As the California Bureau of Real Estate notes, “’Carry backs’ by sellers are evidenced by promissory notes secured by deeds of trust or mortgages recorded in a junior position that may either be held or sold by assignment or endorsement to a permanent investor/lender, either directly or through use of the services of a mortgage broker.” http://www.dre.ca.gov/files/pdf/refbook/ref12.pdf
Basically the seller becomes a lender, and has to evaluate the buyer’s creditworthiness and decide how to structure the loan (interest only, partially amortized, fully amortized, etc.) and then comply with California’s myriad lending laws such as the Financial Code regarding balloon payments, the State Constitution regarding usury, and so forth.
However, in addition to state law, sellers who extend credit may be subject to the federal law as well.
Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, Regulation Z (TILA) has been amended and has made important changes to the law that affect sellers who finance the purchase of residential property comprising 1-4 units. Such sellers could now be considered “loan originators” and thus required to give TILA disclosures. However, there is an exemption under the new Dodd Frank requirements if:
- Seller finances only ONE property within the year; and
- the loan is not negatively amortizing, has a fixed rate or does not adjust for the first five years,
- and the seller is not the builder.
The newly amended Regulation Z in 12 C.F.R. § 1026.36(a)(5) states:
5) Seller financers; one property.
A natural person, estate, or trust that meets all of the following criteria is not a loan originator under paragraph (a)(1) of this section:
(i) The natural person, estate, or trust provides seller financing for the sale of only one property in any 12 month period to purchasers of such property, which is owned by the natural person, estate, or trust and serves as security for the financing.
(ii) The natural person, estate, or trust has not constructed, or acted as a contractor for the construction of a residence on the property in the ordinary course of business of the person.
(iii) The natural person, estate, or trust provides seller financing that meets the following requirements:
(A) The financing has a repayment schedule that does not result in negative amortization.
(B) The financing has a fixed rate or an adjustable rate that is adjustable after five or more years, subject to reasonable annual and lifetime limitations on interest rate increases. If the financing agreement has an adjustable rate, the rate is determined by the addition of a margin to an index rate and is subject to reasonable rate adjustment limitations. The index the adjustable rate is based on is a widely available index such as indices for U.S. Treasury securities or LIBOR.
If the number of transactions increases, such as the seller finances THREE properties in a year, then in order to be exempt from TILA requirements the restrictions increase, such as the loan must be fully amortized and the borrower must have the reasonable ability to repay the loan.
The California Association of Realtors has put forth a Seller Financing Disclosure as page 4 of the Seller Financing Addendum in the November 2013 revision of its forms.
The pitfall for the unwary here is a family trust selling multiple (perhaps adjacent) parcels to a developer and then carrying back the financing until the construction financing pays them off. Such a transaction requires some additional scrutiny to determine if the sellers are still exempt from Truth in Lending Act requirements and disclosures. If you or your clients are contemplating a seller financing transaction, do not hesitate to seek legal counsel to review your compliance obligations.
If you or a friend is seeking real estate legal counsel regarding a California based property, don’t hesitate to contact our law firm at (650) 327-2900 or to learn more about our firm and read attorney bios, visit us on the web at www.BrewerFirm.com.