Background
In 2008, Congress passed the Housing and Economic Recovery Act (HERA) (Public Law 110-289). Hera is designed to assist with the recovery and revitalization of America’s residential housing market. It addresses everything from modernization of the Federal Housing Administration, to foreclosure prevention, to enhancing consumer protections. The SAFE Act is a key component under HERA.
The SAFE Act is designed to enhance consumer protection and reduce fraud by requiring states to establish minimum standards for the licensing and registration of state-licensed mortgage loan originators. The SAFE Act requires states to have licensing and registration systems in effect by July 31, 2010. Kentucky’s SAFE Act law was passed in 2009 and went into effect on July 15, 2010.
The New Law
Are You a “Loan Originator?”
Under the new law, if you are a loan originator as defined by Kentucky’s SAFE Act (KRS 286.4-410 (1)), you are required to have a “Loan Originator License.” In short, this statute provides that any person (or legal entity) that offers or provides a residential mortgage loan or extends credit for a home purchase is deemed a loan originator and is required to get a license.
It appears that a broad interpretation of this statute could require an individual selling property via owner financing or lease to own/ land contract (aka installment contract or contract for deed) to acquire a loan originators license. However, KRS 286.4-410(2) specifically states that this statute does not apply to “installment or conditional sales” contracts.
This means the applicability of these requirements will likely turn on whether a court interprets the contract as an installment contract or a mortgage. There is a broad spectrum of ways to structure owner financing. On one end you have owners who will use a note/mortgage and transfer title, operating much like a traditional lender. While on the other end you have owners who structure financing to resemble a lease, with title to be transferred upon completion of all payments to the owner. The latter seems to follow more of an installment contract approach, in which periodic installments are paid for a specific period, with title to be transferred at the conclusion of the installments.
No Clear Cut Answer
Although, it looks like an installment contract would be the easiest way to avoid the SAFE Act’s applicability to owner financing, it’s not that simple. The problem goes back to court interpretation. It is common for courts to follow the “If it walks like a duck, talks like a duck, then it’s a duck” reasoning, which means if the agreement looks like a mortgage, and operates like a mortgage, then it is a mortgage, regardless of the intent between parties. This reasoning is typically used in a default situation, when the court will require the owner to go through foreclosure proceedings and sale, instead of just taking the property back from a defaulting party. It has yet to be seen whether the courts will apply the same type of reasoning to owner financing under the SAFE Act Requirements.
The Penalty
Under SAFE Act requirements (KRS 286.4-991(1)), any person who operates in violation of this statute without first securing a license, may be charged with a misdemeanor and fined between $500-$5,000. Also, any loan contract in violation of this statute will be void and the lender may not collect any principal or charges from the borrower.
The Other Out for Owner Financing
Under the Penalty section of KRS 286.4-991, another possible out is provided for owner financing. Paragraph 2 of this section states that a violation of this statute must be willful. Therefore, a seller utilizing owner financing unbeknownst of this statutes, would likely not be convicted of any violation that may exist.
Proceed With Caution
At this point it is too early to determine whether the SAFE Act requirements will apply to owner financing. Although, it appears the installment contract will be the safest method for avoiding these requirements. Installment contracts come with their own bag of issues, and may present a substantial risk of loss to the purchaser. It is important to remember:
- If the seller took out a mortgage (1st Mortgage) to purchase the property you are purchasing via installment contract. The property you are purchasing will still be subject to the 1st Mortgage until such mortgage is satisfied. This means, if the seller stops making their mortgage payments the lender holding the 1st Mortgage can foreclose on the property. If this occurs you will likely lose any money you have invested into the property (down payments, monthly installment payments, etc.).
- If your agreement is not properly recorded the seller may use the property as collateral for additional loans which may have priority over your ownership interest in the event of default (operates the same as the 1st mortgage described above).
- If the sellers mortgage has a “due on sale clause,” (which most mortgages do), the sellers mortgage must be paid in full before the seller can actually sell the property to you. If the lender is made of aware of a sale by installment contract, they may have the right to call the note due. In such case, the purchaser would likely lose any money invested into the property.
The most important thing to remember is to ALWAYS consult with an attorney before entering into a real property transaction, regardless of how simple or complex it may seem!
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