Back in 2010, President Obama signed the Dodd–Frank Wall Street Reform and Consumer Protection Act (commonly known as Dodd-Frank) into federal law.
This legislation came in response to a massive economic downturn, which was partially fed by the irresponsible lending practices of some, which ultimately led to a great deal of financial hurt for many.
At the time, many people in the real estate investing community started recognizing that this legislation was going to introduce some significant new restrictions that would cause major issues with their ability to sell properties with owner financing.
I still remember seeing forum discussions, blog articles, emails and social media posts from people who were freaking out about these changes – because for many of them, it was about to alter their business in a big way.
Dodd-Frank and Seller Financed Land
Around the same time, I wondered how this legislation would affect my business. As a land investor, my real estate investing activity was a bit different from most real estate investors, and I remembered hearing from a number of other land investors at the time that Dodd-Frank simply didn't apply to vacant land transactions.
After reading up on it myself, I found much of the same thing. It seemed like there were a lot of exceptions in the rules that specifically excluded vacant land from all of the new cumbersome rules that Dodd-Frank brought into the picture… but it wasn't until just recently that I decided to dive much deeper into the fine print to understand the issues the best I possibly could.
In this article, I'm going to give you my purely non-legal opinion on what Dodd-Frank and the associated regulations have to say about transactions that involve raw land.
Disclaimer: Please be aware that I am not an attorney and the information in this blog post should not be interpreted as legal or financial advice. The information below is a summary of how I read and interpret Dodd-Frank and it's related material. This analysis is based on several sources and should not be relied on for any transaction without first consulting your attorney.
Note: When I was forming my own opinions about how Dodd-Frank applies to land-only transactions, there were several articles (and this one in particular) that were extremely helpful in sorting out the most applicable areas of Dodd-Frank that pertained to the seller financed vacant land deals. As a result, I follow a similar “flow” to covering the information in this blog post.
This article below gives a written summary of my findings, but if you'd prefer to watch a video overview instead, you can see that right here…
Also, if you'd like to jump to my overview of a particular regulation without watching the full 30+ minute video from start-to-finish, here are some time stamps for you to follow:
- 4:41 – Regulation Z Overview
- 14:05 – Regulation B Overview
- 16:40 – Regulation X Overview
- 19:02 – Regulation P Overview
- 26:25 – Reguation N Overview
When Dodd-Frank was signed into law, it created the Consumer Financial Protection Bureau (CFPB), which went on to create several new regulations in its attempt to provide greater consumer protection in the financial sector. From what I found, the most significant regulations are as follows:
- Regulation Z: Truth in Lending Act (click here to read the full text)
- Regulation B: Equal Credit Opportunity Act (click here to read the full text)
- Regulation X: Real Estate Settlement Procedures (click here to read the full text)
- Regulation P: Privacy of Consumer Financial Information (click here to read the full text)
- Regulation N: Mortgage Acts and Practices – Advertising (click here to read the full text)
When most people think about Dodd-Frank, Regulation Z (i.e. – the Truth in Lending Act) is usually the first thing that comes to mind, because for most would-be lenders, it contains the longest and most problematic list of obligations that need to be followed.
The primary purpose of Reg Z is to promote the informed use of consumer credit by requiring disclosures about its terms and cost (source). The idea behind it is to protect consumers against “misleading practices by the lending industry” by requiring lenders to disclose the interest that will be charged on the loan, provide monthly billing statements to consumers, send out written notices when changes are made, and it prohibits lenders and brokers from conspiring to steer consumers to loans with unfavorable terms, among other things. (source)
Investopedia does a great job of explaining (in clear English) what the key provisions of Regulation Z are. For a good high-level overview of what it's all about, be sure to check out this article.
The Truth in Lending Act was originally enacted in 1968, but in 2011, the general rule making authority for Reg Z was transferred to the CFPB as a result of the provisions enacted by Dodd–Frank. Shortly thereafter, the requirements from Reg Z became more problematic, specifically for property owners looking to sell their properties with seller financing.
