Timing Can be Everything

Some time ago, a lender made a loan to the owner of commercial real property.  The property owner defaulted on his loan payments.  The lender foreclosed, and the property was sold at a foreclosure sale.

So far, so good.

But after the foreclosure sale, the property owner hired an attorney and filed suit against the lender for wrongful foreclosure.  The lawsuit contained a laundry list of every possible defect in the foreclosure proceedings.

A review of the claims in the lawsuit made it clearly apparent that the attorneys filing the lawsuit had simply taken every single procedural step involved in a foreclosure proceeding and claimed that the foreclosing lender had incorrectly followed every one of them.  It was equally clear that the foreclosing lender had properly followed all of the necessary steps involved in the foreclosure.

Except one.  Before a property can be sold at foreclosure, a notice of the date, time and location of the sale must be published in a newspaper of general circulation.  Oftentimes these notices are published as a routine matter, and after the foreclosure sale is completed nobody may ever take the time to review such published notices.

Unfortunately for the foreclosing lender in this case, the time of the foreclosure sale was published as “20:00 a.m.”  That’s a problem.  Potential buyers who might have shown up at the sale may not have received proper notice – and so the sales price might have been lower than it otherwise should have been.  Whether or not such a defect is adequate grounds to set aside a foreclosure sale and conduct it a second time is a matter for the courts to decide.  But the technical details of the published time for a foreclosure sale can be critical.

Don’t Be Pennywise and Pound Foolish

I understand the value of a nickel.  I do.

But I also understand the value of a dollar.  As a youngster, I heard the saying “Don’t be pennywise and pound foolish.”  The translated meaning of that?  It’s possible to be very careful about minor expenses – and then to lose large amounts of money due to poor judgment or bad decisions.

I sometimes see this in the context of good, honest, honorable hardworking people who have worked all their lives to put away something for retirement.  They’ve scrimped and saved and gone without so that they could put money away for the future.  That’s an admirable trait.  But when it comes to investment of the big nest egg they’ve saved, they lack the sophistication to properly manage their risk, or their investments, and sometimes they can lose a big part of what they’ve saved.  Sometimes it’s just back luck, but sometimes it’s a desire to save on the cost of employing a skilled professional.  There’s no law that says an individual has to hire a qualified portfolio manager to invest their life savings.  There’s no law that says an individual has to hire legal counsel to review a contemplated real estate transaction, or a change in title.  But these types of transactions can have hidden risks that an ordinary lay person might not appreciate, and a single misstep in these types of decisions can be costly.

Take, for example, a change of title.   Sometimes a couple may want to pass on one of their properties to a son or a daughter.  I often hear of this as just “putting someone on title.”  The concept is that the parents eventually intend to bequeath this property to their son or daughter anyway, so why not just put them on title now?  The potential downside is that such a simple transaction fails to take into account the many complexities that exist in a real estate transaction.

In the first place, many laws govern real estate transactions.  Some of these laws don’t apply to a transfer from parent to child, but others do.  A simple “paper transfer” won’t comply with many of these laws.  Why set up a transaction that doesn’t comply with the law?  That’s never a good idea.

In the second place, there can be unforeseen risks with “putting someone on title” regardless of whether it’s a brother, a sister, an uncle, an aunt, a friend or someone else.  What happens if that person runs into financial difficulty and files a petition in bankruptcy?  The bankruptcy trustee will probably want to know all real estate transfers made by this person in the previous 10 years.  There will be questions about who really owns the property.  If there’s a lot of value in the property, then creditors may be motivated to claim that the holder of title is actually the true owner of the property.  If that’s not the case, then perhaps a creditor’s claim can be defeated.  But this might involve a lawsuit, which can be expensive — and perhaps very expensive.

