Seller Financing

What is seller financing?

Sometimes a seller may act as a lender and provide the buyer with the financing for their home purchase. While rare today, this arrangement was more common in the past, particularly in rural and farming communities where the deals were known as “land contracts”. The seller would hold the note on the home in exchange for regular payments until the parameters of the agreed upon sale were satisfied at which point the deed was transferred to the buyer. These arrangements are experiencing a new life with the advent of the rent-to-own and shared-equity models of home buying.

Types of seller financing agreements

Buyers and sellers can choose from different seller financing agreements based on their needs. These are some of the most common options:

Assumable mortgage: In this arrangement, buyers take over the seller's existing mortgage.
Lease purchase: Also known as a rent-to-own agreement, this set up has buyers/renters pay sellers/landlords an option fee for the opportunity to purchase the property later on.
Land contract: With land contracts, buyers make payments directly to the seller instead of banks or credit unions.

Advantages of seller financing for homebuyers

Seller financing works well when the two parties know and trust each other and when the parameters of the sale and agreement to repay are clearly spelled out and in contract. These arrangements can be tailored to unique circumstances, revised over time, and may save money over a traditional lending arrangement.

Disadvantages of seller financing for homebuyers

Seller financing does not share all the consumer protections embedded in traditional mortgage lending. Land contracts and seller financing agreements have been abused to the detriment of buyers. In some instances, the seller would require repairs be made by the buyer or not credit monthly payments toward the buyer’s debt. Worse, sellers have been known to rush buyers to foreclosure for missing payments and not crediting them with accrued equity, maintenance, or improvements on the property made while under contract.

Seller financing is subject to licensing and regulations that are important for real estate agents to understand. Learn about the rules for seller financing homes listed below in the Advocacy section.

Legal and regulatory considerations in seller financing

Navigating legal and regulatory landscapes is essential for real estate agents involved in seller financing. Agents should be mindful of state-specific regulations governing such transactions, which can vary widely. Key considerations include ensuring contracts are legally sound, understanding disclosure requirements, and advising clients on potential risks. Staying informed about local laws or regional conditions and seeking legal advice when necessary helps agents protect their clients' interests while facilitating smooth transactions.

Consumer protections and risks in seller financing

Understanding the risks associated with seller financing is important for both buyers and sellers in real estate transactions. Unlike traditional mortgages, seller financing may lack some consumer protections, exposing parties to potential abuse or disputes. Agents should educate their clients on these risks, such as non-standard terms, limited recourse in case of default, and the potential for disputes over property conditions. Mitigating these risks involves thorough contract review, clear communication, and possibly seeking legal advice to ensure fair and transparent agreements.

Advocacy

In 2008, President Bush signed the Secure and Fair Enforcement of Mortgage Licensing Act or SAFE Act, which requires licensing and registration of loan originators.

SAFE Act Final Rule: Seller Financing and REOs

The SAFE Act requires licensing of loan originators under state laws that meet minimum federal requirements. HUD has established minimum standards in its final rule published in the Federal Register on June 30, 2011. HUD's overall responsibility for interpretation, implementation, and compliance transferred to the Consumer Financial Protection Bureau (CFPB) on July 21, 2011.

Who must be licensed as a loan originator?

The SAFE Act requires licensing of individuals who engage in the business of a loan originator. To trigger the licensing requirements under the SAFE Act, the financing must be primarily for personal, family, or household use. An individual engages in the business of a loan originator if the individual, in a commercial context and habitually or repeatedly, takes a residential mortgage loan application and offers or negotiates terms of a residential mortgage loan for compensation or gain.

How often does a seller have to provide seller financing to be subject to licensing?

HUD chose not to decide how frequently an individual may provide financing before reaching the requisite degree of habitualness. NAR expects CFPB to defer to reasonable state laws on the number of seller financing transactions that would trigger licensing, but only time will tell.

How can sellers financing the sale of their properties be sure to avoid licensing?

A seller financing the sale of his or her own property would completely avoid the issue of licensing by retaining the services of a licensed loan originator. This ensures that all regulatory requirements are met and provides an added layer of protection and professionalism to the transaction. Additionally, sellers should document all terms clearly and ensure compliance with state and federal regulations to avoid potential legal issues.

What about the sale of your own residence, a vacation home, or inherited property?

