BUYERS (AND AGENTS) BEWARE IF THE SELLER IS UPSIDE DOWN

In the January 30th post, I discussed the California statutes that regulate "foreclosure consultants" who seek to "assist" buyers who are in danger of losing their homes to foreclosure. There is an another group of California statutes that may be a trap for the unwary buyer of a house in foreclosure.

When mortgage defaults and foreclosures increase, investors may actively seek out homes owned by a buyer is in default before foreclosure sale takes place. California Civil Code sections 1695-1695.17 were enacted to protect homeowners in that vulnerable situation. In brief, if an owner resides in the home (or up to 4 residential units) and has equity in the property, the owner is in a protected class as an "equity seller." Subject to specific exclusions, if an investor tries to acquire title from an equity seller and does not intend to reside in the property, the investor is an "equity buyer."

When an equity buyer tries to enter into a deal directly or through an agent with an equity seller, there are a number of special requirements. For example, the equity seller has five (5) days to cancel and the equity buyer cannot pay any money to the seller during that time period. Violations of Civil Code sections 1695, et seq. can result in criminal penalties and fines.

There is another interesting protection for equity sellers. If an equity buyer is represented by an agent, the agent must have a bond from an admitted insurer in an amount equal to twice the fair market value of the property. But no insurer admitted in California offers such a bond, so agents should avoid representing equity buyers.

FORECLOSURE CONSULTANTS --The Risks in Bottom Feeding

The Sacramento Delta is known for its fishing... and for tides that can rise and fall as much as six feet. The residential real estate market goes through similar cycles. A rising market can lift all boats, and a declining market can cause some property owners to run aground.
Some people view this as a business opportunity and look for homeowners facing foreclosure who have equity in their homes but lack the ability to refinance. They may offer to rescue the homeowner from foreclosure and salvage their credit in exchange for title to the house. The distressed homeowner may also be granted an option for a fixed time period to re-purchase their home if they have a reversal of fortune.
But dealing with homeowners in foreclosure may be a trap for the unwary if they are ignorant of the Cal statutes that protect homeowners facing foreclosure. This is not a case where ignorance is bliss -- the violation of the statutes carry both civil and criminal penalties. (Civil Code 2945.6 & 2945.7)
The legislative findings in Civil Code 2945 explain why property owners of 1-4 residential units facing foreclosure need special protection. Civil Code 2945.1 broadly defines the term "foreclosure consultant" to include a variety of dealings with distressed property owners. Although the statutes contain specific exemptions, a 1997 California case holds that a licensed broker can be regulated as a foreclosure consultant.
A foreclosure consultant is required to prepare and enter into a written contract with the owner which discloses the nature of the services to be performed, the total amount of compensation and the terms of compensation. (Civil Code 2943) Foreclosure consultants must provide a statutory notice concerning the homeowner's legal rights under Civil Code 2943.5, including the right to terminate the contract within 3 days. An additional notice is required if the foreclosure consultant will assist the property owner in obtaining the release of any surplus funds after a completed foreclosure sale under Civil Code 2945.3(h).
Following the laws to the letter can protect both the foreclosure consultant and the property owner in California.

MORTGAGE FRAUD--Playing with Dynamite

There is an epidemic causing harm in the billions to the real estate industry -- mortgage fraud. This fraud is often a violation of both civil and criminal laws. That is why the FBI is actively involved in the investigation and apprehension of the perpetrators.

Mortgage fraud can take many forms: a homebuyer inflates his assets or income on a loan application or conceals liabilities; an investor falsely represents that she will live in a condominium to obtain a better loan rate; a con artist uses someone else's good credit to borrow money to buy a residence at an inflated price; or an organized crime ring hatches a complex scheme to defraud a lender using a dishonest appraiser and an insider employed by the lender.

Each of these transactions is governed by Federal Law. Form 1003, the Uniform Residential Loan Application that every buyer signs when he or she applies for a loan, references Title 18, United States Code section 1001. Under that code section, buyers, appraisers, agents, loan officers and other parties are prohibited from lying on a loan application or any other document related to the transaction.

