In July, of 2010, the United States Congress and Senate passed a law called the Dodd-Frank Act.  Over 2000 pages of financial reform aimed at preventing another financial crisis - but does it?  To those business owners who have read and understood the Act, it is clear that the implications to prospective clients, are disastrous.  The Act's provisions will create a gigantic financial crisis in their life because lenders will refuse to lend to them due to the onerous, impractical, and unrealistic provisions forced upon them by the Act.  The authors of this white paper feel that it is immoral in the least, and unconstitutional at the most, to dictate to an individual person or company how he can lend his own money, and in the process, curtail the rights of borrowers who live in the property to borrow that money.

    The authors of this white paper are a group of small private money lending firms in Las Vegas, Nevada.  Every day, these firms lend to borrowers who want to acquire or refinance the property that they live in, and the demand for these loans has never been higher, nor more needed, than during this time of limited credit availability.  The goal of this white paper is to shed light on the reasons why we say unequivicobly: "the Dodd-Frank Act, as written, shall be the end of private money lending for property owners who live in, or intend to live in, the residential property used as collateral for the loan, because the provisions are detrimental to the borrowers, and untenable in their requirements..  

    For further information, please contact Ben Joffs at Direct Investors Mortgage at benjoffs@gmail.com, Corinne Cordon at corinne.cordon@gmail.com, or Angel Fajardo at angelmtgpro@aol.com.


White Paper: The Consequences of the Dodd-Frank Act With Respect To High Cost Loans: 

A Moral Case for Private Mortgage Lending



The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences.  The bad economist sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups.”

                                                                                                                        Henry Hazlitt

                                                                                      Economics in One Lesson, (1946)

In the wake of the financial crisis that resulted from the collapse of the U.S. mortgage market, an angry American public demanded action from their elected representatives.  Congress’s response was the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act).  Proponents of the act aimed to pass a law that would protect the American public from the dishonesty and fraud that undermined the integrity of our financial markets.  As it relates to mortgage lending, the Dodd-Frank Act seeks to reform the industry by purging deceitful lenders while “…ensuring that responsible, affordable credit remains available to consumers.”

In a twist of irony, the act with “Consumer Protection” in its title will unintentionally harm the very consumers it was drafted to protect.  The new rules effectively put an end to the private lending industry’s ability to lend to an “owner-occupant” – someone who wants to live in the house that they have purchased.  The private lending industry is comprised of citizen lenders and licensed mortgage professionals who work together to meet the credit needs of the people in the communities in which they live. 

A Moral Case for Private Mortgage Lending

In communities throughout America consumers need access to mortgage financing that is unavailable to them through banks.  It isn’t because the borrowers are a bad credit risk.  It is because the banks don’t offer a product that meets the borrowers’ needs.  Traditional mortgage products don’t have the flexibility of terms to satisfy every borrower.  An entire market exists comprised of citizen lenders who are willing to invest their own money in borrowers.  It is a vibrant market far removed from Wall Street. In the private mortgage market borrowers and lenders meet to create their own loans to satisfy their own needs.

The freedom to use one’s own property for its highest and best use is the basic right of every man.  Individuals who invest their money in private mortgage lending have spent their lives employing their talents, intellect, and labor to create their wealth.  They are willing to invest the product of their life’s work in their fellow citizens so they too can create their own wealth.  It is a benefit to all parties involved.  Unlike federally related mortgages, there is no risk to the public.  Individual investors bear all the risk.

There is a perfect sports analogy to compare Wall Street banks to the private lender.  Ted Williams and Sam Snead were good friends.  For those too young to remember, Ted Williams was a hall of fame baseball pitcher and Sam Snead was a legend in professional golf.  The two friends regularly compared the game of baseball to golf and argued over which sport was more difficult.  On a fishing trip Ted said that golf was clearly easier.  After all, the crowd doesn’t yell “boo” and the ball just sits there waiting for you to hit it.  Sam replied that unlike baseball players, golfers have to play their foul balls.

And so it has been with Wall Street and private mortgage lenders.  Why would a Wall Street banker care how many bad loans were fouled off into the stands.  He could stay in the batter’s box and continue to swing.  As longs as the process continued to produce mortgage loans the money would continue to flow.  Loans were packaged and sold as securities.  By the time loans went bad it would be out of the banker’s hands and in the lap of the final buyer.  Not so with a private lender.  When a borrower defaults on a loan it is the lender who feels the pain.  Before money ever changes hands the lender has every incentive to ensure that the borrower has the capacity and willingness to meet their commitment.  Their success is inseparably connected to the success of the borrower.  That is the essence of an ethical transaction.  No party takes advantage the other and both parties share a beneficial interest in a successful outcome.

Investors benefit because they receive interest payments in an easy to understand transaction.  They know exactly to whom the funds are lent, how the principal and interest will be paid, and their investment is secured by the property pledged as collateral. It is completely transparent.  In the event of default there is an efficient process of unwinding the transaction.  The borrower can sell the property and recover any available equity after paying off the obligation to the lender, or, the borrower can surrender the property and the lender is free to sell it to recover the original investment.

