On 1/10/2014, the provisions of the Dodd-Frank act affecting Seller Financing went into effect. Although the law was passed in 2010, it gave us 4 years to “become accustomed” to the new provisions. However, what actually happened was that the new regulations were largely ignored and forgotten about until just recently.
In Internet blog posts, chatrooms, and even in some REIAs, you will find such nonsense being touted as “this will kill Seller Financing”, or even “you will go to jail if you don’t comply”. To dispel these myths and provide and accurate picture of what Dodd-Frank is and is not, the National REIA has compiled a 25 minute, narrated Powerpoint. You may download it here: Power Point Download
To summarize, Investors are now responsible for making sure that someone they sell a house to with owner financing actually has enough income to make the payments. There is even an entire new industry created by this act (Licensed Mortgage Originators) who will do so for a fee. Folks, I would sincerely hope that you don’t want to take a large down payment from someone without the income to afford payments on your house, so that you must inevitably foreclose them out later. It was for scenarios like these that these provisions were enacted.
So Why is Seller Financing so Important?
In a capitalistic, free-enterprise society, supply and demand is the governing mechanism that determines, for lack of a better phrase, “who gets what” amongst scarce resources. Today, estimates are that approximately 80% of adults cannot qualify for bank financing. So, even though the supply of housing may be adequate (or more than adequate) to meet the demand amongst those wanting to buy houses, the “real supply” consists only of those houses which are available to the buying public (ie: the house is for sale and available to the buying public at prices and/or terms that they can afford). That leaves a whole lot of demand (people who want to buy a house) unfulfilled. The solution: Seller Financing to the rescue!
Historically, in times when bank financing has either been scarce (like now), or so unattractive as to be, for practical purposes, useless to most consumers (such as in the 1980s when the prime interest rate was 16%), Seller Financing has stepped in to fill the vacuum created by lack of bank financing so that those wanting affordable home ownership could still obtain it. For a healthy and much needed dose of perspective, let’s take a brief look at a time when government intervention in a similar manner has affected the real estate market.
The “Due on Sale” Clause
In 1982, Congress passed into law the Garn St. Germain Federal Depository Institutions Act. Like Dodd-Frank, it did a whole lot of things that do not fall into the scope of our analysis. The facet we will examine is that portion of the act which authorized mortgage companies to enforce the “Due on Sale” or Alienation clause, and foreclose on a property if ownership transferred without bank permission. Prior to this, it was a common practice amongst Investors to buy a house with a bank mortgage, rehab it, and resell it in this manner- the buyer takes over the Investor’s purchase loan, and pays the Investor his or her profit in either down payment money, a second mortgage, or some combination of the two. GSJ put a stop to this practice, at least in theory.
In practice, however, savvy Investors continued to leverage existing financing on properties by inventing and utilizing “Subject To”, which has now become such a familiar concept that it is listed as an option in most Board of Realtors’ Purchase and Sale Agreements. In other words, we adapted. Now, if the consumer internet existed in 1982, I’m sure the blog and chatroom postings would be similar in character but worse in degree than what we are seeing now: “It’s over, guess I’ll have to go get a job, now it’s illegal to transfer houses without paying off the mortgage.” Creative Investors viewed this as nothing more than a bump in the road, and continued to make money.
“Wealth is Created by Chaos”
That’s actually a quote from Ron Legrand, who has the distinction of being one of the few “gurus” out there teaching creative real estate that not only practices what he preaches by actively buying and selling houses, but did so before, during, and after the Garn St. Germain Act. Before GSJ, Ron bought and sold hundreds of houses by letting buyers take over his loans. After GSJ, he has bought and sold hundreds and hundreds of houses “subject to”. While investors exited the Seller Financing market in droves, he stood firm and raked in the cash.
This principle has parallels in other industries as well, my favorite of which is J. Paul Getty. At one point, Getty was estimated as the richest man in the world. He wasn’t exactly born into poverty, his father was a wealthy man. However, his father was so displeased with Paul’s manner of living, that upon his death, he left him “only” around $500K out of an estate of over $10 million dollars. J. Paul Getty did pretty well by himself in the oil business. However, had he confined himself to the oil business, he would have came nowhere near the status of possibly being the richest man in the world, and it is unlikely that today you would have even heard of him (you have heard of him, right??).
When the Great Depression hit, panic on a scale never before seen historically befell the financial markets. There was no “we’ve seen this before, it’ll pass” type of perspective. Rather, it appeared to many people that the American experiment in Free Enterprise had failed, and with it the system of financing corporations by the sale of stock. Stocks and companies were selling for literally pennies on the dollar, and no one was buying. Whoops, did I say “no one?” J. Paul Getty was buying companies and stocks with both fists. When the market rebounded, he ascended the throne of financial supremacy, never to step down for the remainder of his life. Rather than letting fear and public opinion determine his business strategy, he analyzed the situation, and acted on logic rather than emotion.
So, what does this have to do with real estate? The Dodd-Frank act is going to scare a huge number of Real Estate Investors out of the Seller Financing Market not only needlessly, but at the precise time when the demand for Seller Financing is enormous. If you have perfect credit now and want a jumbo loan from the bank, you will put down 20% of the purchase price, and that may soon be revised to 30%. The market has been training buyers to expect this. So if you took over a $500K house “subject-to” or bought it in any other manner that allowed you to sell it without needed to cash it out, if a “vanilla”, “A credit” buyer would have to put down $100K to buy it, is it reasonable to expect that you could sell it with Seller Financing to someone with less than stellar credit or who is self-employed and expect more than $100K down? It sounds to me like a very poor time indeed to be allowing fear and ignorance to force me to exit the Seller Financing market. Dodd-Frank is simply a small change to the way we do business. It is not the first, and it certainly will not be the last.