Beware of Rescuers

February 6, 2008

There is a nearly unprecedented number of foreclosures, prompting among other things press releases by national banks, a foreclosure relief fund created by the City of Seattle and frantic activity by people faced with losing their homes.  The people faced with this financial disaster are often unsophisticated in regard to real estate financing and usually have suffered a medical catastrophe, lost a job or suffered some other personal crisis.  They are usually desperate and easy prey for the unscrupulous.

Before talking about how people fall victim to “foreclosure scams” or what are sometimes referred to “equity skimming scams” let’s discuss time-honored ways to help a person out who is facing the prospect of being foreclosed upon.

A benificent investor wishing to help a financially strapped homeowner might loan the home owner enough money to either bring the loan current and secure this loan by a second deed of trust. This type of approach is being undertaken by the City of Seattle in a rather tepid — but commendable — program which supplies small loans to a narrow set of qualifying homeowners for the purpose of curing mortgage defaults.  Alternatively a high minded investor might pay off the mortgage in default and record a new mortgage (or deed of trust) with new repayment terms that the homeowner could afford, and set a date by which the loan has to be paid off by refinancing or selling the property. This would be an entirely conventional transaction, as sort of private refinancing arrangement.  In either case the investor could realize a small profit while seeing that the homeowner’s equity is protected.

There are two reasons that these perfectly traditional approaches are not pursued. First, in the world of investors in this type of situation there are not many people who have enough money to pay off someone’s mortgage or in many cases even pay off the past due arrearage. Those who have the financial resources are not inclined to make this sort of loan because the return would likely be relatively small. Because the loan by the investor might be a consumer loan, it may fall under Washington’s usury statute, limiting the return to the investor. (It is possible to structure this loan in a way that it is exempt from the usury law, but this is largely unexplored.)

The preferred method among those who seek extraordinarily high returns through “foreclosure rescue” is one that requires little money from the investor, offers immediate return, and creates a  high risk for the homeowner. The basic structure of these deals is that the homeowner transfers title to an investor (who is usually someone other than the “rescuer” with home the homeowner discusses the deal. The home is then sold to the investor for enough money to pay off the mortgage, plus $50,000 to $100,000 or more. The investor gets a loan to buy the house and agrees to rent the house to the homeowner with an option to buy the home back. Instead of going to the homeowner who is “selling” the house, the money (the $50,000 to $100,000 or more) generated by the sale goes to the “rescuer,”  sometimes it is split between the investor and the “rescuer.”

From this basic format there are countless permutations. The most common problem is that the the price to buy the home back is increased $50,000 or $100,000, or more, above the amount necessary to pay off the loan that is in default.  This requires the homeowner to qualify for a loan substantially higher than the amount of the mortgage that was in default.  Many times this proves to be an impossible task.  At best the homeowner’s chance of being able to refinance the house in order to exercise the purchase option is questionable. Unable to exercise the purchase option to get the house back, the homeowner is forced out of the house at the end of the lease term and the investor sells the house to get whatever equity might remain in it.

Even if the homeowner experiences uncommon good fortune and is able to buy the home back at the option price, sometimes other difficulties prevent this from happening.  Some people find that the investor has already sold the house when they try to exercise the option.  Some find that the investor has encumbered the house with additional loans so that it cannot be purchased at the option price but only at some inflated price equaling the sum of all the loans that have encumbered the property since giving it away.

There are alternatives to entering into such a high risk transaction that involves parting with most if not all the equity in the house and way too often involves eviction from the family home.

Selling the house is one traditional action by a homeowner who is confronted with foreclosure.   There are so many of these sales now that realtors call them “short sales.”  By selling, the homeowner receives the equity in the house and a chance to start over. If the homeowner enters into one of these “foreclosure rescue” programs and can’t exercise the purchase option, then he or she has sold the home without getting any of the equity out of it, essentially giving it away.  In the best case scenario when the homeowner is actually able to exercise the option, the price is so high that much of the equity has already been drained by the “rescuer.”  The bankruptcy court is tended to alleviate exactly the sort of situation confronted by the homeowner experiencing an uncurable mortgage default.  Consideration should be given to debt restructuring under a Chapter 13 wage earner plan.  Even a Chapter 7 liquidation offers a means of selling the house to preserve the equity which may have been built up over a lifetime.

There is pending right now in the State Senate Committee on Consumer Protection and Housing SB6413, a bill which addresses some of the issues to which consumers are most vulnerable in these “foreclosure rescues.”.  Apart from disclosure requirements and a five-day right of cancellation, the bill requires the “rescuer” to demonstrate that the homeowner has the financial ability to perform and actually get back title to the home. HB 2791 is the corresponding bill in the House, where it is in the Judiciary Committee.