HUD advises that, "absent evidence to the contrary, the sale and financing the sale of one's own residence, vacation home or property, or inherited property" is not likely to be considered to be engaging in the business of a loan originator. However, it is essential for sellers to ensure that these transactions do not become habitual or commercial in nature. Consulting with a legal professional can help clarify any uncertainties and ensure that these occasional transactions comply with applicable regulations.

Are real estate brokerage activities exempt?

Brokers and agents are exempt from loan originator licensing, to the extent they are performing only real estate brokerage activities and not compensated by a lender or loan originator (or their agents). In cases where a real estate broker/agent receives a commission from the lender for the sale of a property owned by the lender (including an REO), individuals must only be licensed as a loan originator if they engage in the business of a loan originator. Brokers/agents rarely, if ever, take an application or offer to negotiate terms of a residential mortgage loan for such transactions and typically would not have to be licensed as loan originators.

When did seller financing rules go into effect?

State laws requiring licensing are all already in effect. HUD issued earlier guidance and a model statute to assist the states in connection with enactment of their laws. HUD's final rule took effect on Aug. 29, 2011. Since then, the Consumer Financial Protection Bureau (CFPB) has taken over responsibility for interpreting and enforcing these rules. It's important for real estate agents to stay informed about any updates or changes to these regulations, as state-specific amendments and federal interpretations can impact compliance requirements. Regularly reviewing guidance from the CFPB and state regulatory bodies can help ensure adherence to current laws and best practices in seller financing transactions.

Dodd–Frank Wall Street Reform and Consumer Protection Act

President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law on July 21, 2010. Included in the hundreds of Dodd-Frank Act provisions is new section 129C of the Truth in Lending Act (TILA) which provides that no creditor may make a residential mortgage loan without first making a reasonable and good faith determination that the borrower has the ability to repay, based on 8 statutory criteria, to promote responsible, affordable mortgage lending. The term creditor, for purposes of this ability-to-repay requirement, is a person who "regularly extends" consumer credit, which is defined as more than 5 times in a calendar year.

The Federal Reserve Board published a proposed rule to implement the ability-to-repay requirements on May 22, 2011, with comments due July 22, 2011. Authority for future rulemaking, including the final rule for this provision, transferred to the Consumer Financial Protection Bureau (CFPB) on July 21, 2011.

How does the definition of mortgage originator exempt seller financing?

Creditors, not mortgage originators, are subject to the ability-to-repay requirements.

The Dodd-Frank Act definition of "mortgage originator" exempts an individual (or estate or trust) that provides mortgage financing for no more than three properties in any 12 month period from certain requirements of Title XIV, but only if the financing meets certain criteria:

The seller did not construct the home to which the financing is being applied.

The loan is fully amortizing (no balloon mortgages allowed).

The seller determines in good faith and documents that the buyer has a reasonable ability to repay the loan. This provision appears to differ from the section 129C ability-to-repay requirements.

The loan has a fixed rate or is adjustable after 5 or more years, subject to reasonable annual and lifetime caps.

The loan meets other criteria set by the Federal Reserve Board.

How do the rules affect seller financing?

NAR's comment letterpdf observes that seller financing is only subject to the section 129C ability-to-repay requirements if the seller provides financing more than five times in a calendar year and, therefore, would be considered a creditor. The term mortgage originator, which includes an exemption for seller financing described above, is used in a section (entitled "Prohibition on Steering Incentives") designed to prohibit certain compensation paid to mortgage originators to prevent steering in the context of preventing abuses where some originators were paid more for arranging for loans that were disadvantageous to the consumer. Seller financing, of course, does not involve compensation paid by third parties, and NAR believes it should not be subject to the compensation and steering rules. To the extent the CFPB determines any requirements apply to mortgage originators engaged in seller financing, the NAR letter asks CFPB to use its broad statutory authority under TILA to make the exclusion practicable by allowing a balloon mortgage in some circumstances and to streamline any ability-to-repay determination that may apply.

When did the Dodd–Frank Wall Street Reform and Consumer Protection Act go into effect?

On January 20, 2013, The Consumer Financial Protection Bureau (CFPB) published a final rule on Loan Originator Compensation as part of implementation of the Dodd-Frank Act. The final rule took effect on January 10, 2014.

Learn more about the impact of CFPB's Loan Originator Rule on seller financingpdf

What this means for REALTORS®

The ability-to-repay requirements exempt seller financing unless the seller, as creditor, provides financing more than five times in a calendar year. There is uncertainty whether the inflexible seller financing exemption from the definition of mortgage originator will be significant. NAR will continue to seek to minimize restrictions on seller financing.