One major aspect of Regulation Z that many real estate investors and lenders took issue with is in section §1026.43 (“minimum standards for transactions secured by a dwelling”), which includes the Qualified Mortgage Rule and the Ability to Repay provision. From what I can see, the three most notable “problems” Reg Z created for seller financiers were as follows:
- Individuals or businesses offering seller financing must now become licensed mortgage loan originators IF they execute more than 3 loans each year for residential, owner-occupied properties.
- Balloon payments can not be less than six years.
- The seller/lender is required to qualify the borrower by verifying their ability to repay the loan. Practically speaking, in order for a borrower to qualify, they'll already be eligible for a conventional loan, which not only limits the pool of available buyers, but it's also bad news for those who don't otherwise qualify for a conventional bank loan.
- The credit is offered or extended to consumers;
- The offering or extension of credit is done regularly;
- The credit is subject to a finance charge or is payable by a written agreement in more than four installments; and
- The credit is primarily for personal, family, or household purposes.
It's worth noting that Regulation Z wasn't written ONLY for real estate lenders. It also covers a host of other consumer lending industries, so when it comes specifically to raw land, we need to drill down a bit deeper to understand precisely what types of real estate transactions are covered.
According to Subpart E (Special Rules for Certain Home and Mortgage Transactions), you'll notice that just about every individual reference to the requirements and prohibited practices are directed specifically at “credit secured by a dwelling“.
(19) Dwelling means a residential structure that contains one to four units, whether or not that structure is attached to real property. The term includes an individual condominium unit, cooperative unit, mobile home, and trailer, if it is used as a residence.
Judging by this, I'm fairly confident that vacant land with no improvements is NOT be considered a “dwelling”. As such, one could logically conclude that vacant land transactions are excluded from all the Special Rules for Certain Home and Mortgage Transactions.
To support this further, check out the CFPB's Small Entity Guide. In Section 3 (pages 12 and 13), you'll find several bullet points laying out certain types of loans to which the rule doesn't apply. As you'll see in the final bullet point…
- Consumer credit transactions secured by vacant land.
Given this, my understanding of the regulation is that with regard to the Special Rules for Certain Home and Mortgage Transactions – No, Reg Z does not apply to land-only transactions.
(A) Secured by any real property, or by personal property used or expected to be used as the principal dwelling of the consumer;
Given that “real property” is a term that doesn't necessarily exclude vacant land without a dwelling, one could argue that – Yes, the requirements that full under consumer credit DO apply to land-only transactions.
This specific section of Regulation Z requires that lenders send out certain disclosures to borrowers to inform them about the terms of the loan. However, as I was reading through the numerous requirements in this section, much of the information that lenders are required to disclose seemed to already be covered by the various closing documentation that most sellers use in their closing process.
Remember, this section isn't written specifically for real estate lenders, it's written for lenders is many different industries (industries that don't necessarily follow the same closing process of a real estate deal by notifying the borrower about their interest rate, payment amount, balance owed, servicing fees, late charges, etc).
When I close a land contract, for instance – much of this information is baked into my closing documents. Furthermore, when I'm using a loan servicing company or a service like ZimpleMoney, the borrower should automatically receive monthly notifications (via mail or email) about what the payment amount is, the balance, what portions are applied to principal, interest, escrow and servicing fees, etc.
Regulation Z contains A LOT of rules to follow – and while we can be fairly confident that most of them don't apply to seller financed vacant land transactions, the challenge is in picking out the handful of disclosure requirements that might still apply.
As I skimmed through the disclosure requirements, I was fairly confident that I cover these with the closing process and documentation I use… but don't take my word for it. If you have any doubts about whether you're following these requirements, be sure to talk with an attorney (and preferably, one who has some experience with Dodd-Frank) to be sure.
The Equal Credit Opportunity Act was intended to prohibit lenders from discriminating against applicants for consumer credit. Through this regulation, Lenders cannot withhold credit on the basis of age, gender, ethnicity, nationality, marital status or the receipt of public assistance.
For the most part, Regulation B requires that lenders collect certain information from the loan applicant, monitor the loan and provide certain information to the borrower for the basis of making their credit decision. Similar to Regulation Z, you'll find that for the most part, these requirements pertain to credit secured by a dwelling.
For a quick rundown of what the rules of Regulation B are, check out §1002.4 – General Rules.