Or suppose title goes into someone else’s name, and then that person is sued – maybe they get into a car accident, or they have a business reversal, or whatever.  Again, creditors may be on the lookout for assets – and real property is like a big sitting target.  Ownership information is available to the general public, and it’s not difficult to access it if you know how.  Trying to convince a creditor that uncle Bill is just “holding title” may be expensive – and may or may not be successful.

And what about the tax issues?  There can be substantial tax benefits connected with a mortgage interest deduction that could potentially be affected by a poorly planned property transfer.  Or there can be issues with appreciation.  During some time periods, real property values appreciate.  This appreciation can be subject to tax in some circumstances, and this may be adversely affected by a casual transfer of title.  Moreover, property taxes are calculated on the value at a time of transfer.  If property is not held in the name of the true owner, then issues can arise about property taxes that might have been avoided had title been properly conveyed and titled.

Or what about potential liability of landowners?  Sometimes landowners can be liable for cleanup costs for pollution that occurs on their land, and sometimes they can be liable for accidents that occur on their land.  Persons who agree to hold title for someone else could unintentionally be setting themselves up for a big fight over who the true owner is, and what their liability could be for issues relating to the land.

As with many legal matters, real property title issues can be complex.  Persons interesting in selling property or in transferring title would do well to consult competent legal counsel.

Loan Guidelines May Not Always Make Sense

Many people are having difficulty with their home loans these days.  Some homeowners are attempting to obtain “loan modifications” that will allow them to repay their loans on terms which will allow them to stay in their homes.  For example, a homeowner with a loan term of 30 years may seek to extend their loan term to 40 years.   Such a modification could have the effect of lowering a homeowner’s monthly payment by extending the term of the repayment.  Other homeowners may be seeking to lower their interest rates, either permanently or temporarily.  Others may be seeking to have the principal amount of their loan reduced.

These efforts have met with mixed success.  Some homeowners actually have succeeded in having their loan balances reduced down to market value.  But these situations seem to be the exception.  Far more homeowners seem to have been able to obtain a reduction in their interest rate.  Lenders are understandably hesitant to reduce loan balances. And some homeowners seem to be unable to obtain any kind of modification at all.

Sometimes it can seem like a lender’s refusal to modify a loan makes no sense.  But in reality, many lenders are faced with the prospect of holding a large number of loans where the homes are worth less than the mortgage loan balances.  Borrower’s situations can be unique, and lenders may find it difficult to commit the resources that would be necessary to effectively process and negotiate each loan modification request in a way that makes the most sense for both the lender and borrower.  In an effort to process large numbers of loan modification requests, the lenders may find it necessary to adopt rather inflexible guidelines, and these guidelines may not always lead to results that yield the most sense for the borrower and the lender.

For example, some homeowners may want to stay in their homes even though their home is worth less than the amount of their loan.  But these same homeowners may find that their lenders claim that a borrower makes too much – or too little – money to meet the lender’s criteria for a loan modification.  If the lender refuses to reduce the loan balance, and also refuses to reduce the interest rate, then the borrower may find it necessary to foreclose or short sell their property.  In a short sale situation, the best result that the lender can hope for is to receive market value for the property.  But market value may be far less than the loan balance.  If the lender approves a short sale, then the lender will receive less than the loan balance.  Borrowers can wonder why the lender won’t simply reduce the loan balance to fair market value.  It seems like it would make sense for the lenders to reduce loan balances to market value because the lenders only receive market value if the property is sold through foreclosure or short sale.  But even though it might make sense in some situations, lenders seem to be hesitant to reduce most loan balances to the market value of the property.

The most sensible and logical result may not always be the most available result.  In some ways, this is similar to my daughter’s driving situation.  Some time ago my daughter received a commercial driver’s license.  She planned to drive a fifty passenger motor coach bus one summer.  This is a bus that is forty or forty-five feet long, and weights thirteen tons.  This bus has 8 wheels, and each wheel is nearly as tall as I am.  It’s a formidable vehicle.  After extensive training, she finally received a state-approved commercial driver’s license that allowed her to drive such a vehicle on any road, highway or freeway in the United States.   Her license was granted to her because she demonstrated that she possesses the necessary skill, training and expertise to safely and properly operate such an enormous vehicle on public roads.  Presumably the Department of Motor Vehicles and the State believes she also possesses the necessary judgment and maturity to operate such a vehicle.

