SELLER FINANCING: WHEN DO THE SAFE ACT AND DODD FRANK ACT NOT APPLY. John Fleming. Law Office of John Fleming. 700 Lavaca, Suite 1400

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1 SELLER FINANCING: WHEN DO THE SAFE ACT AND DODD FRANK ACT NOT APPLY John Fleming Law Office of John Fleming 700 Lavaca, Suite 1400 Austin, Texas Ph (512)

2 Mr. Fleming is an Austin, Texas attorney who practices in the area of banking, mortgage banking, financial services, regulatory and administrative law, commercial litigation, and arbitration. His clients include banks, thrift institutions, mortgage banks, title agencies, life insurance companies, investment advisers, and securities firms. Mr. Fleming served four years as General Counsel to the Texas Department of Savings and Mortgage Lending that oversees and regulates state chartered thrift institutions, mortgage brokers, and mortgage bankers. He is an adjunct professor at the University of Texas School of Law and a frequent speaker on arbitration, banking, and mortgage law topics. Mr. Fleming serves as the General Counsel of the Texas Mortgage Bankers Association. He is a member and a former director of the Texas Association of Bank Counsel. The American Arbitration Association honored him with the 2008 President's Award for Leadership in Conflict Management in recognition for his work in arbitration, mediation, and education; he also serves on the Commercial Arbitrator Roster of the AAA. Mr. Fleming is a past Chair of the State Bar of Texas Alternative Dispute Resolution Section, and a recipient of the 2012 Frank Evans award presented by the State Bar ADR Section for excellence in the field of ADR. He is a graduate of the University of Houston Law Center and of Lee University. 2

3 Seller Financing: When do the Safe Act and Dodd Frank not apply? I will attempt to first provide an overview of the SAFE Act and its Texas implementation. Second, we will look at how seller finance transactions are treated under SAFE. Third we will look at some of the provisions of Dodd Frank as they may relate to seller financing transactions. For our purposes when we say Dodd Frank, we really are focusing on the revisions to the Truth in Lending Act found in Dodd Frank and earlier statutory revisions. Overview of SAFE and State Implementation Laws. In 2008 Congress enacted the Secure and Fair Enforcement for Mortgage Licensing Act ( SAFE Act ). The legislation creates a comprehensive regime to register or license all residential mortgage loan originators in the United States. The SAFE Act divides all residential mortgage loan originators into two broad classifications: (1) employees of federally regulated depository institutions and their operating subsidiaries;and (2) loan originators of non-depository entities. Non-depository affiliated residential mortgage loan originators are required to be licensed. If a state enacts legislation to conform its licensing laws to the uniform standards required by the SAFE Act, the state will retain its authority to license residential mortgage loan originators. If a state fails to adopt the uniform standards, then HUD is authorized to assume the licensing responsibility for the non-conforming state. Among other requirements, SAFE mandates that states participate in a national registry for mortgage loan originators, the Nationwide Mortgage Licensing System (NMLS). Employees of federally regulated depository institutions and their subsidiaries are not required to be licensed at the state level, but will be required to register through the NMLS. Employees of banks and their operating subsidiaries are designated in SAFE as registered mortgage loan originators. To assist the states in developing SAFE compliant legislation, the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators ( CSBS/AARMR) developed a model state act. The model act differs from the SAFE act in some of its provisions-the major one being a more expansive definition of who is a mortgage loan originator. 3

