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The Safe Act Explained

Jeffrey R. Armstrong – President/Owner of Armstrong Capital

Your favorite Master Note Buyer – Straightforward, Honest, Fair…

Update on legislation, part II, continued from the April 2010 PAPER SOURCE JOURNAL:

I am grateful to Ric Thom ( for letting us know that H.R. 1728 has been folded into H.R. 4173, the Wall Street Reform and Predatory Lending Act, as title 7.  Senator Dodd’s bill, the “Restoring American Financial Stability Act of 2010” (S. 3217), also restricts seller financing.

But there is worse news than the fact that there are bills pending in Congress to restrict seller financing.  One of them flew under the radar and has become law.

The SAFE Act (“The Secure and Fair Enforcement for Mortgage Licensing Act”  — is Title V of the 700-page “Housing and Economic Recovery Act.”  It prohibits anyone except a person selling their primary residence from taking back a mortgage on a residential dwelling (SFR or 1-4 units) without a mortgage originator’s license unless they sell to a direct family relative.  That means real estate investors, vacation home owners, people who own a vacant residential lot and even heirs will have to be licensed to take back a note in almost all cases.  Fewer notes will be created.

The Realtors have a gaggle of highly-paid lobbyists in Washington (I know first-hand — I was a legislative director and subcommittee chief of staff in Congress), and the SAFE Act will mean fewer real estate sales.  Where were they when this bill was being considered?  Probably down at the Hay-Adams tossing back Cristal champagne.

Ric Thom also pointed out that if the SAFE Act isn’t changed you will not be able to buy any residential non-conforming property (property that banks won’t lend on) without paying all cash, nor will you be able to sell those properties except to a cash buyer.

Congress is ignoring the consequences to the people on main street who simply want to sell, say, a vacant lot without having to pay the fees, take the courses, pass the tests and jump through all the other hoops to become a mortgage loan originator.

Ric said, “This will have a devastating effect on real estate values. This is a taking of private property rights…Every property owner will be wondering why their government leaders threw them under the bus when it was Wall Street who created this mess.”

                For decades, seller-held notes (let’s drop the term “seller-financing,” especially when talking to elected officials and regulators; it sounds too much like loan creation, which it isn’t) have been essentially unregulated, with the exception of usury laws for residential notes and a few minor regs.  As one investor said years ago in a talk at a PAPER SOURCE National Convention, “folks, it’s the Wild West out there.” And that’s why most of us liked it!  It wasn’t regulated because it didn’t need regulation.

All of a sudden seller-held notes have caught the attention of the federal and state governments.  Why?  Because so many people got burned by subprime mortgages, low-doc, no-doc and stated-doc loans (where the lender doesn’t ask for much, if any, documentation and accepts anything the borrower claims about his income, debts, etc. without checking, giving him what are aptly called “liar loans”) and even — yes, it’s true — stated FICO scores

But what have subprime mortgages, stated docs, liar loans, etc. to do with seller-held notes?  There’s no mortgage broker or lender involved in a seller-held note, no money changes hands — sometimes there’s not even any interest involved — it’s just an agreement between a seller and a buyer, usually done over the kitchen table, that the buyer will pay the seller installment payments.
Nobody is accusing sellers who take back notes of doing what has made all the headlines:  committing fraud,  packaging mortgages with junk notes, creating securities derivatives and selling them while at the same time selling the securities short.  Name one carryback seller who has ever done that. Name one who knows how to do it.  Heck, name one who has ever HEARD of it.

All the mortgage fraud that has caused the government to react has as about as much in common with seller-held notes as Obama has in common with free enterprise.  But the government has cast a very broad net and defined seller carrybacks as lending.  Their twisted logic goes like this:  Some mortgage lenders are crooks.  Sellers who carry back notes are mortgage lenders. Therefore, some sellers who carry back notes are crooks.

They Have Found The Enemy, And He Is Us

The government has identified the crooks among those sellers who carry back notes.  They are people who invest in real estate.  They are your folks who are getting on in years and want to sell their cabin at the lake.  They are you when you inherit their house when they pass on.             According to the way HUD interprets the SAFE Act — even though “seller financing,” “seller carrybacks,” “seller-held notes” or any other synonym doesn’t appear in the Act — anyone who sells any single family house or 1-4 units and does not live in it as their primary residence and who wants to offer the buyers the benefits of a seller carryback note is a potential criminal who needs to be watched, regulated, licensed and taxed.

These property sellers have to have government approval via licensing before they hold a note or even discuss terms of a note with a buyer that is not a member of their immediate family.  If they are not licensed they will be fined.  If they don’t pay they will go to jail.

A Jailhouse Conversation  

            “What are you in here for?”

