Does your real estate investment business rely on owner finance as a strategy? In the years post-Dodd-Frank, regulatory changes have been ongoing, and with them the way investors do seller finance is significantly changed. To bridge the gap between investors, borrowers, and regulations, using an RMLO is the only option for originating owner finance loans. But what do they do, and why do you need them?
But first, what is an RMLO? The acronym RMLO stands for residential mortgage loan originator. After the housing crisis of 2008 the SAFE Act (Secure and Fair Enforcement for Mortgage Lending Act) required states to set licensing standards for individuals involved in the process of originating a residential mortgage loan. A national, standardized test, required training, and other standards make RMLOs keenly aware of the current regulatory environment as well as holding them accountable to industry standards and best practices.
So, why do you need to know one?
The first reason: To comply with the law. Even if you only generate one owner finance loan this year, that loan is not exempt from federal and state regulations. Many have heard that in the state of Texas it is permissible to have unlicensed investors originate a handful of loans per year, and while it is true that the TX SML allows this de minimus threshold, they also clarify that this exemption only applies to the need to hold a license, not to the regulatory standards required of the loan you will produce. Even if you consider the de minimus national exemption, each state has a different threshold and none of them exempt the lender from following through with regulations and disclosures. If you generate a single seller finance note this year it must comply with all federal and state regulations, including REPSA, TILA, HOEPA, ECOA, and more. Compliance law is a complicated matrix of information and isn’t easily done DIY without making mistakes that leave your loan open to being challenged. Like with the failed attempts to self-diagnose off of Web MD when one should just call a doctor, a google search will not provide investors all the needed information to build a comprehensive compliance system like a licensed RMLO can offer.
What’s the worst that can happen? Even the most well meaning of real estate investors can run afoul of regulations, leaving the life of your loan in jeopardy if the borrowers were to make a claim against you. What are the biggest concerns facing seller finance investors?
While the potential pitfalls and costly violations are theoretically many, there are a few that are most likely to trip up investors. One such is determining the ability-to-repay of the borrower, abbreviated as ATR, which is a requirement placed on the lender extending a higher-priced mortgage loan in Regulation Z of the Truth in Lending Act (TILA) and further in section 1411 and 1412 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). This regulation requires a reasonable, good faith determination that the borrower can indeed afford the loan offered. However, it isn’t as simple as taking the borrowers word for it, even if they really want the house. Regulators point to eight specific criteria that must be examined to meet the ATR guideline, and require that certain third-party records be used to prove the criteria. Investors must do the due diligence to see if the borrower will have enough money leftover each month to truly afford the house and it’s expenses, which can run counter to investors other motivations to move the transaction along and get the house sold. Investors also must, when it comes to seller finance, view themselves as creditors, and understand that their ATR determination must not discriminate individually, but be a broad and systematic guideline they apply to all their loans. There is no statute of limitations on contesting ATR on a foreclosure if the borrower chooses to take action, and could result in significant legal fees, fines, and an eventual loss of value against the loan. Previous studies performed by the CFPB have shown a substantial success rate for borrowers who contest a foreclosure citing certain protections like ATR. Avoid this issue by working with an RMLO to build your approval system for potential borrowers.
Another compliance issue facing seller financing investors is determining when an appraisal is legally required. Depending on the interest rate offered and terms of the loan, some loans are legally required to have at least one appraisal (some flips are required to have two!). Seller finance investors should be keenly aware of the potential of being labeled “predatory lenders,” especially since regulators and those outside of the investment community will not understand your business model. Especially when extending loans with higher interest rates to borrowers with imperfect credit histories, it is important that investors get the details right (and know what details to even look for!). Avoid the notice of regulators and the complaint of a borrower by hiring an RMLO who understands what loan terms trigger a required appraisal, and what additional actions and disclosures are triggered based on specific loan terms, interest rates, and other features.
Finally, it should be remembered that an RMLO originated loan is more marketable. To investors this should read: more marketable = more value. Note buyers are looking for loans professionally originated by a knowledgeable RMLO are therefor more valuable to you as an investor, especially when one remembers that the origination fee is paid for by the borrower. Your investment business has everything to gain, and possibly something to lose, if you choose not to include an RMLO in your seller finance transactions.
How specifically does an RMLO provide solutions to the challenges faced by investors? A licensed RMLO is trained to partner in the transaction for the very purpose of compliance — reducing the risk to your loans. Professional RMLOs working on a seller financing transaction are obligated to examine the terms of the loan, consider the borrowers ability to repay, and transmit all needed disclosures and information within a specific timeframe required by law. An RMLO will parter with your borrowers to be sure they understand everything about the loan they are asking for, walking them through the process of preparing the needed information and closing on the loan. In short, an RMLO takes care of the headaches of compliance law so that you can continue to do what you do well — finding deals and growing your investment business. Successful real estate investors need an entire network of skilled connections, from contractors to attorneys, to build the best business possible, and having an RMLO assist you in growing your note portfolio is just one of the many essentials you should be looking for.
Have a seller finance loan you need to originate? Email us at firstname.lastname@example.org or give us a call at (832) 410-8917!