Re: creating paper for refi…? - Posted by David Butler ANN
Posted by David Butler ANN on November 13, 2000 at 23:43:44:
Well, there are a lot of big issues in Texas lending law… but everything’s bigger in Texas, right
However, the heart of the issue is pretty much the same in every state… when you “manufacture” a note, such as the example you have illustrated, you have created a loan, rather than created a note sale… and I have made several long posts in the past year related to the various factors that go into the equation. Possibly, you can pull one of them up through the archival search engine facility here on CREO.
But, it seems to be an ongoing point of confusion, so I will try to cover the simplest basics. The act of manufacturing a note by itself is not illegal, and chances are, in many states, you can shop around until you find a title company that will insure title in such a transaction. But title companies are getting wiser, so you may have to shop harder - and getting the title on the SALE of that note will be very difficult, so far has you have described the transaction.
And note buyers are getting sharper too… although the very experienced ones have always known what to look out for. In an article I published some four years ago regarding “Due Diligence” so far as it applies to note investing, one of the primary points I included was the necessity of determining “how the note was created”.
There are a whole slew of reasons why this is important, but perhaps the most important one is related to usury. And there are exceptions, or at least “practical” exceptions to some of these rules. For example, as a private property owner, I want to borrow $15,000 against my house here in California. I approach you for a loan, and I agree to create a note against my house to secure the deal. If you are a private party, not licensed to make loans in California, the maximum interest rate you can charge on the face of the note itself is 10%. And, if you are not in the habit of regularly making such loans (which is not specifically spelled out in many state codes by the way), you technically don’t need a license, nor do you need to prepare the mountains of paperwork and disclosures normally required in a loan transaction.
The chances improve somewhat if you are also related, or close personal friends, with the borrower.
However, if you quickly turn around and sell THAT type of note to an investor, at a discount that results in the note investor earning more than a 10% yield on that specific note (again, in California), chances are extremely high, under the circumstances you describe… that the note buyer would be construed to be a lender, and as such, he would be in violation of licensing law violations (if he is a private party buyer)… and even if he was licensed, he would run into disclosure violations under several state and federal consumer lending laws, the 3 day right of rescission requirements, and of course the usury defense, which can be quite ugly for the inexperienced note holder.
Now, the truth of the matter is, there is no government agency out there policing the matter. Leave it to private businesses to solve the problem (in your case, the title company who won’t insure the transaction).
But, when it does come up, it matters. And when it comes up, is usually the result of an unhappy borrower sometime down the road. And it doesn’t matter if he was a willing participant at the time the note was created. And it doesn’t matter if the whole thing was his idea (except for the punitive damage award - he won’t get that over and above his new “interest free” loan).
To be sure, the sale of an existing, non-usurious note at a discount which boosts the rate of return above usury limits does not, in itself, make the loan usurious (and in the case of a bona-fide purchase money mortgage resulting from a seller-financed sale of real property, it has the all-important “sellers exemption” so dear to private note buyers) - it is the circumstances under which the note was created that will determine the outcome.
A full blown discussion is impossible, yet it is required to achieve total clarity… and I don’t know how we can accomplish that completely in this type of forum… but I hope this helps clear up some of the points you are pondering. Best of luck
David P. Butler VP Broker Relations
America’s Note Network