Cashing in on seller financing while staying Dodd-Frank compliant – it’s not just good business, it’s smart business. In this episode, we dive into the complexities of Dodd-Frank compliance, the crucial requirements you need to meet, and the potential pitfalls to avoid with our guest, Russ O’Donnell, founder of Compliant Monk. Russ discusses the critical questions to ask potential borrowers to ensure they meet the ability-to-repay requirements. He sheds light on essential factors such as debt-to-income ratios, pay histories, and the significance of residual income when it comes to compliance. Throughout the episode, Russ emphasizes why Dodd-Frank compliance is essential and the potential consequences if you neglect it. The risk of losing assets looms large if you don’t meet the required standards, and today Russ tells us why. Tune in now.
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Securing Your Seller Finance Investment: Inside Dodd-Frank Compliance With Russ O’Donnell
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Moving on, I’ve got a guest I haven’t spoken to in quite some time because he went into retirement and now he is back at it. I said I got to get him on the show. We haven’t talked that much because I wanted to save it for the show and find out everything that’s happened. Everybody, this is Russ O’Donnell. Welcome, Russ.
Thanks, Kevin. I appreciate you having us on.
It’s great to see you. I got an email from Dave Frankie out in Arizona. You know Dave, I’m sure. He said, “Russ is back.” I said, “Really?” He’s the one who let me know that. What Russ specializes in is making sure that borrowers are compliant with the Dodd-Frank Act. A lot of people in this industry don’t know that when you’re originating a loan, maybe you own a house, bought a house, you fixed it up, you’re selling it, and you sell it with seller financing, when you sell it with seller financing, the Dodd-Frank Act does address that and says, “You have to show that this person has affordability.”
For that, you need an underwriter who can come in and look at all that information and let people know or let you know as the investor if these folks are qualified or not and if they pass the Dodd-Frank threshold. It’s an important part of our industry on that. By the way, it does, in my mind, at least add value to your notes. To those of you who are creating notes, it is very important. To those of you who are buying notes where there are scenarios where they haven’t done the underwriting, you need to pay attention as well. I wanted to do a little preempt there for you, Russ. Compliance is your game. Give us a little history of where you came from. As I said, you went to retirement and now you’re back, so fill me in.
I come from a mortgage background of about 25 years. I spent about 10 of it as a loan officer, then about 15 of it as an underwriter. When we had the Call the Underwriter originally back in about 2017 or 2018, we focused on compliance. We knew that because of Dodd-Frank, the average seller finance investor has the same requirement for underwriting and disclosing to a borrower that Wells Fargo Home Mortgage does or any mortgage company. That’s a big task. We wanted to provide that service for investors who couldn’t, wouldn’t, or didn’t want to handle their own underwriting. About mid part of 2020, shortly after COVID. Of course, there was a dip in the volume for everybody, but shortly after, it took off. It went through the roof.
Unfortunately, my wife and I had a life event. Around November of 2020, we made the decision to sell Call the Underwriter. We sold it to some amazing folks, Max and Michelle Bailey, who’s still an underwriter out of Montana on a nationwide. We snuck away and did our thing for a while. As things come for us, here we are, I’m sitting around going, “What am I going to do now?” I remembered how much I missed the business and how much I wanted to get back in.
The challenge was, I had signed a non-compete with Max. We’re only at the end of year three for that. How was I going to get back in the business legally and do right by those guys? I called Max and we made a green light to let us open a firm here in Arizona. We do all of our own underwriting here in Arizona for Arizona transactions, and then we collaborate with Max and Michelle for underwriting on anything we generate on a nationwide basis.
Good for both of you. I’ve had Max on the show as well. I enjoyed the conversation with him. That’s good to know. That’s a great way to work something out like that because I figured you had to have some non-compete when you sold the business there. You all collaborate on that. A lot of times, my clients would say, “They do underwriting, but do they also provide the paperwork, the note, the mortgage, and that sort of thing, or do I have to do that myself?” Has that changed in your collaboration as well?
No. We could do closing documents for just about anybody. I don’t know why an investor or somebody would want to do their own closing documents if you’ve already done the underwriting to make sure that the borrower meets the ability to repay. The closing docs that come out are a Fannie Mae and Freddie Mac compliance set of note docs, good in any court in the land. It would be as if maybe you were in an attorney state and the attorney did those documents for you. It’s funny to know that there are still some investors who are still drawing up their one-page notes. For as little as it is to have that protection, I can’t imagine. We would handle the closing docs as well.