We are currently in an environment where many borrowers have blemished credit or a record with a foreclosure.  Their history keeps them from qualifying for conventional or FHA financing. Without access to the additional credit provided by private mortgage lenders, borrowers who were denied credit would be forced to rent their housing.  Private lenders give them the opportunity to own their homes and build equity. The federal government has long recognized the benefits of home ownership and has created government entities with the sole purpose of promoting home ownership. Beyond the benefits of home ownership, there are cases where private lenders help borrowers to reduce their monthly housing expense.  Either way, it is an opportunity for borrowers to enjoy the benefits of home ownership while repairing their credit so they can qualify for a conventional or FHA mortgage.

Prior to Dodd-Frank, Section 32 of the Truth In Lending Act imposed strict guidelines on high-cost loans with respect only to the refinancing of an owner-occupied dwelling. Purchases were excluded from Section 32, and borrowers had the right to negotiate the terms and conditions of their private money loan with their private money lender on a purchase.   Now, the Dodd-Frank Act extends the scope of the high-cost loan provisions to any “residential mortgage loan”.  A “residential mortgage loan” is defined as any “consumer credit transaction that is secured by a mortgage, deed of trust, or other equivalent consensual security interest on a dwelling or on residential real property that includes a dwelling, other than a consumer credit transaction under an open end credit plan or, for purposes of sections 129B and 129C and section 128(a) (16), (17), (18), and (19), and sections 128(f) and 130(k), and any regulations promulgated thereunder, an extension of credit relating to a plan described in section 101(53D) of title 11, United States Code."

The new provisions of the Act, found in section 1431 pertain only to those borrowers who will live in the home, and does not impact properties being purchased for investment purposes.   For owner-occupants, the Act:  1) dictates the terms and conditions of the prospective loans; 2) imposes mandatory pre-loan counseling; 3) imposes strict qualifying criteria for borrowers that are more onerous than conventional qualifications;  4) mandates that borrowers provide tax returns to the lender for verification of income as opposed to the traditional methods private money lenders use to verify income; 5) mandates that  the private money lender submit said tax returns to the IRS for verification; and 6) mandates two appraisals be performed on the property.  These regulations aren’t just onerous, they are in direct opposition to the use and purpose of private money lending, namely speed and ease of application. 

We agree with the majority of Americans that reform is needed to prevent a repeat of the sub-prime meltdown and we agree that some of the regulations not listed here could be beneficial to borrowers; however, we don’t see how applying these types of Wall Street regulations to private money will benefit communities and private citizens at any time, in any way.

Conclusion

 
The mortgage lending reforms in the Dodd-Frank Act may be a necessary measure to prevent another meltdown in our financial market.  While appropriate for Wall Street, these measures when applied to the private lending industry will have unintended consequences.  Borrowers will have less access to credit, investment capital will leave communities for other markets, mortgage professionals will exit the industry, and the cost of borrowing will increase.  Private citizens should remain free to lend their own money without interference and borrowers should remain free to negotiate with private lenders the loan terms that satisfy their needs.

By revising the act’s definitions to exclude private capital this new legislation can achieve its intended reforms while ensuring that responsible and affordable credit remains available to consumers.

Changes Needed to Section 1431

Regulators could easily change the definition of “residential mortgage loan” in the Frank-Dodd Act to exclude private money transactions.  They must clearly identify that the term “residential mortgage loan” applies only to loans funded by a federally regulated financial institution or loans sold to a GSE such as Fannie Mae or Freddie Mac, not loans brokered between two individuals (including their LLC’s Trusts and Corporations), and managed by a licensed mortgage professional.

The analysis of the unintended consequences on private lending arising from new Dodd-Frank rules produces a recurring theme—rules intended to reform Wall Street and federally regulated mortgages will harm the private lending industry and the consumer.  Title XIV of the Frank-Dodd Act is replete with limitations that may have success in curbing Wall Street dishonesty but will bring the demise of community lenders who never engaged in Wall Street style abuses.  The most harmful limitations include a prohibition on balloon payments, mandatory HUD approved counseling for prospective homeowners, mandatory duplication of appraisals, and elimination of fee income for work done as a mortgage broker modifying or extending a loan. For a passive student of the Dodd-Frank Act such rules seem necessary to protect consumers and to lower the cost to obtain a mortgage.  However, a careful analysis of the effects on all groups reveals the opposite.  Borrowers will have less access to capital, professionals will leave the industry, the available credit that does remain will be harder to find and come at a much higher cost because of the fear of litigation that mortgage professionals will be susceptible to because they dared to lend to an owner-occupant. The nature of private money lending is “private, easy, and fast” and that nature does not lend itself to extensive verification and cumbersome regulation, and possible legal ramifications from the United Stated federal government. 

Ben Joffs
Private Lender
Las Vegas, Nevada

Corinne Cordon
President Capella Mortgage
A Private Lending Firm
Las Vegas, Nevada

Angel Fajardo
President,  Direct Investors Capital
A Private Lending Firm
Las Vegas, Nevada 


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