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New Regulations Reduces Residential Construction Costs

Question: I have friends and business associates who are looking to fix and flip (or fix and hold) residential rental properties in Oregon and can not obtain traditional bank financing. Is private money lending an option for these parties?

Short Answer: Until recently, because of the nature of the property, this type of transaction would have required the services of a licensed mortgage loan originator, adding substantial costs to the transaction.  However, effective September 9, 2016, there is a new regulatory exemption applicable to private money commercial construction loans if the lender: (1) verifies the borrower is a licensed general contractor, (2) verifies the loan is for a business purpose and will be used to construct a residential structure, and (3) refrains from certain other prohibited activities. Keep on reading for the details (a later column will address the additional investment opportunities this affords private money lenders).

Long Answer: Unlike federal law and the law in most other states, Oregon mortgage licensing law focuses on the nature of the collateral, and not the purpose of the loan.  If the loan is to be secured by one to four unit residential properties, or even vacant land on which is intended to be built one to four unit residential properties, a lender, unless exempt, must involve the services of a licensed mortgage loan originator (MLO).

This applies to even just one loan made by the lender, and applies whether or not the loan is a consumer purpose loan (i.e., for personal, family or household purposes), or a business purpose loan, such as the commonly known “fix and flip” or “fix and hold” transactions involving residential rental properties.  The fees of the MLO can range from one to two percent or more of the purchase price of the property.  So, for a $200,000 purchase, the additional fees could range from $2,000 to $4,000, or more.

For a number of reasons, such transactions will either generally not qualify for traditional bank financing (having nothing to do with credit qualification), or the mechanics just don’t make sense for such bank financing (i.e. multiple transactions in a short period of time).  So, what is the alternative? That would be private money loans.  These include those made by family, friends, or other individuals who have some extra cash, and are looking for a better return than they may find in bank deposits or the stock market or may just be looking for more diversification. It also includes those who are regularly engaged in the business of residential mortgage lending, but these types of private money lenders will not qualify for the exemption because of the regulatory terms, as set out below.

Until recently, the additional costs of the MLO would have to have been borne by either the seller or the buyer/borrower in the transaction.  The Oregon Department of Consumer and Business Services, on September 9, 2016, adopted Oregon Administrative Rule 441-880-0009 (full text available here: http://arcweb.sos.state.or.us/pages/rules/oars_400/oar_441/441_880.), which provides an exemption enabling qualifying parties to avoid these additional costs.

Generally, to qualify, the following must be satisfied:

a.  The lender must be an individual.

b.  The funds will be used for the construction, repair or development of one to four unit residential properties, or  vacant land intended for such use.

c.  The borrower does not intend to reside in the dwelling (or even one of the dwellings, if more than one unit, such as a duplex), upon completion.

d.  The borrower must be licensed with the Construction Contractor’s Board.

e.  The purpose of the loan must not be primarily for personal, family, or household purposes.  In other words, the loan must be for commercial purposes (this would ordinarily cover “fix and flip” or “fix and hold” residential rental properties).  The regulation includes a number of factors to review in making this determination.

f.  The lender does not advertise or hold him or her out as being in the business of making residential mortgage loans.

g.  There are other conditions, including the lender not engaging in certain defined wrongful conduct, and having to maintain specified records relating to each transaction for a period of time.

The full text of the regulation should be reviewed closely to assure that the lender is in full compliance, and assistance of a legal advisor would be advised, as the penalty for a violation could be as much as a $5,000 administrative fine per transaction.

Disclaimer: this column does not constitute the giving of legal advice, and your reading this column does not create an attorney/client relationship. You are encouraged to consult a lawyer or accountant should you have questions about how this information may be applicable to your particular situation.

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