Maybe I’m wrong on this, but I was almost certain that Max stopped doing that paperwork and was focused on the underwriting and left the paperwork up to the investor. Am I wrong on that?
I’m glad you brought that up. In fact, Max and I had a phone call and he confirmed that they’re doing closing documents. To set the record straight, the amount of work for us on the compliance side, we do a lot of it on every deal, but the real work comes when we certify that the borrower is compliant and the investor is okay to proceed with the closing and the note. The real work begins when you go to create those documents.
We have everything, so we push it over, we create the loan documents, and we ship them off the title. What happens when those documents get to title? There are lots of times when title doesn’t respond right away, maybe sometimes last minute. When they do finally review the documents, there are ten changes they want, the CD doesn’t balance, and they’ve got the borrower coming in in an hour.
As compliance people in trying to provide that service, we now have to drop everything because we’ve got a buyer on the way to closing and a set of documents that maybe the title company’s having a problem with for whatever reason. We may have to do amendments or who knows what based on what they thought they understood from the investor. There is a lot of confusion that happens last minute where we have to drop everything. That can turn us off from doing closing. As of now, Max and I are doing closing documents.
It is a specialized skill. Anybody that tries to do their own underwriting, why? If you’re an investor, focus on the investing part. Outsource to the specialist to do this stuff. Compliance, let’s detail it down for everybody. What is the compliance issue that we have creating seller finance notes according to Dodd-Frank? What’s the threshold? I want to break down after that. What does that entail then? What information do you need to pull from the borrower and that thing to show the detail and depth of what that is? Let’s start with the threshold. What’s the main line that we have to make sure that we’ve looked at?
As most of us know, Dodd-Frank was created so that we would never have another 2008. What Dodd-Frank says in all of its 2,000-plus pages is that, “You as a lender, we don’t care who you are. As a lender, if you’re a mom-and-pop or you’re Chase, you have to make sure that this borrower meets the ability to repay requirement.” What does that mean? Is it a 43% debt-to-income ratio? Does it mean they have to have enough money to close? What does that whole thing mean?
It’s based upon debt-to-income ratio, but also it’s based on, “How well did you pay the last twelve months rental payments? How’s that pay history and can we document it? Can we document two years of employment history, whether you’re self-employed or employed? Can we get that in writing? Can we do that? What does the credit report look like? What’s the credit score?” Not that seller finances are credit score driven, we underwrite everything. Most of the time up against FHA’s manual underwriting requirements, which let us go down to a 500 score. Lots of times that doesn’t work, but sometimes it can.
It’s a blend of everything. Why it’s not just the debt-to-income ratio is because of this. Let’s say that you’ve got a borrower who is on fixed income and say they makes $1,200 a month on Social Security or disability income. They have no other debt. The new mortgage payment is going to be $500 a month. All in, PITI, servicing, all of it, it’s going to be $500 a month. That puts our debt ratio somewhere in the mid-40s, which looks attractive from a lending standpoint. The challenge is that because her family size is three-plus, the residual income requirement for her is well over what she has left at the end of the month. Even though the debt-to-income ratio looks good, she doesn’t pass residual income.
At the end of the day, regardless of debt-to-income, they have to make sure they have enough net after taxes and the size of the family, feed the kids, feed the cat, and how much money is left over at the end of the day. Underwriting can get pretty complicated and we want to make sure that every deal that goes to the note phase is Dodd-Frank compliant.
What is the maximum debt-to-income ratio that’s allowed for seller finance notes?
Dodd-Frank was not created for seller finance. It was created for Fannie, Freddie, FHA, VA, and USD. It was created for all of that. Even in those agencies, we talk about the max debt income ratio. What would Fannie Mae approve as a maximum debt-to-income ratio? With 20% down, we’ve seen approvals go to 50% debt-to-income ratio on automated underwriting depending on credit score. We’ve seen FHA go as high as 58% on gross income, depending on credit score, down payment, and reserves. It’s all over the board. As you can see, the 43% that was advertised for Dodd-Frank doesn’t apply. How high can you go?
Even if we get into a high debt-to-income ratio, we’re always going to do a residual income test because residual income has way more weight than debt-to-income. If a customer has a 60% debt-to-income ratio, maybe they make a lot of money and they have a lot of debt, but they’ve got $3,000 or $4,000 a month leftover for residual income, that buyer qualifies.Residual income has way more weight than debt-to-income. Click To Tweet
You don’t start with debt-to-income, then look at residual. It’s a combination of all of those to get the full picture. How much does credit score weigh in on all of this? I didn’t think credit score was relevant if they met the thresholds.
