Washington’s New Distressed Property Law (1)

June 9, 2008

HB2791, entitled “Property Conveyances — Distressed” becomes effective June 12 and this prospect is causing concern and confusion in the residential real estate industry. Memos are flying around real estate agencies and you hear occasional cries of doom from bleak Cassandras and doleful Jeremiahs The law is not complex, so reasonably diligent agents and others in the field should at least not be confused. Furthermore, the law will not entrap any reasonably well intentioned and informed person in the future. It should, however, dramatically reduce pandemic fraud.

First, it applies to contracts signed after June 12. Any pending unconscionable equity skimming transactions, while not subject to the terms of the new law, should be abandoned in some sensible fashion, however, because of common law and statutory liability that predates SB 2791. (I have several of these lawsuits brought by deceived homeowners under the previously existing law.)

I often hear that this new law does far more harm than good because it scares aware legitimate foreclosure rescue investors. The homeowners will be tied to the tracks of nonjudicial foreclosure procedure and left destitute and homeless. That of course is exactly where these equity skimming schemes leave people. I have been involved with these for a few years now and I have yet to meet a homeowner who cliamed to have benefitted by an equity skimming arrangement, and I have heard of only one family that came out of it with their home. They lost all their equity and could barely make the payments on their heavily encumbered house but they last I heard still had it.

What is not spoken of much is that part of the scam is to convince homeowners not to legitimate alternatives to avoid the foreclosure. First, people can sell their houses and buy new ones, using the equity from the sale. They can also resort to bankruptcy to sell the house or reorganize their debts. That after all is why bankruptcy courts were created. Also a foreclosure slae does not mean that the homwowner will necessarily be left penniless.

Equity skimming is generally done by people who cannot afford to bid at a foreclosure sale and who want to get homes more cheaply than they would if they could afford to bid at a foreclosure sale.

Recently prices of homes being sold at foreclosure sales, because of competitive bidding, were about 60% on average of fair market value. The difference between the balance on the mortgage being foreclosed and the foreclosure slaes price would go to the homeowner. If not it went to pay secured debt that would have followed the homeowner after the foreclosure. So usually the homeowner would be in better financial shape with a foreclosure than by falling into one of the equity skimming schemes.

Sincere investors who really wanted to help the homeowners would just have to loan them the money to bring the mortgage currently, typically $8,000 to $20,000, and take a second mortgage at a profitable interest rate. Very simple and straight forward. Equity skimmers are after extravagant profit at the expense of distressed homeowners.


Equity Skimming in Washington: A Brief History

June 7, 2008

There are three main reasons that real estate has attracted so many unscrupulous people in recent years.

First it is an asset that can be highly leveraged. Homes can be purchased for a relatively small amount down and the balance financed. When property goes up in value this confers wild profit on the owner. For example, say you buy a home for $100,000 and pay 10% down. When the transaction closes you have purchased a $100,000 asset for an expenditure of one tenth its value. Putting aside transactional costs, if the property increases in value 25%, you have gained $25,000 in value on an original investment of $10,000. You more than doubled your money on a 25% increase in value of the asset.

The second aspect that attracts the criminally inclined, is that these very valuable assets are often owned by people who are not sophisticated in real estate financing. This is an area where people typically just given themselves to the grinding wheels of commerce without knowing a lot about what is going on in a real estate transaction. Thus there is great opportunity for duplicity behind a mask of convention.

This area is also relatively unpoliced. In the early 1900’s the scam of choice was securities fraud. So many people were falling victim to fraudulent securities schemes that the federal government created the Securities Exchange Commission and in the 1930’s passed legislation imposing severe penalties for securities fraud and implementing broad disclosure requirements.

Many equity skimmers would probably have been selling bunko stock one hundred years ago. The equity skimming schemes of today occupy a relatively unpoliced area without much in the way of legislation (although states such a Washington are passing legislation to thwart this form of fleecing). In short home sales is an area where a lot of money passes hands, there is potential for fast profit and there is not a great deal in the way of scrutiny — similar to stock sales before the Security Exchange Commission.

There have always been lots of real estate scams but for our purposes the story starts in the 1970’s. There was a recession in the early 70’s (or something that looked remarkably like one). An average house in Seattle could be purchased for $15,000, due in large part to local economic problems. This was followed by a period of inflation and breathtakingly high interest rates.

The inflation encouraged people to sell their real estate profitably, but the high interest rates prevented many people from getting loans to buy real estate. These pressures created an era of seller financing. The buyer would give the down payment to the seller and make monthly payments to the seller with an agreement to pay the purchase price off in full in three to five years, when financing could be obtained. This sort of arrangement was commonplace.