The "straw buyer" is the most pathetic character in the annals of mortgage fraud--the pig in the cartoon. For example, a con artist persuades a straw buyer to take title to a residence that is being leased, using their good credit to obtain a loan. The straw buyer is promised by the con artist that he will make all the mortgage payments, sell the residence in one year and split the profit 50-50. The deal is "too good to be true." The con artist may, in cahoots with the seller, inflate the price of the house with a false appraisal and get cash back at the closing for repairs that are never made. The con artist then disappears with the kickback and the straw buyer finds herself saddled with an inflated mortgage and a house with no equity in a declining market. The straw buyer stands to suffer a foreclosure and ruin her credit, unless she sells the house short for a loss and compensates the lender for the loan deficiency. Perhaps worst of all, the straw buyer has unwittingly engaged in violations of Federal Law that carry criminal penalties.

To read more about mortgage fraud and the types of schemes used by the culprits, click here.

EMINENT DOMAIN -- "The Times They Are A Changing"

The Supreme Court's decision in Kelo v. City of New London set off shock waves among property owners. In Kelo, the Court upheld the City's taking of Ms. Kelo's well maintained home City so that a Fortune 100 corporation could build a new office complex. In response, legislation has been passed across the country that makes it more difficult for private property to be taken by eminent domain for private, not public, use.

On January 1, 2007, several new laws went into effect in California which will impede a redevelopment agency from taking private property for development for a private use. Under Health & Safety Code 33031, a city or county can declare urban property to be "blighted" as the first step in the process of eminent domain. The primary purpose of such a taking is the generation of increased property tax revenues through redevelopment. But what if a parcel of property in the project area is already improved with a building that is in fine condition and is being put to a productive private or public use. Why should a government agency be able to force the sale of that property so it can be transferred to a private developer for a private use (for example, the development of a new shopping center)?

These questions have been addressed in part by Health & Safety Code 33320.1(b)(2). That code section prohibits the inclusion of nonblighted parcels in a redevelopment project area for the purpose of obtaining property tax revenue without "substantial justification." In other words, the taking of private property by a city for private use is no longer justifiable on the basis that the city will generate more property tax revenue after the shopping mall opens for business.

So let's say a city wants to take a medical clinic to be part of a parking lot or retail store for a new shopping mall. If the medical clinic is not blighted, there must be a substantial justification for its taking. Increased property tax revenues for the city is no longer a relevant factor, and it is unlikely that a court will find substantial justification from the opportunity for shoppers to purchase a pair of designer jeans or a caffe latte in a new mall.

"CREATIVE" FINANCING -- The Slippery Slope in 2007

The overheated residential real estate market between 2002-2005 gave rise to billions of dollars in "creative" financing and sub-prime loans. The "creative" part was the offer of interest only loans with low initial rates (a/k/a teaser rates) which would re-adjust in about 3 years to an above-market rate. Some $500 billion of these loans will readjust in 2007. For borrowers with little or no equity in their homes, the prospect of an unaffordable monthly payment raises the specter of foreclosure.

Sub-prime loans are offered to borrowers with credit problems at above-market interest rates from the inception of the loan. There is widespread concern that about 20% of these recent sub-prime loans will go into foreclosure in 2007. At least one respected economist, Nouriel Roubini, has written at length about the dramatic impact these foreclosures will have on the lenders who made the loans and the economy in general.

Since these loans are bundled and sold in the secondary market ("securitized"), they are subject to regulation as securities. Last September, various federal agencies issued new guidelines to lenders to tighten their lending standards and reign in the creative financing. These new guidelines, which are quasi-regulatory in nature, have put lenders on notice that residential lending may not be the best place for creativity. Real estate agents should be aware of these guidelines, because a sharp increase in foreclosures may call into question why unsophisticated buyers were sold loans and homes they could not afford.

ALL THAT GLITTERS IS NOT GOLD

Some types of real estate litigation would be significantly reduced if disclosures required by California statutes were made consistently by sellers, lessors, lessees or lenders. The Department of Real Estate has provided a handy compendium of the required disclosures in a publication aptly titled, "Disclosures in Real Property Transactions." The publication is available on the Department of Real Estate's website. If you are negotiating a transaction and are concerned that the other party is not telling you what you are entitled to know, check the publication. Either it will help you get the information . . . or help you decide to deal with someone else.