4 In Texas, the Safe Act and the licensing of mortgage loan originators is found in Finance Code Chapter 180 (general licensing requirements); Finance Code Chapter 156 (mortgage companies, formerly called mortgage brokers); Finance Code Chapter 157 (mortgage bankers and individuals sponsored by a mortgage company or a mortgage banker). Unless exempt Chapter 180 requires persons that meet the definition of a residential mortgage loan originator to become licensed by either: (a) (b) the Office of Consumer Credit Commissioner (those originators working for regulated loan companies under Finance Code Chapter 342; persons working for manufactured housing financing entities licensed under Chapter 347 and certain personnel for motor vehicle sales under Chapter 348); or the Department of Savings and Mortgage Lending (mortgage brokers under Chapter 156; and mortgage bankers and individuals sponsored by a mortgage banker or mortgage broker under Chapter 157). An exemption from state licensing for bank employees and bank subsidiaries is found in Finance Code Section (1). Mortgage originators who are employed by a bank or a bank subsidiary do not have to be licensed, but they must register with the National Mortgage License and Registry System. The bank or bank subsidiary employer is responsible for doing a criminal back ground check and reviewing the credit history of a bank loan originator. In theory, both licensed originators and bank loan originators are subject to the same standards. In fact the banks and bank subsidiaries are not applying the same standards or are not doing equal due diligence. The financial regulators appear to be only checking institutions to see if the depository has an appropriate policy in place and do not seem to be examining how the bank is applying that policy to scrutinize prospective loan officers. 4

5 When Does the SAFE Act Apply to a Seller Financer? Who has to be licensed? Finance Code requires an individual who acts as a residential mortgage originator to be licensed. Definitions under Chapter 180 are critical. A residential mortgage originator is defined in (19) as an individual who for compensation or gain or in the expectation of compensation or gain: (i) takes a residential mortgage loan application; or (ii) offers or negotiates the terms of a residential mortgage loan. But what is a residential mortgage loan? Finance Code (18) defines Residential mortgage loan" as a loan primarily for personal, family, or household use that is secured by a mortgage, deed of trust, or other equivalent consensual security interest on a dwelling or on residential real estate. Finance Code (20) defines residential real estate to mean property in this state on which is situated a dwelling or intended for the construction of a dwelling. Based upon these definitions, a license is required of anyone who makes a loan primarily for personal, family or household use that is secured by a one to four family dwelling or a vacant lot on which a dwelling is intended to be constructed. A person who only makes loans to an investor is not required to be licensed even if the property qualifies as residential real property. The original enactment of Chapter 180 exempted an individual who sold and financed his or her residence. This was the only seller finance exemption in the 2009 version of the act. At the time of the enactment of Chapter 180, Finance Code Chapter 156 provided an exemption for seller financing transactions where the seller did not engage in more than five seller finance transactions in any twelve month period. HUD, who at that time was the federal agency responsible for evaluating whether or not the state acts complied with SAFE, did not appear to approve of a broader seller finance exemption. This was so even though the primary authors of SAFE (House Financial Institutions Chair Barney Frank and Ranking Member Spencer Bachus) wrote a letter to HUD supporting a de minimis exception for seller financing. The Texas Department of Savings and Mortgage Lending continued during this period to interpret Chapter 180 and Chapter 156 together and to recognize an exception from licensing for a seller who finances less than five transactions a year. 5

6 Subsequently, Chapter 180 was amended to add (6) and (7) to expressly exempt an owner who in any 12 month period makes no more than five residential mortgage loans to finance the purchase of residential real estate from that owner. So then, the answer to the question of When does SAFE not apply to a seller finance transaction is this: 1. SAFE does not apply if the seller finance transaction is to an investor and the loan is not for personal, family, or household use. 2. SAFE does not apply to an owner who finances the sale of a dwelling or a vacant lot intended for construction of a dwelling if the owner does not make more than five such transactions within any twelve month period. One additional caveat. Finance Code Chapter 180 requires that an individual be licensed before the individual may engage in the activity of acting as a residential mortgage loan originator. However, Finance Code Chapter 156 requires that any person who engages in the business of originating residential mortgage loans be licensed. When used in a Code (such as the Finance Code), the Code Construction act defines the term person as a natural person and also a corporation, organization, government or governmental subdivision or agency, business trust, estate, trust, partnership, association, and any other legal entity. (See Government Code (2). What are the penalties for not being licensed. A person who acts as a residential mortgage loan originator or mortgage company without being licensed commits a Class B misdemeanor and is subject to fine and up to six months in jail (however, to the knowledge of the author, no one has actually been prosecuted for failure to be licensed). The person is subject to issuance of a cease and desist order or other administrative action (this can and does happen with regularity). However, the most overlooked sanction is found in Finance Code : A person who received money, or the equivalent of money, as a fee or profit because of or in consequence of the person acting as a residential mortgage loan originator without an active license or being exempt under this chapter is liable for damages in an amount that is not less than the amount of the fee or profit received and not to exceed three times the amount of the fee or profit received, as may be determined by the court. An aggrieved person may recover damages under this 6