The buyer got the house and with it the obligation to pay payments to the seller and the obligation to continue to pay the seller’s mortgage. The buyer could assume FHA loans but usually the buyer just agreed to make the payments for the seller after the sale. The malevolent instincts that had been somewhat suppressed by federal laws in the area of securities sales were revived in this situation.

All sorts of bad things happened. Crooks would buy homes with faulty seller financing documents so sellers could not foreclose if they were not paid by the buyer, while at the same time they remained obligated on the mortgage which the buyer might choose not to pay. Companies were formed that bought real estate on seller financing, then just stripped the property of everything of value and left the barren property for the sellers to foreclose upon.

Seller financing deals could be structured to protect the seller, but there is always a portion of the population that does not consult a lawyer before entering into a transaction of this sort. It is this group around which financial vultures circle.

There was nothing of the magnitude of the massive systematic fraud of recent years, so the legislature was relatively slow to address the problem of equity skimming. In 1988 Washington passed a law that criminalized equity skimming and declared it to be a violation of the Consumer Protection Act. The forward to the bill states in part:

The legislature finds that persons are engaging in patterns of conduct which defraud innocent homeowners of their equity interest or other value in residential dwellings under the guise of a purchase of the owner’s residence but which is in fact a device to convert the owner’s equity interest or other value in the residence to an equity skimmer, who fails to make payments, diverts the equity or other value to the skimmer’s benefit, and leaves the innocent homeowner with a resulting financial loss or debt.

Financial institutions had their hands full in the 1980’s. Seafirst Bank, the biggest bank in the Northwest was going bankrupt until it was purchased by Bank of America. Other big banks swallowed smaller ones into the nineties. Two of the biggest Seattle banks, Peoples Bank and Old National Bank, were bought by U.S. Bank of Oregon and merged into U.S. Bank of Washington. This activity seemed to occupy attention much more than occasional fraud on homeowners.

The opportunity for homeowner fraud errupted like never before during the Bush Administration. The administration’s laizes faire, anti-regulation bias allowed this situation to reach international economic crisis proportions, despite obvious abuses all along the way. (The policies that created the situation were constant between Clinton and Bush, but Bush’s response to the financial crisis made Katrina relief look adequate and timely.)

The subprime era was awash in home loan money; lenders could hardly give it away fast enough. Home loans were obtained without a great deal of review for as much as the full purchase price of a home. This was like a petri dish for raising a culture of financial fraud.

People were so eager to get at the money there were numerous seminars given on equity skimming. Small fortunes were made on the price of admission alone. These week-long seminars were packed with local real estate people, real estate agents, brokers and miscellaneous others. People from Seattle, Everett, from all over the Western part of the state attended.

Recently indicted Charles Head (California based) advertised on the internet, sent faxes to mortgage brokers and people in the real estate industry and nurtured relationships with lenders and escrow companies. He had dozens of companies that were nothing more than names to confuse the public. Sometimes the companies described themselves as facilitators, sometimes as lenders, sometimes as lenders’ agents, sometimes buyer’s agents, sometimes both lender and buyer’s agents and often not at all.


What you Should Do If Facing a Foreclosure

March 14, 2008

It is readily understandable when people in financial distress make bad decisions and a notice of default or foreclosure from your bank is certainly distress inducing. I will list some things that everyone in this situation should at least look into. I will focus on Washington law, which may be instructive to people in other states but care should be taken to verify the law of your state. This almost certainly requires seeing a lawyer.

Almost all foreclosures are deed of trust foreclosures but you must know what type of instrument encumbers your home. For example with seller financing, if you went that way instead of conventional financing, a real estate contract may be involved and sometimes a mortgage rather than a deed of trust is involved. Because mortgages have used in all states the literature usually refers to “mortgage foreclosures” and when used in this way “mortgage” is being used as a generic term covering any or all of the three mentioned security instruments.

I will be writing in reference to nonjudicial deed of trust foreclosures because over 99% of home foreclosures are of this sort. It is called “nonjudicial” because there is no lawsuit; instead there is only a series of notices culiminating in a trustee’s sale.

The Process

The sequence of events involves typically a few preliminary letters from the bank. This is followed by a notice of default which is a formal notice that starts the statutory foreclosure process. It is mailed, and may be served or posted on the door. It contains information about the debt and information about the foreclosure process. After at least a month and maybe a longer period you receive a notice of foreclosure and a notice of trustee’s sale. These have all the details about the foreclosure sale and the debt to the bank and set the time and date of the foreclosure sale (called the “trustee’s sale” in the notice). Notices are published and recorded but there a no more notices sent to the homeowner.

