or earnings statements, IRS Form W–2s or similar IRS forms used for reporting wages or tax withholding, or military Leave and Earnings Statements. If the consumer intends to make payments from other income, the person considers the consumer’s income from sources such as a Federal, State, or local government agency providing benefits and entitlements. If the consumer intends to make payments from income earned from assets, the person considers the relevant assets, such as funds held in accounts with financial institutions, equity ownership interests, or rental property. However, the value of the dwelling that secures the financing does not constitute evidence of the consumer’s ability to repay. In considering these and other potential sources of income to determine in good faith that the consumer has a reasonable ability to repay the obligation, the person making that determination may rely on copies of tax returns the consumer filed with the Internal Revenue Service or a State taxing authority.15
Again, the seller financer must ask themselves why they are trying to be exempt from the LO Comp Rule, and it is worth the trouble of complying with the seller financing exemptions.
VI. Conclusion In closing, remember that
1) the Seller Financer Rule is part of the LO Comp Rule under Reg. Z, and only applies when the seller carry back loan will be a consumer loan secured by a 1-4 unit dwelling, and 2) nothing mandates that a seller financer has to follow the Seller Financer Rule. Seller Financers should understand the rule so they can choose whether or not they want to follow an exemption under the rule, and if so, decidewhich exemption to follow under the Seller Financer Rule.
- 12 CFR 1026.36(a).
- 12 CFR 1026.36(a)(4) & (5) (2013).
- 12 CFR 1026.36(a)(4)(iii)(B) (2013).
- The Dodd-Frank Seller Financer rule is located at section 1401 of the DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT and codified at 15 USC 1602 (2013). If you wonder how the CFPB can change a law passed by Congress without going back to Congress and getting an amendment, the CFPB asserts that Congress themselves gave the CFPB the authority to “prescribe additional criteria … aside from those enumerated in the statute.” (78 Fed. Reg. 11280-01 (2013) at p.45).
- 12 CFR 1026.36(a).
- 12 CFR 1026.36(b) (2013)
- 12 CFR 1026.36(a)(1)(i)(D (2013).
- 12 CFR 1026.36(a)(4) (2013).
- 12 CFR 1026.36(a)(5)
- 12 CFR 1026.36(a)(1)
- 12 CFR 1026.2(a)(17) – the full definition of a creditor is much longer than the summary in this article.
- 12 CFR 1026.36(a)(1) (2013).
- 12 U.S.C.A. 5102(4) (2013).
- 12 CFR 1026.43 (2013).
- 12 CFR Part 1026, Supp. I, Part 3, Official Interpretations 36(a)(4)-1 (2013).Frank