With a quick read through these rules, you'll see that Regulation B is mostly about what lender's CAN'T do. For instance…
(a) Discrimination. A creditor shall not discriminate against an applicant on a prohibited basis regarding any aspect of a credit transaction.
(b) Discouragement. A creditor shall not make any oral or written statement, in advertising or otherwise, to applicants or prospective applicants that would discourage on a prohibited basis a reasonable person from making or pursuing an application.
(c) Written applications. A creditor shall take written applications for the dwelling-related types of credit covered by §1002.13(a).
(d) Form of disclosures—(1) General rule. A creditor that provides in writing any disclosures or information required by this part must provide the disclosures in a clear and conspicuous manner and, except for the disclosures required by §§1002.5 and 1002.13, in a form the applicant may retain.
(e) Foreign-language disclosures. Disclosures may be made in languages other than English, provided they are available in English upon request.
What I noticed from the General Rules stated above is that in terms of the specific actions a lender is required to take, they seem to be directed only at creditors who are working on dwelling-related types of credit as covered by §1002.13(a).
(2) Dwelling means a residential structure that contains one to four units, whether or not that structure is attached to real property. The term includes, but is not limited to, an individual condominium or cooperative unit and a mobile or other manufactured home.
As I read this, my non-legal opinion is that this definition does not seem to cover vacant land transactions.
Furthermore, I noticed that the TMHA article referenced above summarizes the same issue like this…
If a lender is making a loan only upon and secured by land, then no dwelling will be involved and the Reg. B valuation disclosures should not apply. However, if the loan will cover both the land and a manufactured home, or the lender will make a separate loan secured by a manufactured home, the Reg. B valuation disclosure will apply.
Given this, my understanding of the regulation is that generally – No, Reg B does not apply to land-only transactions.
With that said, keep in mind that if you're offering seller financing on a property and you're going to say “No” to a particular buyer, it would be prudent to find a verifiable rationale for this decision that does NOT have anything to do with the prospective buyer's race, color, religion, national origin, sex, marital status, age, etc.
Furthermore, if you're advertising that seller financing is available on your property for sale, don't make any openly discriminatory statements in your listing (i.e. – “Seller Financing is available for any white, english-speaking men over the age of 30!“)… hopefully this is obvious, but in case it's not, don't do it.
The Real Estate Settlement Procedures Act was originally passed by Congress in 1974, with revisions that went into effect in 2010. It was created as a means of protecting prospective property owners from some questionable lending practices. Ultimately, it requires lenders to provide more information to their loan applicants during the closing process.
Again, Investopedia gives us some more helpful background on why Regulation X was necessary…
Before this act was created, it was a common practice for a lender to advertise a loan at a certain rate of interest provided the borrower use the lender's title insurance company or other affiliate at a greatly inflated price. The affiliate would then pay the lender a portion of the inflated fee as a kickback.
Since the average home buyer is completely uneducated about what goes on in the standard closing process, Reg X put some protective measures in place to keep the less-ethical lenders of the world from taking advantage of the common home buyer.
§1024.5 Coverage of RESPA.
(a) Applicability. RESPA and this part apply to federally related mortgage loans, except as provided in paragraphs (b) and (d) of this section.
(4) Vacant land. Any loan secured by vacant or unimproved property, unless within two years from the date of the settlement of the loan, a structure or a manufactured home will be constructed or placed on the real property using the loan proceeds. If a loan for a structure or manufactured home to be placed on vacant or unimproved property will be secured by a lien on that property, the transaction is covered by this part.
Given that vacant land is clearly called out as a type of property that isn't covered by Regulation X, I am fairly confident in concluding that – No, Reg X does not apply to land-only transactions.
However, we should also note that this exclusion specifies that vacant land is only considered “vacant land” IF there are no improvements built or placed on the property within two years of the closing date. In other words… the buyer should have no plans to immediately develop the property after the closing (because if the property is improved within 24 months, it's not considered vacant land anymore).
For this reason – it may be wise to include a provision in the loan documentation specifying that the borrower agrees NOT to develop the property until the loan is paid in full.
Regulation P governs the treatment of “nonpublic personal information” about “consumers” by “financial institutions”. The central idea with Reg P is to keep the borrower's private information private.
