So, what’s with all of this anti-investor legislation going on all over the country? Isn’t it akin to throwing out the baby with the bath water? Well, yes…and no. The inundation of so-called GURUs and their mass market spiel have created not only a bunch of novices in the field of real estate investing but also floods the market with many grossly misinformed people who are being taught things completely contrary to what the law actually says about these “creative” transactions.
In fact, to legislatures, the term creative has become synonymous with shady, predatory, and fraudulent. Can creative real estate be done both legally and ethically? Certainly! For the word creative really just means to think outside of the proverbial box to come up with a solution that works for all parties in the transaction; however, if you purchased a course or boot camp from many of the GURUs out there, there is a strong likelihood that what you were taught it could get you into trouble.
Let’s take perhaps one of the most oppressive creative practices to date: loan modification. Many states have legislation against loan modification companies. The process itself isn’t a bad idea. The borrower doesn’t want to communicate with the lender (who has now become a debt collector and has called them incessantly), so said borrower would rather prefer to have an intermediary intercede on their behalf.
The problem arises first in the predatory fees these companies charge (many charge as much as one month’s mortgage payment or higher), and this adds insult to injury–taking an already volatile financial situation and making it worse for the homeowner. Then many collect the fee and do nothing to aid the homeowner. And still others will tell the homeowner they are getting a consolidation loan and no longer have to make any back payments, which spirals them down into an inevitable foreclosure. Some companies even include a deed hidden within the paperwork, stealing the homeowner’s house! But there are good companies out there who are legit. Typically, the fees are low with a legit company, and that is one indicator. And the good ones are often nonprofit organizations, which is why many state laws have an exemption for nonprofits. For the most part, I completely agree with the legislation against these types of companies.
Subject to Investing
Let’s move on to subject-to. Surely, it has to be illegal to sign over one’s house to someone when it is security for a loan, right? Well, actually, it is perfectly legal. You own the house, shown by a Deed… and what you own, you may sell. But the loan remains attached to the property, with the property pledged as collateral. Said loan will stay in the borrower’s name despite a transfer of ownership in the property. These transactions have been quietly done for decades in commercial real estate, and “loan(s) taken subject-to” is even listed on the HUD-1 settlement statement. That in and of itself proves that the HUD does not view these transactions as illegal. But the problems arise when one conceals the transfer.
Almost all the courses (with very few exceptions) teach “creative” (i.e. shady, predatory, and fraudulent) ways to carry out this. Which brings in a new twist to subject to investing called Mortgage Assignments, or Assignment of Mortgage Payments.
These types of course twist the fact that when the property changes hands without lender consent, no laws have been broken. The loan has a Due On Sale Clause (DOSC), which, as the name implies, requires that the full balance of the loan become due upon sale of the property. A violation of this DOSC is a beach of the contract. The lender may then, at its discretion, call the note due requiring full payment. It is not likely that a lender will turn a performing asset into a nonperforming one, because it adversely affects what the lender can borrow from the Fed (such as, one million in nonperforming assets might penalize the lender two million…then three times…then four times, etc), and the Fed could close the bank doors if they get too high in nonperforming assets, which we have actually seen happen during the past few years. So, if the lender is receiving the payments (a performing asset), they will probably look the other way.
What they fail to tell you is …
That it doesn’t mean banks don’t keep their right to do so simply because they have accepted payment from the new purchaser; in other words, they don’t waive that right. One of the exemptions that forbids the lender from calling the note due upon sale of the property is transfer to a trust. This is where it gets interesting.
The intent of the court case that created this exemption is that family members may transfer the property to a family trust without it violating the DOSC. But GURUs teach that using a non-family trusts to both hide the transfer and to “circumvent” the DOSC, which amounts to nothing less than fraud.
And guess what? If you enlist the help of the seller or direct the seller to deny that the house was sold, then that’s conspiracy to defraud. There’s one popular subject-to course that teaches to send the lender a letter informing them that you are “the new property manager.” What do you think that is? You guessed it–fraud! You are not the property manager–you are the new owner.
So, in summation anything you do to cover up, hide, or conceal the sale is fraud. If you enlist anyone else’s help, it’s conspiracy. If you involve anyone in another state, it’s an interstate crime and is subject to prosecution under the federal RICO Act (racketeering).
If you say anything that’s not true, it’s not just a lie–it’s fraud. And not saying anything at all can be fraud by omission if you omit a material fact. This is some serious stuff, folks! We are talking a room with no view. North Carolina attempted twice to ban subject-to transactions. Both times, it failed to pass, because people should have the right to sell private property in a free country, but the Attorney General said if a trust is used, it’s mortgage fraud, and that he personally will go after anyone who does so. Neither the seller nor the buyer has a legal obligation to tell the lender that the property has been sold; however, if you in any way conceal it, you can go to prison.
So, while there is no Due On Sale jail, fraud is still fraud. Leaving the current insurance policy in place is also a risk, because although you can only legally claim on one policy, having two could be deemed as showing intent of a future insurance fraud…or in the very least indicative of one’s intent to deceive the lender. Combined with other evidence, it would help build the case against you.
The real problem with subject-to is when a house is in foreclosure. Always follow the state law to the letter in cases such as these. Many states have stringent requirements, and a subject-to is even banned completely and totally forbidden in Florida if the seller is behind in payments. Any subject-to on a preforeclosure is risky, but if you give the seller half of the equity, it can lessen the risk (making the seller a partner, as opposed to stealing their home for little or nothing).
So, what about lease options? Done correctly, they can be a powerful technique that solves many problems in a down real estate market. They have been abused by predatory investors, and this has made legislatures take notice, especially in the state of Texas where they have attempted to legislate them out of existence. Fortunately, the Texas legislature left a loophole in the law, so they can still be done (if you follow the law), but the executory contract provision of the law has completely done away with land contracts in Texas (unless owned free-and-clear).
Agreement For Deeds and Wraps
Finally, let’s briefly discuss all-inclusive trust deeds (AITD) or wraps. This is true owner-financing where a new loan wraps an underlying loan. Yes, it violates the previously-mentioned DOSC, and yes it is risky, but if done properly and with disclosures to all parties, it can solve many problems in today’s real estate market. Many homes cannot be sold, and with owner-financing, it can open up opportunities for buyers who cannot qualify for a loan from a bank… but the buyers should meet other qualifications (down payment and job/income).
The federal S.A.F.E. Act required every state to adopt its own version or to fall under federal guidelines, and all but two states passed their own. This prohibits owner-financing on residential property unless it is the seller’s primary residence (or is to a close family member as defined by the Act). Some states allow up to four or five sales to be exempted. If not exempted, then you must include a registered mortgage loan originator (RMLO) who will run a credit check and take the application. The buyer would normally pay the fee as part of the closing costs. The S.A.F.E. Act also applies to land contracts.
Is creative real estate a thing of the past? Not hardly. But be sure to follow your state’s laws to the letter, and take anything a so-called GURU tells you with a grain of salt without first checking on its validity yourself.
Randall Mixon – Guest Author and Real Estate Investor – www.freeriches.com