At the same time, my daughter was unable to operate a rented two-door subcompact economy car that seats four or five passengers.  Why was that?  Because she was less than 25 years old.  And due to some car rental company guidelines, she was presumed to lack the sufficient skill, training, judgment and maturity to safely and responsibly operate such a vehicle.  I find it interesting that on the one hand she was fully and legally qualified to safeguard and protect the well-being of 50 passengers, plus herself, plus untold motorists and pedestrians while she operated one of the largest vehicles on the road, but at the same time she was deemed to lack the necessary skill, maturity and expertise to responsibly operate a rented subcompact two-door coupe.  These two perspectives on my daughter’s ability are completely inconsistent, and yet they exist.  On one hand, this makes no sense.  But the reality is that she is subject to car rental guidelines which have been prepared for addressing a large number of potential car renters, and these guidelines aren’t specifically tailored to individual situations.   In other words, guidelines don’t have to make sense in a given situation – they just have to be what they are.

Loan Modifications Can Make Economic Sense

Years ago, before the recent market downturn, loan payment problems between lenders and borrowers were often referred to as “loan workouts” or simply as “workouts.”  These were situations where the lender and borrower worked toward a realistic resolution of the borrower’s inability to pay their monthly loan obligations as they became due.  In more recent months and years, these types of negotiations have become known sometimes as “loan modifications” or “short sales.”  A “loan modification” is part of a workout process where a lender agrees to restructure the loan, with possibly a reduction or deferral in interest payments, and possibly even a reduction in the principal balance due.  However, many lenders seem to resist principal reductions, and they seem much more interested in deferral or reduction of interest.

This makes economic sense for the lender.  If the lender were to foreclose at a low property value, then the lender may give up a hundred thousand dollars or more in lost principal that it would never recover.  However, if that same lender reduced the loan’s interest payment by a thousand dollars a month, then over a period of three years, that lender would only lose $36,000 because it would receive $36,000 less in interest payments than if the loan hadn’t been modified.  If the market improves so that the property is worth the amount of the loan, then the lender is in a very positive position.  Any reduced interest rate could be adjusted back to where it was before, and then the borrower could repay the loan at the higher interest rate.  If the buyer can’t make the payments, then the lender can foreclose.  If in three years the property is worth at least $36,000 more than it is today, then the lender is ahead. This is because the lender would receive either more at the foreclosure sale, or if the lender bought the property at the foreclosure sale, then the lender could turn around and sell the property for more than it could if it foreclosed today.   If in three or five years the property is worth $100,000 more than it is today, then the lender is far, far ahead because it will recover much more when it forecloses in a few years.  If a lender can defer interest payments instead of reducing the interest, then the lender is also ahead if the market improves and the borrower elects to keep the property.  So the current lender reduction in interest rates may be an indication that lenders are hoping that the real estate market will improve so that lenders can foreclose, if need be, in the future with smaller losses.

Honesty Is Still the Best Policy

Some years ago, a Northern California newspaper recently ran a story about a police officer who had been charged with felony mortgage fraud.  According to the article, the officer took out two loans on two different residential homes at approximately the same time.  That’s certainly not a crime.  But the officer has been charged with applying for each loan as an “owner-occupied” loan. What’s more, the officer was apparently charged with substantially overstating his income on his loan applications.  The police officer denied any wrongdoing.

If true, these charges would amount to lender fraud.  Lenders want to know the economic status of the borrowers they deal with.  That’s the reason lenders require Borrowers to fill out loan applications.  A good credit score isn’t enough.  The lender wants a true snapshot of the borrower’s financial condition.  The lender wants assurance that the Borrower has the financial resources to repay the loan – with interest.  And the lender wants further assurance that the Borrower will be motivated to repay the loan.