            “I murdered my boss.  What are you in here for?”

            “I sold a house and took back a note.”

Why Sellers Who Hold Notes Are Not The Enemy

When a property seller agrees to take back a note, he or she makes it possible for people who cannot qualify for conventional financing (for many reasons, not always bad credit*) to buy a home.  Therefore, more homes are sold.  That is good for families.  That is good for the economy.   That is good for everybody.

What’s more, buyers save money and time when a seller carries back the note.  There are no points or fees, hidden or otherwise.  The process is simpler and faster than conventional financing.  It’s just the seller and buyer, two people, coming to an agreement over a cup of coffee.  The seller who is carrying back the note is a person, not a bureaucracy.  He or she can (and usually does) work with the homeowner if circumstances arise that make it necessary to change the payment amount, extend the term, skip payments or help solve problems in many other ways, and often with no charge.  Try that with Citibank.

So naturally, the government wants to stomp on it.

Why?  The reason given for public consumption is because a bunch of fly-by-night mortgage brokers and conventional lenders ripped off a whole lot of people. Again, what’s that got to do with seller carrybacks, which doesn’t involve a mortgage broker or a lender?  It’s a question the authors of the SAFE Act and those who voted for it never thought of.

Always Follow The Money

The real reason is, the more licensing, the more money the government gets in fees and fines (while they appear to be solving a problem), and the more money flows into the coffers of the associations who run the mandated continuing education.

To its credit, the National Association of  Mortgage Brokers is asking HUD to exempt property owners who take back notes from the SAFE Act licensing requirements.

The SAFE Act does not mention seller financing, seller carrybacks, or anything like it.         The model SAFE Act (, which is the model law HUD is trying to get all states to adopt, also does not mention it.  It requires licensure for someone arranging or counseling for a “residential mortgage loan” and defines it thusly:

(11) RESIDENTIAL MORTGAGE LOAN—The term ‘‘residential mortgage loan’’ means any loan primarily for personal, family, or household use that is secured by a mortgage, deed of trust, or other equivalent consensual security interest on a dwelling (as defined in section 103(v) of the Truth in Lending Act) or residential real estate upon which is constructed or intended to be constructed a dwelling (as so defined).

The SAFE Act cross-references the definition of “dwelling” in section 103(v) of the Truth in Lending Act (TILA) (15 U.S.C. 1601 note).  Regulation Z, which implements TILA, defines “dwelling” as “a residential structure that contains 1 to 4 units, whether or not that structure is attached to real property. The term includes an individual condominium unit, cooperative unit, mobile home, and trailer, if it is used as a residence.” [(12 CFR 226.2(a)(19)] ( Thus the SAFE Act also applies to those people doing “Lonnie deals” flipping used mobile homes.

“Seller Financing” Is Not Lending

             “Seller financing” (a.k.a. seller carrybacks, seller-held notes, etc.) is not lending. It is an extension of credit.  Therefore it does not fall under the definition of “residential mortgage loan.”  In fact, both the federal SAFE Act [Sec. 1503(3)(a)(i)(iv)] and the model SAFE Act [MSL XX.XXX.030 DEFINITIONS Sec. (6)(a)(i)(B)(iv)] exempt from licensure those involved in transactions that are extensions of credit.

Both Acts apply the exemption only to timeshare transactions.  Apparently timeshare salesmen are thought to have a higher standard of ethics than Mom and Pop who offer to carry back a note.

The Defining Issue

The issue is one of the definition of words, specifically “loan” and “mortgage originator.”  The SAFE Act defines some of its terms in Sec. 1503, but it does not define “loan.”  The definition of “residential mortgage loan” in the SAFE Act says it “means any loan…”  I was taught in grade school that you cannot define a word by using the word in the definition.

Webster’s Dictionary defines “loan” as “money lent at interest.”  Does seller financing involve money lent?  Does any money change hands?  No and no.  Sometimes there’s not even any interest.
Again, “seller financing” is not a loan. It is an extension of credit.  Therefore, those who provide it are not lenders and are not loan originators as defined by the federal and model SAFE Act.

Here is how the SAFE Act defines “loan originator,” Sec. 1503:


(A) IN GENERAL.—The term ‘‘loan originator’’—

(i) means an individual who—

(I) takes a residential mortgage loan application; and

(II) offers or negotiates terms of a residential mortgage loan for compensation or gain;

(B) OTHER DEFINITIONS RELATING TO LOAN ORIGINATOR.—For purposes of this subsection, an individual ‘‘assists a consumer in obtaining or applying to obtain a residential mortgage loan’’ by, among other things, advising on loan terms (including rates, fees, other costs), preparing loan packages, or collecting information on behalf of the consumer with regard to a residential mortgage loan.