It doesn’t. If a customer has less than a 500 score, we will turn them down based on the score. That’s the only instance we would turn somebody down based on just score because FHA would not allow somebody with a 500. We never want to step outside the big box of Fannie, Freddie, FHA, and VA when it comes to a major indicator like that, the same way that if somebody could only document one-year-worth of income, but you can’t go there. That is a hard stop. 500 credit score, 2-year employment history, maybe somebody who can’t verify prior rental history. Those are hard stops. No matter what the rest of the deal looks like, those are hard stops.
What about someone who doesn’t have a credit score?
That’s sometimes better. That brings up another question when somebody says, “What if my borrower doesn’t have a social?” That won’t necessarily stop somebody because, oftentimes, they’ll have either a tax identification number or an employment identification number. Maybe somebody’s in the country and working on that but doesn’t have it yet, but is working. They’re paying taxes and they can produce a year’s worth of business bank statements that can show that they’re bringing in enough money. We have calculations for how much of the deposits we can use. They can calculate that. They can meet the ability to repay requirements for Dodd-Frank, but they don’t have a credit score because they don’t extend themselves. They don’t use credit cards. That’s not always a bad thing.
Break it down for us in the underwriting then. To calculate debt-to-income, to look at pay histories, and all those sorts of things, what’s the procedure that you all go through? I know it’s in-depth. I’ve seen enough of your reports and Max’s reports and they’re very involved. I don’t think that everybody has a full grasp of what information you go after. They’d appreciate that because if you’re selling a house to somebody and you’re creating a loan, don’t you want the best-qualified person for yourself? You don’t want to take the first person who comes along with $500 bucks and have them on the note. It’s going to be a problem. Have somebody who’s qualified. The depth that you do if you can light on it for us, what information you gather to come up with all these numbers?
I’m going to start with how I recommend that an investor pre-qualifies their buyer before they ever go into taking an application, collecting income documents, and maybe wasting their time. I would ask them three questions. I would say, “Can you get a signed letter from your landlord indicating that you’ve made the most recent twelve months’ pay history for your housing payment on time?” If the answer’s no, I’d move on.
2) Can you document two years’ worth of income? If you’re employed, the most recent two pay stubs and the most recent two years W2s. If you’re self-employed, it’s either your tax returns, which we know never work, or the most recent twelve-month bank statements showing your business deposits. If they can’t, I would move on because they’re probably not going to meet the requirements. 3) If a bank or mortgage company were to turn you down for a mortgage loan, what’s the biggest reason? That’s where you’re going to open up the big red flag as to why they’re looking at seller finance.
Those are three great questions there.
That way, you begin to get either a warm and fuzzy or you start having your internal BS radar factor going on. That in a nutshell will either give you a comfort level or not a comfort level to move on. Of course, if you’re getting answers that you don’t know how to field, you can always pick up the phone and call, and we’ll help walk you through that.
Let’s say they passed that muster test. You feel good. We need three things to get them into underwriting. We need a completed and signed mortgage loan application, which is easier than you think. We need a signed borrower’s authorization, which is included in the application now. We need two years’ income documents. All of that can be done on our website.
They can fill out the application online. They can do it on their phone. They can do it on the computer. They can sign the borrower’s authorization. Once we get it, we can confirm we have it and it’s complete. They then can upload their income documents. You never have to touch any of it. You can, if you want. You can download it, print it out, and write it out if you want. We used to get a lot of stuff like that, so you can still do that if you like it that way.
When the borrower submits all that to us, we verify that it’s complete. We send them a link to order their credit report. The cost is $25 per borrower. That’s the only money that they should be out. If at the end of the day, we get the credit report, based on all of everything we calculate and we underwrite, they just don’t meet requirements because of too much debt and not enough residual income. That would be the money that they’re out. We don’t refund it. They pay it directly to the repository. When they do it, we get a copy from the repository. That’s how we begin our underwriting process.
Once that gets passed and somebody’s like, “They look like they’re going to approve.” You then go into the full process, and then there’s an additional fee for that, which I suppose either party could pay the potential borrower or if the potential lender could pay it. Normally, I would think the borrower would pay for that cost. They’re the ones trying to get approved.
