Most people who invest in real estate for commercial or personal reasons are aware of the nifty little transaction that is the “installment land contract.” This type of arrangement allows an owner of an investment property sell to a buyer over time. Usually the buyer has poor credit or not enough money for a down payment. Sometimes the buyer wants to “rent to own.” The tricky part of these contracts is when title passes from seller to buyer. Generally speaking, the seller holds title until the buyer has paid all of the installment payments under the contract. However, there have been circumstances where courts have found that title will pass EARLIER to buyers if the buyer has paid a substantial portion of the installments and the buyer has made improvements to the property, paid the taxes, or otherwise increased the value or acted as if it had title and possession. There are lots of other potential pitfalls for buyers and sellers under these arrangements – risks such as whether the seller can encumber title during the contract, whether the buyer has sufficient credit to make the payments, whether the agreement should be recorded, etc.
However, recent legislation has uncovered a new risk: selling an investment property on contract could require a mortgage loan originator license. The SAFE Act is a federal mandate which allows for the individual states to adopt and add to it. Indiana’s version can be found at IC 24-4.4-1, First Lien Mortgage Lending.
A mortgage loan originator license is required under the SAFE Act to sell certain types of loans associated with real estate, in particular, loans associated with a “first lien mortgage” or with a “mortgage transaction.” A “first lien mortgage” or “mortgage transaction” specifically excludes a “land contract.” Pursuant to IC 24-4.4-1-301, a land contract means a contract for the sale of real estate in which the seller of the real estate retains legal title to the real estate until the total contract price is paid by the borrower.
Therefore, if a property owner sells real estate on contract, so long as the seller retains title until all installments are paid, the seller is not required to obtain a mortgage loan originator license. However, it is far more common that a seller transfers title (either by implied or express conduct) prior to receipt of all installment payments. Under that scenario, the seller is acting as a holder of a mortgage or note on the property and the seller is required to be licensed as a mortgage loan originator. Note – this analysis only applies if no exemptions apply. Exemptions may be available if the property is the seller’s own residence.
The scary part is the penalties. The first violation of the SAFE Act can result in a civil fine of $5,000.00. Repeat violations can result in civil penalties of up to $10,000.00 plus restitution. These penalties may tip the balance in favor of buyers under these types of arrangements. It is not difficult to imagine plaintiff’s lawyers using the requirements of the SAFE Act to generate significant damages or get out of a contract completely in the event that a buyer simply got cold feet, was unable to pay the installments, or otherwise didn’t intend to honor its obligations under the agreement.
The upshot is that owning, renting, and selling investment properties is not nearly as simple as it used to be. An example might be a good way to demonstrate some of the risks:
Jim owns an old two bedroom house in Broad Ripple. He purchased the home for $100,000.00 in cash, and plans on holding on to it to generate some income before selling it. Tina comes along and rents it for $1000.00/month for one year. During year two, Tina mentions that she wants to buy it, but she can’t get a mortgage because her credit is bad and she doesn’t have enough money for a down payment. Jim and Tina enter into an installment land contract which provides that Tina will pay Jim $160,000.00 plus 5% interest for a total price of $168,000.00, payable in equal $2000.00 monthly installments for 84 months. During the installment contract, Tina puts a lot of money in the house, including fixing the foundation, building a new garage, paying all the taxes, and repairing everything that needed fixing. With 14 months remaining on the installment contract, Tina runs out of money and can’t meet her monthly payment obligations. Jim tries to evict her, claiming that she doesn’t own the house. Tina claims that title transferred to her because she paid the majority of the payments, the work and money she invested in the house, and the relative length of time left on the contract. Tina also claims that since Jim transferred title to her prior to the end of the contract, he was acting as a holder of a note without the requisite mortgage loan originator license. At this point Tina can pick her remedy. She could seek to recover all the money she paid to Jim and walk away from the house OR she could seek to enforce the contract and get title. Both approaches cut against Jim.
See how this new law could really screw sellers? Be sure you understand installment contracts and their unique problems. They are very popular right now because of the number of investment properties out there coupled with the cash crunch for many would-be borrowers. As a seller, don’t give your buyer so many “outs.”