Does Regulation P apply to a seller of vacant land who is offering owner financing to the buyer? In order to fully comprehend this, we need to understand how three important terms are defined:
- Financial Institutions
- Consumers and Customers
- Nonpublic Personal Information
Luckily, the FTC put together an extremely helpful guide to help us figure this out (you can read through the entire guide here). I'll provide a few references from this article to help spell this out…
Are you a Financial Institution?
The FTC guide explains it like this…
Under the Privacy Rule, only an institution that is “significantly engaged” in financial activities is considered a financial institution. You need to take into account all the facts and circumstances of your financial activities to determine if you are “significantly engaged” in such activities. The FTC's “significantly engaged” standard is intended to exclude certain activities that might otherwise fall under the Privacy Rule. Two factors are particularly important in determining whether you are “significantly engaged” in a financial activity. First, is there a formal arrangement? A store owner or bartender who “runs a tab” for customers is not considered to be significantly engaged in financial activities, but a retailer that offers credit directly to consumers by issuing its own credit card would be covered. Second, how often does the business engage in a financial activity? A retailer that lets some consumers make payments through an occasional lay-away plan is not “significantly engaged” in a financial activity. In contrast, a business that regularly wires money to and from consumers is significantly engaged in a financial activity.
As with most legal issues, the answer to whether YOU are “significantly engaged” in financial activities depends on how frequently you engage in seller financed transactions and how formal your documentation is.
When I look at my business, every seller financed transaction I do is very well documented – so (in my opinion) there is definitely a formal arrangement involved. The frequency of seller financed closings I do varies from year to year, but if I regularly closed more than one transaction per year, I'd be fairly confident that yes, I do enough seller financing to be considered a financial institution.
Do you work with Consumers or Customers?
Again, the FTC guide gives us this explanation…
If you are a financial institution, your obligations depend on whether your clients are “customers” or “consumers.” The Privacy Rule requires you to give notice to all of your “customers” about your privacy practices, and, if you share their information in certain ways, to your “consumers” as well.
Under the Rule, a “consumer” is someone who obtains or has obtained a financial product or service from a financial institution that is to be used primarily for personal, family, or household purposes, or that person's legal representative. The term “consumer” does not apply to commercial clients, like sole proprietorships. Therefore, where your client is not an individual, or is an individual seeking your product or service for a business purpose, the Privacy Rule does not apply to you.
Based on this information – most of the buyers I sell properties to with owner financing are NOT businesses. In almost every case, they are individuals who are using the property for personal, family or household purposes. This may vary for other land investors, but this is how my buyers are typically classified.
Given this, I would be fairly confident it the knowledge that yes, most of my clients are consumers, not customers.
If you aren't sure who whether you're working with a customer or a consumer, be sure to read more from the FTC about how to define “customers” vs. “consumers”.
What is Nonpublic Personal Information?
The FTC guide offers us this explanation…
The Privacy Rule protects a consumer's “nonpublic personal information” (NPI). NPI is any “personally identifiable financial information” that a financial institution collects about an individual in connection with providing a financial product or service, unless that information is otherwise “publicly available”…
NPI does not include information that you have a reasonable basis to believe is lawfully made “publicly available.” In other words, information is not NPI when you have taken steps to determine:
- that the information is generally made lawfully available to the public; and
- that the individual can direct that it not be made public and has not done so.
For example, while telephone numbers are listed in a public telephone directory, an individual can elect to have an unlisted number. In that case, her phone number would not be “publicly available.”
Publicly Available Information Includes:
- federal, state, or local government records made available to the public, such as the fact that an individual has a mortgage with a particular financial institution.
- information that is in widely distributed media like telephone books, newspapers, and websites that are available to the general public on an unrestricted basis, even if the site requires a password or fee for access.
In essence, you'll need to use your head to figure out whether the information you've collected from your borrower is “publicly available” or not. For example, if you collected enough information to pull a personal credit report (such as their social security number, any unlisted phone numbers or personal financial information, etc.) you're almost certainly working with Nonpublic Personal Information.
