New Note Laws As Of Jan 1
Published: Tue, 12/10/13
December 10, 2013
Hi ,
If you ever sell real estate and carry back notes...if you ever
buy or sell notes...if you ever broker notes...or if you ever buy
real estate and assume notes, you need to read this e-mail.
On January 1 new laws go into effect that will determine how some
seller-carryback notes must be written. If you create, buy or sell
these notes in violation of the law they could be voided.
There's been a lot of misunderstanding about what changes on Jan. 1.
I asked Ric Thom to give CASH FLOW EXPRESS subscribers the true
story. I don't know anyone who is more familiar with these new
laws than Ric -- he has been tracking this legislation since it was
first introduced, advising the National Association of Realtors on
strategy.
His article is below.
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W. J. Mencarow
President, The Paper Source, Inc.
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Ric Thom is one of the leading authorities in seller carryback real
estate contracts.
He owns Security Escrow in Albuquerque, New Mexico. He has
served as a director and the president of Valencia County Board
of Realtors. He also served as a director of the Albuquerque Board
of Realtors as well as a director of the Realtors Association of New
Mexico. Ric was recently named Affiliate Of The Year by the
Albuquerque Board of Realtors. He is a certified instructor for the
New Mexico Real Estate Commission's continuing education program.
He teaches the course "Practical Application of Real Estate
Contracts," which he created.
GET READY TO CHANGE HOW YOU CREATE, BUY & SELL NOTES
by Ric Thom
SETTING THE STAGE
First, none of what follows affects anyone today. It all applies to
transactions on or after January 1, 2014. Further, none of it
applies to any seller-carryback transactions where the buyer will
not use the property as their personal residence.
When Dodd-Frank ("The Dodd-Frank Wall Street Reform and Consumer
Protection Act") was enacted into law on July 21, 2010, it said
that you could only do three seller carryback transactions a year,
and those transactions had to meet certain requirements:
(1) The note could not have a balloon.
(2) It had to have a fixed interest rate for five years, then it
could adjust.
(3) You had to prove and document the buyer's "ability to repay" in
accordance with the Qualified Mortgage Rule (QM), which is quite
restrictive. That's the same rule that banks have to use if
they want a safe harbor and not get sued for making a loan that
didn't fit the QM.
Because so many people wrote comments to the CFPB --- and THE
PAPER SOURCE took the lead -- the bureau relaxed the seller
financing restrictions. They came out with something that was a lot
more relaxed than the Dodd-Frank law was originally.
The CFPB subsequently issued the following regulations. They apply
to seller carryback notes created on or after January 1, 2014.
THE ONE PER YEAR CATEGORY
The CFPB broke seller financing into two different categories. One
category is for those individuals, trusts or estates who do just
one seller carryback transaction a year on a property that has a
dwelling that the buyer will use as their primary residence.
Let me repeat that, because there has been so much misinformation
circulated about it: this category is for those individuals,
trusts or estates who do just one seller carryback transaction a
year on a property that has a dwelling that the buyer will use as
their primary residence. For them:
* You do NOT have to prove or document their ability to repay.
* You CAN have a balloon in your note with the buyer.
* The note must have a fixed interest rate for five years, and at
the end of five years the interest rate can increase no more than
two points per year with a cap of six points above whatever you
started at. You have to tie it to an index like a T-bill or the
prime rate in the beginning.
That's probably going to affect all but three to five percent of
individuals who carry back notes.
Remember that these restrictions only apply to seller-carryback
transactions on properties that have a dwelling that the buyer will
use as their primary residence. A transaction on a lot or vacant
land is exempt, even if the buyer plans to build a primary
residence.
If the property has a dwelling,but the buyer is not going to use it
as their primary residence -- say they're going to rent it or use it
as a second home -- then none of this applies, and you can offer
seller financing with no restrictions.
Commercial property and multifamily that is five units or larger
is also exempt from the restrictions.
Once again -- the one seller carryback transaction per year
category applies to individuals, trusts and estates. It does NOT
apply to corporations, LLCs, partnerships or other legal entities.
In that case the second category applies, which I will discuss
below.
And again, these rules only apply to what the CFPB refers to as a
residential mortgage loan where the note is secured by a dwelling or
residential real property that includes a dwelling. Most people
only carry back a note once in their lifetime, when they sell the
big house, retire and move somewhere else. Some might do it a
few more times. Even many real estate investors only do it once a
year. These regulations are not a huge change for most people.
