Seller Financing – Creating Notes and Dodd Frank Explained!
PLEASE NOTE: This is meant to be a surface level primer on Seller Financing and not a full-blown course. The idea here is to make “some major light bulbs go off in your head!”. We are first and foremost a software company but we also aim to educate our clients on real estate investing, so that they stay ahead of their competition. Seller Financing is, these days, a highly regulated field, so if you engage in these deals, make sure you have proper legal representation review your docs and deals!
“If you think compliance is expensive – try non-compliance.”
~Former U.S. Deputy Attorney General Paul McNulty
This quote rings true for investors, and any other professionals whose careers touch the real estate and mortgage industries.
As an investor, are you focused on avoiding fees so much that you’re overlooking state and federal regulations? If so, you could run into some major trouble – especially when it comes to seller financing.
If you’ve been following my mini-series on seller financing, you already know the basics of seller financing, and you’ve got an idea of where to find sellers now too.
Now, the next step is to deepen your understanding of seller financed notes and compliance regulations such as the Dodd-Frank Act.
I know, thrilling, right?
But, trust me, grasping this info – even at a basic level – is vital to your success. And that’s exactly why I want to cover it today…
Luckily, when it comes to seller financing – and all the details that go along with it, such as notes, compliance and regulations – I can always consult my friends Mark Stein and Terry Lewis – San Diego-based real estate brokers, mortgage loan originators and investors.
I chatted with Mark and Terry about the ins and outs of seller financed notes and Dodd-Frank, so I could share the most important points with you.
So, here we go…
Notes (Not the Kind You Used to Pass to Classmates During School)
To get right into it, I learned about the 3 types of notes from Mark and Terry:
- Performing (basically the “perfect loan”). Payments are current.
- Non-performing (you’re able to grab the note at such a low price point).
Now, the value of the note is always established when the loan is created. Mark emphasizes that you should never worry about the value of pennies!
Here’s the key: If you want to be able to sell your note after it was created 1) with no issues and 2) at the highest price possible, you HAVE TO make sure the paperwork that goes along with this note is tight and comprehensive and that the note was created in full compliance.
For that reason, you really should look to add a “mortgage loan originator” to your team that will help you put all this paperwork together and navigate Dodd Frank and other legal crap for a small fee. Trust me: it’s well worth the money.
Realistically, you want to look at it like this… this is your investment! Don’t write a crummy note – it’s worthless. A perfect seller financed note that doesn’t have any errors, and includes the credit, collateral and capacity will ensure you make the most possible money from selling it.
Side Note on Discounted Notes: You can buy notes at big discounts. After all, you can just foreclose on the property if something doesn’t work out. We’re talking about massive discounts, which means you can do really well with discounted notes!
Wherefore Art Thou, Note Buyer?
Brokering notes is another way that people make a profit off of notes. You might see some of this on Craigslist. There are a couple of ways to go about this, as Mark points out:
- You can build your fee into the sale
- You can take a flat fee
Now I was surprised to hear that there are 23 different ways to sell a note. If you don’t have that great of a real estate note, there are ways that you can creatively package it into the sale. It’s all about creating that win-win situation.
So… how do you find a note buyer?
How to Find a Note Buyer
There are a lot of ways to go about finding a note buyer. Usually, your personal relationships with people who have IRAs are probably your best bet. (In other words, your “financial friend network.”)
Same people that would “private lend” your deals would buy notes for income.
The second option would be to reach out to fellow investors who are doing this to make a living. (You might use LinkedIn to accomplish this). Really, as Terry said, it’s all about relationships.
Mark also brought up the game of “daisy chain” that’s often played in this industry…
What he meant by this is: When a note is for sale, there’s all these people involved, and you can never talk directly to the seller. That’s one of the major problems with the institutional notes – where they’re being sold off as either discounted notes or even performing notes.
One of the great things about dealing with the seller financed notes is that you always know who the seller is. And when you bring a buyer to the table, you know where the note is coming from.
The industry is starting to get turned on to this idea again (which was popular in the ‘80s) -that we don’t have to play this daisy chain “game” anymore. Which is great! I’m all for progress, how about you?
So, when you’re taking on seller financing, think of yourself as a high-end “matchmaker” who is providing solutions for:
- Buyers who can’t buy
- Sellers who can’t sell
- Investors needing to live
We can certainly create a note through merging a buyer and a seller – or as our own deal, as the investor. Merging these 3 people who all need something is what we can do to provide a solution.
Dodd-Frank Explained and Beyond: Learning the Rules
Not to be a Debbie Downer, but when you’re providing any type of credit or rewriting a note, you are subject to federal and state laws.
Now, this is not a fun topic, per-say – but it’s an important one.