On the other hand, if you're only working with the buyer's name, address, publicly listed phone number and you haven't collected any other sensitive information – then there's a fair chance you're only working with Public Personal Information, and in these cases, Regulation P most likely wouldn't apply to you.
Again, if you aren't sure whether you're collecting Public or Nonpublic Personal Information, don't take my word for it. Be sure to read more from the FTC about what information is covered.
Unlike the previous regulations, Reg. P doesn't appear to contain any provisions stating that it only applies to transactions with a “dwelling”. As such, those who are selling vacant land with owner financing will have to use their own deductive reasoning to determine whether or not Reg. P applies to them.
If cases where it does, this section from the FTC's guide explains what the lender's obligations are under Regulation P. In my read through this section, the requirements can be fairly simple OR complicated, depending on whether the lender is planning to share the borrower's nonpublic personal information with any outside third parties.
In my case, the most sensitive “NPI” I've ever collected from my borrowers is their social security number (for the purpose of possibly pulling a personal credit report) and in some cases, a copy of their driver's license and passport (just to verify their legal name and mailing address) and under no circumstances was I ever planning to share it with a third-party. It was only being collected so I could verify their identify (to make sure I drafted their deed correctly) and pull a personal credit report prior to extending credit (to make sure my borrower was creditworthy).
As I understand it, this information is clearly in the realm of “Nonpublic Personal Information” – and in the cases where I collected it, I was required to provide the borrower with a notice (whereas, when I didn't collect it, Regulation P didn't apply and no notices were necessary).
If the lender collects any NPI from their borrower (whether they plan to share it with a third-party or not), they must give their borrower an initial privacy notice when the relationship is established.
At one point, an “annual notice” was also required for the duration of the lending relationship, but according to this article, the annual notice is no longer required for lenders when both of the following conditions are met:
- The financial institution does not disclose NPI in a manner that triggers a consumer’s right to “opt-out” of such disclosure.
- The financial institution has not changed its policies and practices with respect to the disclosure of NPI to non-affiliated third parties from what was disclosed in its most recent privacy notice to consumers.
If you do not share NPI with nonaffiliated third parties outside of the exceptions described here, here is one example of the “initial notice” you could provide to your borrower (note that it does not give the customer any option to “opt-out” of having their NPI shared with a third-party – because the issue doesn't apply).
If you do share NPI with nonaffiliated third parties outside of the exceptions described here, here is an alternative example of the “initial notice” you could provide to your borrowers (note that this one does give the customer multiple, clearly-explained methods by which they can opt-out, and a specified period of time by which to do so).
If you look closely at both versions of the form – you'll notice that neither version requires any signatures from the borrower. The notice simply needs to be completed by the lender and provided to the borrower, so they're fully informed as required by Regulation P.
Now, if you'd rather just SKIP this entire step of giving another piece of paper to your borrower to review, the only feasible way to do this would be to check one or more of the following boxes:
- Verify that you're NOT a financial institution.
- Confirm that you only work with customers and not consumers.
- Don't collect any Nonpublic Personal Information from the borrower.
In my opinion, the notices required by Reg. P aren't difficult to comply with – they're just an added step in what can already be a very paper-intensive closing process… so if you need to provide the notice, then provide the notice (seriously, it's not a ton of extra work).
Otherwise, if you're willing to deal with the potential consequences of not pulling a credit report, not verifying your borrower's identity and/or if you rarely ever work with seller financed deals (among other things), these would be some of your only feasible ways to steer clear of this requirement.
Regulation N exists to prohibit lenders from making any material misrepresentation, in any commercial communication, regarding any term of any “mortgage credit product”.
The idea behind Reg N is to keep lenders from doing a “bait and switch”, where they advertise some amazing terms for their loan product, and then switch up the terms of the loan prior to closing (i.e. – advertising one thing and selling a notably different product at the closing table).
According to §1014.2, “mortgage credit product” is defined as follows…
Mortgage credit product means any form of credit that is secured by real property or a dwelling and that is offered or extended to a consumer primarily for personal, family, or household purposes.
Unlike some of the definitions we find in Regulations Z and X, this definition specifically includes credit secured by real property (leaving the “dwelling” as a separate item). Given this, it seems reasonable to conclude that Yes, Regulation N does apply to seller financed vacant land transactions.