THE MORE THAN ONE PER YEAR CATEGORY
The second category applies to individuals, trusts and estates that
do more than one seller carryback transaction per year when the
buyer will use the dwelling as their primary residence.
It also applies to any seller-carryback transaction -- even one
-- where the seller is a corporation, LLC, partnership or other
legal entity and when the buyers will use the dwelling as their
primary residence.
* The note cannot have a balloon.
* The note must have a fixed interest rate for five years, and at
the end of five years the interest rate can increase no more than
two points per year after the fifth year with a cap of six points
above whatever you started at. You have to tie it to an index like
a T-bill or the prime rate in the beginning. This is the same
restriction as the first category.
* You must determine the buyer's ability to repay.
* If you do no more than three seller-financed transactions per year
you do not have to become a Mortgage Loan Originator (MLO).
* If you do more than three you must become an MLO -- or find an
MLO who is willing to be the go- between.
Just as in the "one per year" category, these restrictions only
apply to seller-carryback transactions on properties that
have a dwelling that the buyer will use as their primary
residence.
If you have a rental house and the renters want to buy the house to
use as their primary residence, and you want to carry back a note
with a balloon (and you don't do more than one seller carryback
transaction per year), and that rental property is in a corporation,
LLC, partnership or other legal entity, you're going to have to move
the property into a trust or into your personal name. Otherwise,
you're going to fall into the second category which says you cannot
have a balloon unless you are an individual, trust or estate.
If you think about it, not having a balloon but being able to
do an adjustable rate almost serves the same purpose. Let's say
you start out with an interest rate of 6% on the note and then
after five years it goes to 8%, then it goes to 10% and then it
goes to 12%. That's a huge incentive for the buyer to refinance out
of the property and pay you off. If they don't, then you're
rewarded for your risk in carrying that paper; you're now getting
12% for holding that paper, and there is no balloon.
ABILITY TO REPAY
The second category requires you to determine the buyer's ability
to repay, but the rules and the regs don't specify any standards
for doing it (such as the qualified mortgage standard, a 43% debt
to income ratio, etc.). You don't have to do any of that; you can
just ask them if they have a job, can you see a paystub, can
you see their tax return (which they may or may not give to you).
All you are required to do is to make some good-faith determination
that they're able to afford that payment, and you do not have to
document it.
It would be prudent to have some documentation in case there's a
default and the buyer's attorney says "where's the documentation?"
and tries to create a legal defense against paying you. But there
is no requirement that you have to document. All it says is that you
should determine the buyer's ability to repay.
I asked an attorney at the CFPB about how one should determine the
buyer's ability to repay. He said that if you fall under category
two you have to determine the ability to repay, but he admitted
that there are no set guidelines. You just have to show that you
used good faith in determining, for example, that the buyer has a
job, his rent was $1,000 per month, but the payment on the note is
$900 a month and you think in good faith he can afford this
property because he could afford the rental house he was in before.
WHEN YOU'RE BUYING A NOTE CREATED ON OR AFTER JAN. 1, 2014...
You're going to be able to tell from the note if the mortgagee is a
private individual or an entity. If it is a private individual,
trust, or estate, then ask them to sign an affidavit saying that
they have not done more than three of these in a 12-month period
and how many of them had balloons. If it's an entity, an LLC, or a
corporation, etc., ask for an affidavit saying how many it
has done and how many of them had balloons.
If there is a balloon in that note that you're buying from an
LLC, corporation or partnership, etc., you know there's not supposed
to be one (again, if that note was created on or after January 1,
2014). You'll have to have the note modified to remove the balloon
before you buy it. Otherwise at some point the mortgagor could use
the fact that the note was not in compliance when it was written as
a defense against paying the debt or foreclosure.
One more thing -- I want to thank Bill Mencarow and PAPER SOURCE
subscribers for getting the word out there, because, honest to
God, without those comments we would be stuck with the original
statute -- which would have killed seller carrybacks. In the
Federal Register the CFPB wrote that they relaxed the rules on
seller financing because of the numerous comments they received.
Ric's websites are www.securityescrownews.com and
www.securityescrow.com
Copyright 2013 by Ric Thom.
Permission to reprint this article, including electronically,
is granted ONLY if you reprint the entire article AND include
the following:
Copyright 2013 by Ric Thom. Websites: www.securityescrownews.com
and www.securityescrow.com This article first appeared in
THE PAPER SOURCE JOURNAL: www.PaperSourceOnline.com or call
800-542-2270.
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PAPER SOURCE JOURNAL subscribers were the first to get this
information last September. THE PAPER SOURCE JOURNAL is our
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