Some Questions

            What is a “residential loan application” [(3)(A)(i)(I)]?  HUD says it means “any request from a borrower, however communicated, for an offer (or in response to a solicitation of an offer) of residential mortgage loan terms, as well as the information from the borrower that is typically required to make such an offer” (Commentary on the SAFE Act, 1/9/09).  This conflicts with the statutory definition in  RESPA:

Application means the submission of a borrower’s financial information in anticipation of a credit decision relating to a federally related mortgage loan… (Regulation X (24 C.F.R. §3500.2)

I thought “federally related” was a typo; surely it is supposed to be “federally regulated.”  But that’s what the law says.  Is a seller-held note a “federally related mortgage loan”?  It’s not a loan, and it’s not “federally related,” whatever that means, so the answer is no, and statutorily whatever a property owner does in gathering information for a carryback is not an “application.”

What does “compensation or gain” in the SAFE Act above [(3)(A)(II)] mean?  If someone is not paid to offer or negotiate terms is he excluded from the definition of loan originator?  Obviously the intent is to target mortgage brokers who get paid for processing a loan application, so if that’s the intent then it should not include private parties offering to hold a note
What does “on behalf of” [(3)(B)] mean if there are only two parties involved, the property buyer (or “consumer”) and the seller?  The language appears to assume a third party in the transaction, a lender for whom the information is being collected, and thus the intent is to target mortgage brokers, not property sellers
On what basis is a seller carryback note subsumed under “residential mortgage loan” when it is not considered to be a mortgage loan by any other federal or state law with the exception of usury?  For example, in most cases seller carrybacks are exempt from RESPA requirements.

Your Homework

Can you think of other ways the definitions of “residential mortgage loan” and “loan originator” in the SAFE Act do not apply to seller carryback notes?  Or have you thought of other ways the law does not apply? If so, please let me know.

States are not required to adopt the model SAFE Act in it’s entirety.  According to HUD (, all the federal SAFE Act requires of states is “to have in place, by law or regulation, a system for licensing and registering loan originators that meets the requirements of sections 1505, 1506, and 1508(d) of the SAFE Act.”  Those sections relate to administering the licensing system; they do not define any of the terms, including “residential mortgage loan” and “loan originator” (however,  the federal government may argue that the definitions of the SAFE Act, Sec. 1503, control the bill and therefore states are required to adopt those definitions — if so, states can either reject that or go to court).   The question is, can a state exempt seller financing from their own state SAFE Act without running afoul of the federal government?

Every state has enacted the parts of the SAFE Act required by federal law.  For the licensing requirements for each state, see   That website does not indicate which states require licensing for seller carrybacks.  Any state that does so is taking liberties with the model SAFE Act, since it does not mention seller financing.

If you know whether or not your state requires licensing for seller carrybacks under the state SAFE Act, please tell me.

Why Not Just Get A License?

If it was a simple process that would be the solution.  Unfortunately, obtaining a mortgage originators license is not simple in any state, because the federal government has mandated minimum requirements, including: 20 hours of classes; passing a written test covering both, federal and state laws; submission of fingerprints to the FBI for a criminal background check; a credit check; 8 hours of continuing education annually.  Some states require more, such as a staffed office open to the public.  And don’t forget the fees.

How many real estate investors, how many Moms and Pops, how many people who just inherited a  house are going to go through all that to get a license?  You know the answer as well as I do.


A few days ago I surveyed the major national and regional note investors.  I asked them how much of their business involves notes created by people who sold a single family residence or up to 4 units (which is what the SAFE Act covers) that was not their personal residence.

In other words, how many notes do the major national and regional investors buy from people who will now have to be licensed to create those notes?

The SAFE Act will cause such notes to dwindle.  Not only will non-licensed investors be prohibited from selling SFRs and 1-4 unit residential properties by holding the note, but heirs will not have the right to sell property that way either, nor will those who have second homes, vacation homes, etc.

One investor told me they only buy notes created by owner-occupants.

Two investors told me they only buy notes created by non-owner occupants.

The other investors buy anywhere from 6 percent to 90 percent from non-owner occupants (including sellers of second homes, heirs, etc.).

One Investor Said…

“50% (of the notes we buy) easily are properties where the seller never occupied the home

“What bothers me is, how about when Pop helps his daughter get their first home — is he an investor who would need to be licensed to sell holding a note?”

Another Said….

“The type of scenario you’re describing

only impacts around 10% of the notes we evaluate in a given year. 90% of the SFR, duplex, triplex and quad notes we buy are true owner-occupied notes.”

