Those familiar with the standard real estate forms promulgated by the Colorado Real Estate Commission will notice a change on the 2014 contracts. Previously the contracts contained “fill in the blanks” for the buyer and the seller to agree to the terms of seller financing, but no longer. Why the change?
In brief, the commission decided that seller financing is getting too complicated for real estate brokers and their clients to handle without legal advice. The reason is something called the “Ability to Repay” (ATR) rule promulgated by the Consumer Financial Protection Bureau (CFPB).
The CFPB is a new federal agency established by the Dodd-Frank Wall Street Reform and Consumer Protect Act, which became law in 2010. The CFPB is charged with protecting consumers from certain loan practices that contributed to the financial crisis. The CFPB is actively rolling out regulations, one of which is the ATR rule effective Jan. 10, 2014. The ATR rule prevents creditors from making certain types of loans without first making a reasonable and good faith determination, based on verified and documented information, that the borrower will have a reasonable ability to repay the loan according to its terms.
This means that obtaining a residential loan will be harder in many cases because the borrower will have to provide documents showing ability to repay that, let’s just say, weren’t always required during the lead up to the financial crisis.
The ATR rule imposes really bad penalties on any creditor that does not comply.
The bad news is that the ATR rule generally applies to sellers of residential property carrying back financing. The good news, if there is any, is that the ATR rule provides an “exemption” that many sellers will be able to satisfy. Comply with the exemption and the ATR rule will not apply. Fail to comply with the exemption or the ATR rule and face the really bad penalties.
So, how does a seller comply with the exemption?
First, the seller must be a “natural person,” estate or trust, not any form of legal entity such as a limited liability company. If title to a property is held by an ineligible seller, it may have to first be transferred to an eligible seller for the exemption to apply.
Second, the seller can only carry back financing for one property in any 12-month period if the property is security for the loan. For many sellers with only one property to sell or who do not sell properties often, this should not be an issue.
Third, the seller cannot have constructed the home or acted as the general contractor for construction of the home. This will prevent many builders of “spec homes” from taking advantage of the exemption.
Fourth, and finally, the financing cannot result in “negative amortization” (an increasing amount due even if the buyer makes all required payments) and must either be fixed rate or adjustable rate after five or more years, subject to reasonable annual (2 percent) and lifetime (6 percent) interest rate increases and based on accepted indices such as LIBOR. A balloon mortgage is permitted.
Even where a seller complies with the exemption, which is a matter of federal law, the seller must still contend with additional disclosure requirements imposed by Colorado state law. The world of seller financing is now much more complicated than it used to be and sellers and real estate brokers need to take note and obtain appropriate legal advice.
This article is just an overview and does not address many important details.
Many sellers of residential property who carry back financing will fall under the exemption to the ATR rule discussed above and need not concern themselves with federal law issues. However, these sellers must still satisfy state law requirements.
Noah Klug is owner of The Klug Law Firm, LLC, in Summit County, Colorado, emphasizing real estate, business, and litigation. He may be reached at (970) 468-4953 or Noah@TheKlugLawFirm.com.
As part of regulations being rolled out by the new Consumer Financial Protection Bureau, borrowers in many cases will have to provide documents showing “ability to repay” that, let’s just say, weren’t always required during the lead up to the financial crisis of 2008.