7 subsection in a court. Interpreted broadly, this would mean that an unlicensed lender could be liable for up to 3 times the amount of all the interest that had been paid on the note. When is a Seller Financer a Creditor for purposes of Truth in Lending Note here, that I have altered the frame of the question from when does Dodd Frank not apply. I do this because it is the Truth in Lending revisions that pose the most important thresholds. The provisions of Truth in Lending apply to creditors who extend consumer credit. As with SAFE, definitions are critical. The definition of creditor is found in 12 CFR (17)(i) A person who regularly extends consumer credit that is subject to a finance charge or is payable by written agreement in more than four installments (not including a down payment), and to whom the obligation is initially payable, either on the face of the note or contract, or by agreement when there is no note or contract. Subsection (17)(v) provides that a person regularly extends consumer credit if the person enters into more than five transactions secured by a dwelling in the previous calendar year or the current year. This has been the traditional standard for coverage for many years. What is new and reflects amendments in Dodd Frank is this: A creditor becomes subject to TILA if the person makes more than one high cost mortgage loan (12CFR (17)(v): A person who regularly extends consumer credit that is subject to a finance charge or is payable by written agreement in more than four installments (not including a down payment), and to whom the obligation is initially payable, either on the face of the note or contract, or by agreement when there is no note or contract. Prior to Dodd Frank the definition of high cost mortgage loans did not include a residential real estate transaction (a purchase money loan. However Dodd Frank extended the provisions relating to high cost mortgage loans to include the previously excepted transactions. Here is the definition of a high cost mortgage: (12 CFR : (1) The requirements of this section apply to a high-cost mortgage, which is any consumer credit transaction that is secured by the consumer's principal dwelling, other than as provided in paragraph (a)(2) of this section, and in which: (i) The annual percentage rate applicable to the transaction, as determined in accordance with paragraph (a)(3) of this section, will exceed the average prime offer rate, as defined in (a)(2), for a comparable transaction by more than: 7

8 o o o (A) 6.5 percentage points for a first-lien transaction, other than as described in paragraph (a)(1)(i)(b) of this section; (B) 8.5 percentage points for a first-lien transaction if the dwelling is personal property and the loan amount is less than $ 50,000; or (C) 8.5 percentage points for a subordinate-lien transaction; or (ii) The transaction's total points and fees, as defined in paragraphs (b)(1) and (2) of this shall be adjusted annually on January 1 by the annual percentage change in the Consumer Price Index that was reported on the preceding June 1; or (iii) Under the terms of the loan contract or open-end credit agreement, the creditor can charge a prepayment penalty, as defined in paragraph (b)(6) of this section, more than 36 months after consummation or account opening, or prepayment penalties that can exceed, in total, more than 2 percent of the amount prepaid. 12 CFR (2) defines"average prime offer rate" as an annual percentage rate that is derived from average interest rates, points, and other loan pricing terms currently offered to consumers by a representative sample of creditors for mortgage transactions that have low-risk pricing characteristics. The Bureau publishes average prime offer rates for a broad range of types of transactions in a table updated at least weekly as well as the methodology the Bureau uses to derive these rates. The most recent tables found not on the CFPB website but on the Federal Financial Institutions Examination Council (FFIEC) website show that an average prime offer rate ranges vary from 3.17% for a fixed rate 1 year loan to 3.27% for a 20 year term. So then if a creditor made two or more high cost loans in 2013, and enters into a high cost loan in November of 2014, he triggers TILA coverage if the loan if for 20 years and the rate is 9.77% or higher. Once the triggers are reached, the seller financer then becomes subject to the ability to repay requirements, the TILA disclosure requirements, the TILA appraisal requirements, and the high cost mortgage loan requirements. 8

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