Now, I can't claim to be the foremost legal expert in how to keep from violating the requirements set forth in Regulation N, but from how I interpret the prohibited representations stated in §1014.3 (which simply lists all the things you can't misrepresent in your advertising), it all boils down to this:
Don't advertise one thing and sell something different.
For instance, let's say you included this excerpt in your property listing:
SELLER FINANCING AVAILABLE: With a $5,000 down payment, the owner will offer financing in the amount of $20,000, at an interest rate of 9.99% for a term of 60 months. Payments come out to $499 per month, all fees included!
The rules don't say you aren't allowed to make this kind of statement.
The rules say you can't misrepresent this information… so if you choose to include a statement like this in your listing, you may be painting yourself into a corner if you aren't 100% that these are actually the terms you're willing to offer, because you can't advertise one thing and then change up the terms at closing.
Based on how I interpret Reg N (remember, I'm not an attorney – so don't take this as legal advice), stating one set of information about your loan product and then using a different set of information at closing would be a clear misrepresentation of your “mortgage credit product” as listed here.
As an alternative, you could just state that seller financing is available in much more general terms. Like this…
SELLER FINANCING: Call now to explore the possibility of obtaining seller financing on this property.
Granted, this kind of generic statement doesn't “pop” quite as nicely in a property listing, but it also leaves you plenty of room to determine what you're willing to offer at closing.
Also keep in mind, in accordance with §1014.5, you'll want to keep good records of your listings and any other applicable marketing information that describes the terms you offered with your seller financed property (for up to 24 months). In the unlikely event that anyone ever tries to cause trouble for you later, having these records on hand can help you comply with Reg N and avoid any unsubstantiated claims against you.
What if You Don't Comply?
Under Dodd-Frank, if the seller doesn't comply with all the requirements, the buyer can cancel the transaction and has the option to get his or her money back.
Now, most buyers will have no idea what Dodd-Frank even is (not to mention whether you as the seller have done everything you need to in order to comply with it)… so most buyers aren't likely to cause issues for the seller on their own volition. However, if the buyer ever decides to get an attorney involved (and that attorney happens to be resourceful and knowledgable in all the requirements of Dodd-Frank that actually apply to you), that's when you would be more likely to encounter issues.
Is it worth the risk of ignoring any/all of these requirements? The textbook answer is “no”. The real world answer is, “it depends on what you're willing to lose”.
As I look at the requirements that apply to vacant land transactions, they don't appear to be overly difficult to follow. The biggest issue is simply being aware of what you need to do in the first place (and that's where most people will come up short).
Hopefully this article gives you some deeper understanding of what aspects of Dodd-Frank actually apply to vacant land transactions.
With respect to land investors specifically, my biggest takeaway is that if the property is truly considered raw land and doesn't have any improvements on it, and if you go even further by including in your terms of seller financing (i.e. – the land contract, note, etc.) the requirement that the note must be paid off in full before improvements are made to the property – you generally don't need to worry about any major compliance issues with Dodd-Frank.
As a side note – it's worth noting that some states have separate laws in addition to Dodd-Frank and the Federal SAFE Act (which each state is required to implement). With respect to seller financing, it's usually worth some investigation to this end as well – however, most SAFE Act legislation seems to follow the same definition of a “residential real estate” as defined in Regulation Z – which defines it as a property with a “dwelling” on it (and again, vacant land wouldn't apply to this definition).
Further Reading & Special Thanks
I referenced several external articles when putting together the information above (many of which were mentioned to me by fellow REtipster Club member Karl James). Furthermore, Clint Coons, Esq was also kind enough to take a look and verify that I was on the right track with most of the information above. For more information on the subject, you may want to explore these articles as well:
- The Whole Land, Nothing But The Land, So Help Me… Are Land Only Loans Covered By The Dodd-Frank Changes?
- Dodd-Frank and the Note Business Explained by W.J. Mencarow
- Owner Carries Under The Dodd-Frank Act by Eckley & Associates
- The New Dodd-Frank/CFPB Rules For Writing Seller Carries by Eckley & Associates
- Dodd Frank Summary by Brian Gibbons