That is a typical and normal customary fee, whether they’re applying at Chase, Wells Fargo, or in seller finance. What I recommend you do when you’ve got when you’re dealing with a borrower and you’re set to move forward to underwriting, I would collect a minimum of $500 bucks upfront as an escrow deposit to cover our underwriting fee. If the borrower doesn’t meet requirements, there’s no charge from us. We don’t charge anything for that. If they do meet requirements, we’re going to sign off on that and we’re going to issue our invoice for $495 immediately, and it’s due whether the loan closes or not.
We want to make sure the investor is covered for that price. What it means is, you have a borrower, and they’ve gone through underwriting and given us everything they need. They meet requirements, we sign off on it, and then the borrower, for whatever reason, decides to jump ship. They ghost or disappear. We don’t want you having an invoice out of your pocket.
Everybody, I’m talking with Russ O’Donnell. Compliant Monk is the company and CompliantMonk.com is the website.
You can even reach us by going to DoddFrankCompliance.com. That will forward to our website as well.
Let’s talk about timeframes. How long does the underwriting process start? I’ll frame it up for you. I’m an investor looking to create a note. I’ve asked those three great questions that you mentioned. I’ve got a good feeling that these people are going to qualify. I turn them over to you, and then the clock starts. What’s a typical timeframe?
From the time we get all of the documents we need from the borrower, the signed application, the signed borrower’s authorization, and a complete set of two years’ worth of income documents and the borrower orders their credit report. Our underwriting turn time is 48 business hours. You’ll have an answer from us within 48 business hours. That could be the borrower’s approved and we send out the loan disclosures. The borrower is denied because they didn’t meet residual income requirements and we couldn’t get anything from the borrower, there was no other income.
Also, we have a suspense. Meaning that we think there’s more income out there and we’re just trying to get ahold of the borrower. We’re waiting on it. It turns out they have maybe disability. They have maybe some child support income, they have other income coming in, or maybe there’s another borrower when we underwrote the first borrower and they didn’t quite make it. We asked them if there was anybody else going on the loan or somebody going on the loan or more income and they found somebody to co-sign or they found another borrower that was going to go on the note with them. We’re waiting on their income documents so we can finish it on. Within 48 hours, you’re going to have a response from us one way or the other.
Forty-eight hours. The timeframe really is more dependent upon the potential borrower providing the documentation because you’re 48 hours after you get the docs.
You got it.
It’d be a good idea as an investor to prep that borrower. You’ve asked the three questions that you outlined and said, “To proceed, please start gathering, if you need to, some income verification.” Maybe prep them with that a little bit, because then it can be expedited pretty darn quickly.
That is absolutely rule number one. The better job that the borrower and the investor can do on the front end is to prep and get ready. If we can get everything we need the first time around, it sure happens fast and it ends up being a great borrower experience.
Do you have a prep checklist for investors or anything like that?
We do. There’s a needs list on our website.
That way, an investor would know, “Here’s what they’re going to need, so I can provide this from the get-go to my potential borrower.” It then helps you guys get everything in order. The website is CompliantMonk.com.
DoddFrankCompliance.com is easier.
You can check them out there as well. It’s such a great service to have. On the other end, what people don’t realize is what the potential penalties are if you do a loan and you don’t do proper underwriting.
You got that right. Let’s say that you have a Chase or Wells Fargo. Nobody’s perfect. The Department of Financial Institutions walks into every single Wells Fargo Mortgage Branch every single year, does an audit, and nobody gets away clean. Everybody’s fine. Everybody gets. It could be the tiniest. They’re looking for the tiniest little thing. Nothing completely protects anybody, no matter how great you are at doing this, but there’s no maximum penalty for this. If you completely blow off compliance, you can lose the asset. You can just lose the asset. There’s everything in it to protect the borrower. If you don’t do it, all they need is a smart attorney and you can lose the asset. Just hand them the house and the keys.Nothing completely protects anybody, no matter how great you are doing this. Click To Tweet
It’s of utmost importance to do the compliance. You don’t have to pay for it if you collect the money from the borrower. The borrower knows if they go to a mortgage company. They’re going to pay so many more fees and points. You know how it goes. The seller finance way to go is way less expensive, but it’s a typical fee, so get it done.
I agree. In all fairness, I haven’t heard of a single case where someone who did seller financing has lost in court or even made it to court because of a non-compliance issue. I haven’t heard that, so I don’t know if that exists or not. If we’ve seen how the courts react to somebody who’s not compliant. There has to be a percentage of investors who don’t even know about the Dodd-Frank Act, let’s face it.