First, let’s take a quick look at the SAFE Act (passed in 2008):
- A federal law that requires mortgage licensing
- Granted the state and federal governments licensing powers
- Enforced by the state and federal governments; they also implement annual testing
- Created the NMLS registry
- Created quarterly reporting of all consumer loans taken and made by category, type, race, etc.
Next, the Dodd-Frank Financial Reform Act (passed in 2010):
- Requires disclosures for sellers/brokers involved in certain seller-financed deals
- Amends the Truth in Lending Act (TILA) to require disclosures for seller-financed transactions
- Sellers have to meet very strict guidelines to be exempt from disclosure requirements
- Brokers have the same standards for exemption as the SAFE Act but must be careful with compensation
If you’re thinking, “Huh?” don’t worry, it might seem like Greek at first – but you’ll understand it more with time. And here’s the thing…
You may know that I always talk about building a strong team. Don’t put the burden on yourself to understand all the state and federal compliance regulations – because you’ll never have the time and resources to keep up with it. Plus, it’s not your area of expertise – investing is, right?
You need someone on your team, such as a mortgage originator or an experienced attorney, who understands industry compliance and regulations.
While Dodd-Frank has been around for several years, there can still be some confusion surrounding it.
The Quick and Easy Test: If the buyer is a consumer who will occupy the property, the transaction is NOT exempt from Dodd-Frank.
Now, there ARE specific exemptions, and there are a bunch of them. Check out your state regulations or consult with your attorney or mortgage originator to sort out those particular details.
HERE ARE A FEW CRUCIAL EXEMPTIONS THAT WILL PROBABLY APPLY TO YOU:
Dodd Frank Does NOT Apply to:
- Sellers who finance properties to non-owner occupants (investors)
- Private Lenders and Hard Money Lenders who finance investors
- Sellers financing apartment buildings (5 units or more) or vacant land
- Investor Buyers who purchase with owner financing
- Investors who borrow from hard or private money lenders
So for the purposes of this entire blog series and the type of deals you’re doing, chances are Dodd Frank won’t affect you unless you’re selling to owner occupants with seller financing.
Just remember: Don’t be a “Grinch.” Stop stepping over dollars to try picking up pennies.
If you’re going to be engaged in these deals regularly, hire an expert to advise you and steer you clear of regulations. A mortgage loan originator is one such advisor. Keep in mind that:
- The fee with a mortgage loan originator consultant is highly negotiable
- The fee is usually paid by the buyer and it’s less than they’d pay for a regular deal anyway
- The fee can be built into the price or financed – to make you more money
- The fee is free insurance and helps you close the deal
- It makes your note much more marketable
- And, most important of all, it’s federal law (not optional, people!)
Usually, the fee is going to be somewhere around a minimum of 1% of the note amount or a minimum of $2,000 – but that’s just a ballpark estimate.
So, don’t get caught with your pants down (I apologize for that visual) – just make sure you’re at least familiar with your state and federal regulations. And consult with someone who knows them completely (such as your attorney or mortgage loan originator). You need to use the correct disclosures!
The Dodd-Frank Act means the Consumer Financial Protection Bureau (CFPB) has a ton of control. The CFPB was created to enforce all consumer transactions – including mortgages. With the regulations in this industry always evolving, it’s imperative to have an expert on your team to keep you updated on all the changes.
Killer Example of a Seller Finance Deal
I wanted to end this by giving you an awesome example of a seller finance deal that my friend and business partner, Jim Ingersoll, recently did on an apartment building. Think about how powerful a deal like this can be, especially if you do a few of them over the course of a year.
Jim found an apartment building from a seller who was motivated and agreed to owner financing. They negotiated a $500,000 sales price to Jim, with 5% down and 5% interest rate.
Jim then turned around and found a buyer pulled from his cash buyer list and sold this deal at $575,000 with seller financing. Only on the resale, he negotiated a 10% downpayment and 8% interest rate. He did what’s called “wrapping the note” – he wrapped his note from the seller with his note to the buyer. (Again, a good real estate attorney can help you put this paperwork together easily).
Here’s the kicker: they did a double closing, so that Jim didn’t have to bring any money to the table. As he walked away from the closing table, he left with:
- $32,500 in cash (10% on $575k minus 5% on $500k)
- $1,471 in monthly cashflow. He paid $1,979.16 in interest-only payments to seller (5% interest on $475k) and received $3,450 from his buyer (8% interest on $517,500)
Now this is creative financing and deal making at it’s finest!
Go out and put what you’ve learned to work!
Again, it all comes back to offering as many solutions as possible. Investors who have more “tools” in their belt are more likely to experience the financial success that comes along with it.
Until next time,
Don’t Be Shy
What lingering questions do you have on seller financing? Talk to me in the comments below.
What burning questions do you have about seller financing? Talk to me in the comment box below.