Borrowers who use a loan to buy their principal residence may be more motivated to repay a loan than borrowers who are purchasing investment property.  If a borrower runs into financial trouble, that borrower may be more likely to default on an investment loan than on a loan on the home where they live.  Thus, an “owner-occupied” loan may have less risk than a loan on an investment property.  The simple reality is that a borrower’s home is often the last, and possibly most important, asset that most borrowers will ever have.  Lenders can gain some assurance from knowing that a borrower is accepting a loan for a home where they plan to live.

Borrowers receiving an “owner-occupied” loan can often can get a loan on better terms than they could on a loan for purchasing investment property.  There can be a substantial economic incentive for borrowers to claim that they intend to live in the property when they actually don’t intend to.  If borrowers falsely represent they intend to live in the home they are buying, then the borrowers commit a fraud on the lender when they make such a representation.

The officer in the story referred to above apparently overstated his income by a significant amount.  This can be a problem because a lender relies on income information in determining whether or not a borrower can repay the loan.  Without sufficient income, the borrower may not qualify for the loan  There can be a significant incentive for borrowers to overstate their income in order to qualify for a loan.  Again, such a practice constitutes lender fraud.

In the story above, the officer reportedly refinanced both loans within a few months of receiving initial loans.  He reportedly pulled cash out of the properties through refinance loans, and he then allegedly defaulted on the loans.  The defaults probably spurred the investigation that resulted in his being charged with felony lender fraud. If loans are fully paid as agreed, then lenders may not have any incentive to confirm whether or not any misrepresentations were made on the loan application.  But once loans go into default, and especially if a lender will suffer a loss, then a lender has an economic incentive to carefully review the borrower’s application to determine whether or not all of the representations were truthful.

What a terrible risk to take.  When borrowers take out loans on investment property in a hot real estate market, misrepresentations on a loan application can seem to be a minor thing.  But when the lender loans hundreds of thousands of dollars on those representations, and if the market turns downward so that there’s a foreclosure, then a borrower who is less than honest can end up facing criminal charges.  Nobody expects this when they fill out a loan application – but it’s a real possibility.  The end result?  Honesty truly is the best policy – even when it’s more expensive.

Security First Rule Can Be a Protection

With the 2006 downturn in the market, lots of homeowners found their home was worth less than they owed on it.  Sometimes these owners ran into financial trouble due to illness, divorce, or loss of employment.  When this happened, those owners often couldn’t make their monthly mortgage payments.

When the market was good, these homeowners had several options.  Because of rapid and significant market appreciation, owners often had substantial equity when trouble arose in their home after holding it for a short period of time.  If they couldn’t make their payments, such owners could sometimes refinance their home and borrow against their equity, which would provide them with cash for living expenses and mortgage payments.  If they couldn’t qualify for a refinance loan, then they could sell their property and cash out their equity.

When the market went down, all that changed. Because of the economic downturn, many owners found themselves “upside down” in their properties, with their home being “under water.”  The terms “upside down” and “underwater” are commonly used to refer to properties where the mortgage debt is more than the property value.

California has a “Security First” rule.  In most cases this means that a lender can’t ignore a mortgage and sue directly on a loan.  When a property is “underwater,” then if a borrower has assets other than real estate, a lender might prefer to ignore the mortgage and sue directly on the promissory note.  When borrowers take out a mortgage loan, they sign a promissory note whereby they agree to make monthly payments.  If there is little or no equity in a property, the lender might prefer to just ignore the mortgage and sue the borrower on promissory note.  But California law usually won’t allow this, because of the “Security First” rule.  California requires a lender to foreclose on a mortgage before looking to a borrower’s other assets.  This rule can help protect a borrower’s other assets by requiring a lender to first foreclose a mortgage on real property before looking to a borrower’s other assets.