Predatory lending is a buzz word borne out of historically low interest rates and the housing market frenzy in the early part of this century. Predatory lending practices, including sub-prime loans and loan to equity financing in excess of 100 percent led in part to the financial crisis of 2007.
The sinking of the housing market, the significant rise in foreclosures and the shutting down of overnight loans were biproducts of this financial crisis and created the backdrop for sweeping federal legislation that altered the face of mortgage lending. Mortgages that were once easy to come by suddenly became nearly impossible to secure, even for those with good incomes and good credit. Buyers and borrowers, particularly those with less than perfect credit, turned to private financing to purchase homes.
In 2014, Congress passed the Dodd Frank Act, which was designed to protect consumers from the predatory lending practices that helped fuel the financial crisis, and made sweeping changes to the ability of individuals to provide owner financing secured by a personal residence. The mortgage loan component of the Dodd-Frank Act, and its Colorado counterpart, the Mortgage Loan Originator Act, severely limited private lending for residential mortgages. Under the new legislation, lenders must have a mortgage loan originator license to provide financing for homebuyers. There are, thankfully, some exceptions, such that owner financing is still available if certain criteria are met.
First, consider whether the buyer is a natural person or an entity. The state and federal acts apply only to consumer credit; therefore, if the buyer is an entity, the acts do not apply, and the owner financing transaction can occur.
The second consideration is whether the buyer is going to live on the property. Only residential property is covered by the acts. In Colorado, a residential property is defined as property in which a residence is or will be constructed. If the land is commercial, vacant, agricultural or the buyer is purchasing the property for investment purposes only, the loan is exempt, and the borrower and lender can proceed to their deal.
If the property is residential, and the buyer is going to live there, the next consideration is whether the lender owns the property. If the lender does not own the property, and the residential property will secure the loan, the lender must be a licensed mortgage loan originator or use the services of one in making the loan.
On the other hand, if the lender is the owner of the property, the lending transaction might still be viable. If the owner is an individual, trust or estate, the owner can make the loan without a license if he meets certain tests, including that he finances only one property in a 12-month period, he was not the builder or contractor for the property, and certain interest rate requirements are met.
If the property is entity owned (corporation, limited liability company, etc.), or the owner finances between one and three properties in a year, the owner can proceed with the loan without a license so long as certain tests are met: no more than three such loans are made in a 12-month period; the seller was not the builder or contractor; there is no balloon payment; the seller must make a good faith determination that the buyer has the ability to repay the loan; and certain interest rate requirements are met.
If these criteria cannot be met, the loan must proceed through a licensed mortgage loan originator. This can add to the time and cost involved in buying a home.
The consequences for violating the federal or state acts range from financial penalties and jail time if prosecuted, to the possibility that a borrower could avoid repayment of the loan, interest or fees, or worse, obtain a refund of interest paid, closing costs or damages against a lender.
If at first the transaction does not fit the exceptions, there may still exist creative means by which private financing can occur without violating the law. However, there is a general adage in the law that one cannot do indirectly what is prohibited directly. The mortgage lending legislation is still new and untested, and it may take several years before there is certainty as to how those laws will be applied in different situations.
Owner financing is an attractive alternative to conventional mortgages because of the cost and time savings, flexibility in rates and payments and is especially attractive for those lacking the ability to jump through the credit hoops required by banks because of poor or insufficient credit. However, the new financing laws are complex and provide pitfalls for the unwary. Private lenders should carefully consider Dodd-Frank and its Colorado counterpart and their exceptions before making loans to ensure compliance.
Nancy Agro is a Durango attorney practicing water, real estate and business law. She has been in practice for 23 years. Reach her at agro@mydurango.net.