What to Do

1. Read every letter and notice carefully. This is rarely done. Most people are so upset they do not know what the communications say, but they contain vital information that must be considered.

2. Try to refinance. Make this a rigorous process. Talk to the foreclosing bank if you can and other banks, then talk to several mortgage brokers. They do not all have the same information or ability.

3. Consider selling. There are so many of these sorts of sales that they warranted a name: “short sales,” meaning they have to close before the trustee’s sale. Find a good real estate agent with whom to list the property. Again talk to more than one. The listing agreement should include exactly what will be done to market the property. Put that in — all the details — because the form will only have very general information. Get the most aggressive plan that you can find. Often there are scheduled price reductions as you get closer to the sale date. If you do this, write to the bank to see whether the bank will cooperate with the sale. It may agree to put the foreclosure off to allow a sale by you because if the foreclosure goes through the bank usually ends up with the property and then it has to try to sell it. Your sale of the property can save the bank time and money.

4. Inquire about programs to help you you bring the loan current. You may qualify for a program designed to assist you. There are not many of these but inquire of the city, county and state whether there are any programs that might provide financial assistance.

5. Talk to a bankruptcy lawyer. Bankruptcies are intended to provide relief for this sort of financial distress. There may be a plan which will enable you to bring the loan current. Even if there is no such plan available, you may be able to sell the property under the protection of the bankruptcy court so as to be able to preserve the equity you have in the property.

6. You are likely to receive a number of “rescue” proposals in the mail. Do not enter into any of these without consulting with a real estate lawyer. Usually the inducement for people to offer these to you is that they can take your equity in your home. There are dozens of ways to accomplish this. These “rescues” are so frought with peril for the home owner that you should absolutely never enter into one without legal advise and a clear understanding of what is happening. Some of these “rescues” even involve identity theft and forgery, so do not even apply for anything before you are certain of what you are doing and who you are doing it with.

7. Make sure your adviser complies with the law and make sure that everything of consequence that you are told is put in writing. You can just jot it down and ask the adviser to sign it. In any case there should be a record of the things that you are told. Also be aware that these “advisers” are probably required to be licensed as a real estate agent. Find out all you can about the person and his or her history. Find out how many of these deals they’ve done and how many ended in the eviction of the homeowner. Get this in writing. Do a property record search to see how many homes this person or her company has taken. Search for everyone involved in the transaction, as there are usually at least two people and a company or two.

The Bill to Prevent Scams

The Washington legislature just passed a law to regulate people who come forward with advice for you about how to escape your situation. As of this writing House Bill 2791 has not been signed by the governor but it surely will be, as it passed both the state senate and house without a dissenting vote. It should become effective 90 days after being signed by the governor.

This bill requires that a number of different written disclosures and notices be provided to the homeowner by the “distressed home consultant.” The terms of the transaction must be spelled out in detail, including all the money being paid to the consultant and others who are involved. This must be signed by both parties. If the consultant represents anyone else, this must be fully disclosed in writing. Follow up on this very carefully. Find out all the details of the other relationship and be sure you get them in writing.

The bill creates a fiduciary duty from the adviser to you. This is the highest duty imposed by law. You are owed the duty of complete disclosure and full honesty. Your questions and concerns must be fully addressed. They are required to act in your best interest, so it is quite possible that a relationship with someone else in the transaction creates a conflict of interest.

All contracts are required to be in the language used by the homeowner. (This requirement would reduce fraud in a number of different situations apart from foreclosures, but at least in Washington I believe that it stands alone.)

The contract must comply with a number of requirement, including a notice of a five day cancellation right.

No doubt the most significant substantive right created by the bill is the duty of the consultant to verify that in fact the homeowner is able to buy back the home. Usually in these situations, the home owner is given an option or something of the sort to buy the property back after giving it away. In my experience it is unusual for a homeowner to be able to exercise this right before it terminates. This bill puts the burden on the facilitator to verify, and be able to prove, that the home owner had the ability to buy his or her home back.

Another provision with teeth is the requirement that the homeowner recieve at lease 82% of the market value of the home before an eviction can be done. This will certainly slow down people motivated by windfall profits and it gives assurance that the homeowner will not usually be left homeless and penniless.

There are a number of other aspects of the bill but time prevents a full discussion.


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.