If you’re doing this on a regular basis, you’re held to a higher standard than some Joe Smith who inherits a house and sells it with financing. He’s not held to the same degree in the law that you are if you are an investor who’s doing this on a regular basis. If you’re in the business, you’re supposed to know about the compliance issues. I haven’t heard of any cases where it’s gone there, but the threat of it enough, you don’t want to be the first example either. Are you familiar with any cases that have gone to court with compliance in that scenario?
I still, to this day, don’t know of a single case. Even seller finance investors who are doing volume every month. It’s a wheelhouse. They’re doing it for a living. I don’t know of anybody who’s had the whip cracked. I do know that Signature Bank got fined over $100 million obviously on the radar. I don’t know of any seller finance person investor that’s ever been crucified by the CFPB, yet it would suck to be first.
I tell people that all the time. To counter that, the threat of it should be enough, especially the fact that it doesn’t cost you any money as an investor because the cost is going to be paid by the borrower. Why not do it? Especially if you’re doing this on a regular basis, you’d be foolish not to do it and say, “There’s never been a court case.” For a borrower, if a borrower balks at being qualified and paying $500 to do it, that’s not your borrower anyway. You don’t want to work with that person. They have to expect that there’s going to be some qualifications. Even if somebody’s going to rent from you, don’t you qualify that person to some degree?
I was glad to hear that because I hadn’t heard of any cases, but it still makes so much sense to do it and do it the right way. Especially, it doesn’t cost you any money. If they get the documents here, you’re looking at two days and you’re good to go, it’s a great thing. I’m glad to hear that you and Max are collaborating and doing this together nationwide. No matter where you’re creating these things, they can do it for you and the team has grown. Anything else that you can share with us? We covered a lot of ground.
I think we covered everything. The only question that I have for you would be off-topic. You are a major component of the seller finance industry. A lot of people that we get for underwriting come to us with maybe sometimes their first deal and it’s all the money they’ve got. They want to do a second one or they want to do a third one like, “Maybe I could do something with this,” but they don’t have the funding sources to do it. Of course, we’re compliance guys. We’re not the actual lender, you are. Any help you can give us on sources that might help us answer that question? Maybe some of your investors are lending sources and funding sources for those who are creating notes. That would be helpful as well.
In the note business, you put your capital to work and then when your capital runs out, you’re like, “I guess that’s it.” You have to start thinking as a real estate investor would, “I got to start using other people’s money.” How do we do that? I had a good interview with Justin Bogart. Do you know Justin?
I met him at the note expo a few years ago.
He was a great example of somebody who started out in the business flipping notes, wholesaling notes, and making fee income to buying his own notes, and then started partnering. The natural progress is you start to partner with people on deals. You have to be proactive in going to events and meeting other investors. We certainly talked about that. Your own social circles are part of that. Real estate investment clubs are everywhere. You can set up your own meetup groups and that’s what Justin did and had investors come there and learn, but also share and build it up. It’s letting people know the industry that you’re in. It’s marketing yourself and it starts very localized.
If you want to take it to the next level, that’s when you’re looking at building a fund or something like that. That gets much more complicated, so that’s somebody who’s going to be in this full-time as a fund manager, but certainly partnering with other people as a natural progression. I’m going to start to see more of that, for example, in my own business with my clients that I do the personal consulting with. We’ve already done deals where I got somebody who wants to sell a note or a partial on a note. I got people who want to buy a note or buy a partial on a note. They’ve done deals together and the trust factor’s high because they’re all clients of mine.
I see it very easily going to that next level of, “We’ve got a good opportunity here, maybe 3 or 4 of the clients get together and do that.” If you’re a part of a mentor group like I have, if you have local meetup groups or anything like that, start surrounding yourself with other investors. That’s going to be good.
Real estate investors now are the ones who are struggling to find good deals. The people aren’t selling as much. Distressed sales aren’t as high as people anticipated. They’re looking to put funds somewhere. If you go out there and start to share and talk with investors at real estate clubs and turn them on to the note business, you’ll absolutely capture some investment partners there as well. It’s a natural progression, but you got to get yourself out there marketed. That would be the short of it.
I love it.
This has been great. It was great to see you again and great to talk with you. I’m glad things have worked out for you. It’s good to see you back in the business. It’s a service that is sorely needed. Thanks, everybody, for tuning in to the show. Thanks, Russ, for being on. I look forward to putting together another show for you all soon. Thanks again, Russ.
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