“With the amount of seller financing compared to conventional lending growing from 1 in every 400 in 2006 to more than 1 in 50 today, far more than just rehabbers need alternative financing today. The make-up of industry inventory (who carries seller financing) has changed.

“Three years ago the greatest percentage of the notes we bought, as did all the other industry players, would have been affected by the SAFE Act. With loose lending practices, home owners and their Realtors simply didn’t need seller financing. Back then, by far the largest percentage of the inventory of seller carried loans was created by dealers (investors).

“Today our note purchases from dealers are less than 15% to 20%. We’ve filtered our marketing…we think 75% of all seller-financed notes aren’t buyable today because they are poorly underwritten (“trash can deals,” with no trash can note buyers around). And the greatest percentage of those 75% un-buyable notes are created and held by investors selling rehab houses (and must be SAFE Act compliant).

And Another Said….

“Bill, (non-owner occupied sellers, the ones who would have to be licensed under the SAFE Act) are running right at 50% as we mandate ‘chain of sales price’ as part of our underwriting process (a copy of the note seller’s closing statement from their acquisition).  If the answer to that question is a secret, then so is our offer!!!  In these investor cases we strictly put out conservative partial offers…leaving the seller in the deal with some of their ‘skin’ at risk.”

The bottom line is the investors surveyed buy 52% of their SFR to 4 unit notes from sellers who are not living in the property as their principal residence.  Most of those notes will not be created in the future because of the SAFE Act.


How can you be in compliance with the SAFE Act without getting a license?  I can think of several ways:

1)  Depending upon the resolution of the definition of “residential mortgage application” between what HUD wants and what the law says (see “Some Questions” above),  don’t use one.  Caution:  This has not been settled, so don’t try it yet.
2)  Use a contract for deed, a.k.a. real estate contract.  Since the closing and transfer of legal title doesn’t take place until the terms of the contract have been fulfilled, you may be able to take back a note and not have to be licensed under the SAFE Act.  Caution:  Your state may have laws that could complicate this (such as in Texas, where contracts for deed are limited to three years maximum and in most cases are six months), so get legal counsel before you try it.

3)  Get a licensed residential mortgage loan originator in the state where the property is located to deal with the buyer.  Do not take any financial information from the buyer, orally or in writing.  Do not negotiate or even discuss anything relating to the terms of the note before it is created; leave all that up to the licensed originator.  Document which of you performed what functions in case there are questions in the future.  Caution:  The federal (and model) SAFE Act is silent about this.  No one knows if every state will permit it.  I know of one state that apparently will allow it, but I am awaiting further confirmation.  Check with the regulatory authorities in your state before you do it.

If you find that your state will permit this, please let me know. I will be glad to put together a state-by-state registry of licensed residential mortgage originators who are willing to perform this function.

The following are long-term strategies intended to kill off the offending part of the SAFE Act:

4)  Convince state legislators to amend their SAFE acts to exclude non-owner occupant seller carrybacks.

5)  Convince state regulators to exclude non-owner occupant seller carrybacks.

States have this freedom because neither the SAFE Act nor the model state SAFE Act expressly includes seller carrybacks.

6)  The last resort would be a test case, preferably brought by a disabled minority single mom with 12 kids whose only asset she has is the house her loving granny left her, and she can’t afford the expenses so she must sell it quickly.  She takes back a note without being licensed and is charged with violating the SAFE Act.  She then litigates with the goal of having the licensure requirements for non-owner occupants of the SAFE Act voided by the court.  The real estate and note industries would have to be involved, including paying the costs. This is how the left often changes laws they don’t like.

If You Do Business (R. E. and/or Notes) In Texas…

You ought to know this, from the Texas Dept. of Savings & Mortgage Lending (

            Q:  Does a seller who, with his or her own funds, finances the sale of a property to a consumer for use as a residence and takes a security interest in the property need to be licensed? 

            (Note the phrase, “with his or her own funds” to describe a seller carryback!  What funds?? — WJM)

A:  It depends.  The Texas SAFE Act exempts an individual who offers or negotiates terms of a residential mortgage loan secured by a dwelling that serves as the individual’s residence.  An exemption is also granted for a person who offers or negotiates terms of a residential mortgage loan on behalf of a person if direct familial relationship.

            If the dwelling does not serve as the individual’s primary residence or on direct behalf of a direct familial relative, then the individual is acting in the capacity of a residential mortgage loan originator and must be licensed for even just one occurrence.

There’s an important meeting about the Texas SAFE Act in Dallas on June 9.  See  for details.

For continuing coverage of this and other issues keep checking my blog at  You can also sign up there for “The Cash Flow Express,” our free e-mail newsletter.  Cheers,


W. J. Mencarow
Editor, The Paper Source Journal

Copyright 2010 The Paper Source, Inc.

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