Dodd-Frank’s Impact on California Owner Occupied Hard Money Lending

While I specialize in California hard money loans, I typically do not assist with owner occupied transactions.  Many people who call looking for this type of hard money lending are surprised as to why I would not want to take on these transactions.  The main reason is the increased regulations and their incompatibility with the way our hard money loans are funded.

Our loans are not funded by banks or institutions, but rather by individuals, groups and private funds.  With the many restrictions put in place by the Dodd-Frank act, more paperwork and liability is introduced when a consumer loan is made.  In addition, lender protections are still being taken away.

With new proposed regulations set to take effect in January 2013, it is likely that I will no longer be able to provide any owner occupied consumer lending.  Here is a look at these new regulations, as well as information on why they are not conducive to hard money lending.

The first thing to understand is what transactions are covered by these rules.  Typically speaking, a hard money loan is going to fall under the definition of a high cost mortgage if it is secured by an owner occupied home:

The Bureau proposes to revise § 1026.32(a)(1) to implement the definition of “high-cost mortgage” under TILA section 103(bb)(1), as amended by the Dodd-Frank Act. As discussed below, TILA section 103(bb)(1) generally provides that the term “high-cost mortgage” means a consumer credit transaction that is secured by the consumer’s principal dwelling, other than a reverse mortgage transaction, if any of the prescribed thresholds are met.

Already we cannot make these owner occupied loans based only on equity, but must document income just like the banks:

TILA section 129(h) generally prohibits a creditor from engaging in a pattern or practice of extending credit to consumers under high-cost mortgages based on the consumers’ collateral without regard to the consumers’ repayment ability, including the consumers’ current and expected income, current obligations, and employment. TILA section 129(h) is implemented in current § 1026.34(a)(4).

The proposed regulations, however, go one step further and create more barriers to consumers trying to obtain alternative financing on an owner occupied property.  The first one requires HUD counseling before the loan can be made.  Before the loan can be made, the lender must get certification that the borrower has met this counseling requirement:

…creates a counseling requirement for high-cost mortgages. Prior to extending a high-cost mortgage, TILA section 129(u)(1) requires that a creditor receive certification that a consumer has obtained counseling on the advisability of the mortgage from a HUD-approved counselor, or at the discretion of HUD’sSecretary, a State housing finance authority.

The Bureau is proposing to implement the counseling requirement for high-cost mortgages contained in new TILA section 129(u) in proposed § 1026.34(a)(5). Specifically, proposed § 1026.34(a)(5)(i) requires certification of counseling, proposed § 1026.34(a)(5)(ii) addresses the timing of counseling, and proposed § 1026(a)(5)(iv) sets forth requirements for the content of certification

Additionally, financing of any points or fees will be prohibited.  With hard money financing, there is no such thing as a no cost loan.  Brokers can offer institutional loans at no cost as the banks can simply mark up the interest rate, pay the broker and then sell the loan on the secondary market.  With hard money, however, this is not feasible.

Section 1433 of the Dodd-Frank Act added to TILA a new section 129(m) prohibiting the direct or indirect financing of (1) any points and fees;

So basically if a consumer is going to take a hard money loan under this provision, they would have to bring cash to the closing table to pay the points and fees – they cannot finance it with the loan.

Other items of note include the banning of balloon payments and prepayment penalties:

The proposed rule also tightens existing restrictions for high-cost mortgages… Balloon payments would largely be banned, and creditors would be prohibited from charging prepayment penalties and financing points and fees.

Most hard money loans are put out for anywhere between 12 months and 5 years, with a balloon payment due at that time.  Investors typically do not want to commit their funds to a loan for a full 30 years.  In addition, borrowers typically do not plan to stay in their hard money loan for longer then they must – these loans are usually used as short or medium term ‘band aids’ to allow a borrower time to set their affairs right and obtain institutional financing.

By banning balloon payments, this is going to force investors to commit their funds for a longer period of time.  Essentially it is going to drive more investors out of the owner occupied market.  With no investors to write checks for the loans, there will be no money available to fund the loans.

In addition, by banning prepayment penalties the cost of these loans will increase.  Prepayment penalties are used to guarantee investors a certain return on their money.  With no guarantee of this type available, investors are likely to require more points upfront – basically taking their guaranteed return on the front of the loan.  This means costs will go up and we will be unable to mitigate those costs by adding a prepayment penalty instead of charging more points.  If you have been paying attention, you will remember that these points cannot be financed, so it will simply make these loans that much more expensive ‘out of pocket’.

While these regulations may not end hard money lending on owner occupied properties, they are certain to dampen that type of lending, and/or make it more expensive than it already is.  Hopefully this paints a clear picture of the issues hard money lending has with the Dodd Frank act, an act with good intentions that may end up having unexpected consequences for those in need of alternative financing.

 

Citation – All quotes were taken from the Federal Register.  You can visit the site for a more complete overview of the Dodd Frank act and proposed regulations.

While I typically do not work with owner occupied hard money loans, I can help with most other California hard money loans that are not for consumer purposes.  If you need a loan for investment purposes or business purposes and it is secured by real estate located in California, give me a call today at 877 462 3422.

 

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