LOAN MODIFICATION UPDATE -- Help for Owners Who Are Upside Down?

This Blog began on in late 2006 with the mortgage debacle on the horizon. A number of posts have been devoted to mortgage fraud, foreclosure consultants, home equity purchasers, loan modifications and the like. Recently, the Federal Government has launched new initiatives to promote loan modifications.

Today the Los Angeles Times ran an article on page 1 of the Business Section with a good but very general overview about mortgage modifications. The author advises borrowers to look for free help from federal programs or non-profit legal services. The article is entitled, "IS IT HOPE OR HYPE FOR HOMEOWNERS?"

The advice to look for free loan aid is worth considering. Many "opportunists" have entered the loan modification business as a way to make a quick buck from distressed homeowners. As we have discussed in other posts, it is very difficult to provide mortgage modification assistance for a fee in California under to State laws regulating "foreclosure consultants." In a future post, we will discuss how the laws governing foreclosure consultants will change effective July 1, 2009.

9 Hurdles for a Borrower to Negotiate a Loan Modification

With the increase in pending foreclosures and mortgage defaults, many borrowers are feeling squeezed and are looking for relief from their lenders. The following checklist may be be helpful in approaching a lender about a loan modification:

1. A loan modification is may be available to a borrower who was unable to make regular payments for several months due to exigent circumstances such as an illness, the loss of a job, or a divorce, but who has now solved that problem. The lender will want to see a "hardship letter" and detailed financial information that demonstrates the borrower can resume regular payments on modified terms. The modified terms may include a lower, fixed interest rate with the delinquent amounts added on to the principal of the loan. In a few cases, the borrower may persuade the lender to "write down" (decrease) the principal balance.

2. If a borrower is delinquent, the lender will probably require a "good faith" payment of a substantial part of the delinquency when the loan modification is consummated. A borrower who has put their mortgage payments in the bank while trying to work out a loan modification has a much better chance of success than a borrower with no money to put on the table.

3. The borrower will have to get past the financial institution's collection department and to a person is a position of authority in the loss mitigation department to negotiate a loan modification. This is one area where a lawyer can be helpful.

4. When a borrower is trying to convince the lender that he or she can now make payments on new terms, the lender will want to see historical financial information. If the borrower provides information that contradicts their original loan application, the borrower may be unwittingly creating a record that will give rise to an action for mortgage fraud. (See my January 14, 2007 post.)

5. If a non-lawyer offers to perform the services described above and asks for the payment of their fees in advance completing the services, ask them if they are licensed by the State of California and, if so, how they are licensed. Can the consultant demonstrate to you that they are exempt from the laws regulating "Foreclosure Consultants"? If not, can they demonstrate to you that they are providing the disclosures and documents required of Foreclosure Consultants. (See my January 30, 2007 post.)

6. If the borrower has more than one loan secured by their property, it will probably be necessary for all lenders to agree to the terms of the loan modification before it is finalized. If the modification of the first trust deed loan puts the holder of the second trust deed at greater risk of a default under the first deed of trust, the holder of the first will lose its priority without the consent of the holder of the second to the modification agreement.

7. It will take months, not days, to negotiate a loan modification with a lender, so start as soon as possible after you go into default. Once the borrower is served with a Notice of Default to commence a non-judicial foreclosure, he or she should begin the process of contacting the lender about a loan modification -- do not wait until you receive a Notice of Trustee's Sale.

8. Keep all your loan records well organized, including all communications with the lender about the loan.

9. Consult your CPA or tax adviser to determine if the modified loan will result in any adverse income tax consequences.

Real Estate Appraisers -- Decline in Home Prices Exposes Inflated Appraisals

In a surging real estate market, the "rising tide lifts all boats." The rapid appreciation of home prices makes it less likely that a buyer will complain about problems with his purchase that are discovered after the close of escrow. But for every high tide there is a low tide that exposes rocks below the surface and barnacles on grounded ships.

A down cycle in the real estate market also exposes a variety of reasons for the artificial inflation in prices: lax loan underwriting, fudged loan applications, rampant speculation, "creative" financing, a secondary market for sub prime loans, and inflated appraisals. The last of these problems is the subject of this post.

Since the savings and loan debacle in the 1980's, the federal government has regulated real estate appraisers who prepare appraisals for loans by federally insured institutions. For example, California established an apparatus for licensing real estate appraisers in 1989.

Appraisers can be liable for negligence or negligent misrepresentation to lenders or buyers who rely on inflated appraisals that have not been prepared in accordance with the standard of care. Based on anecdotal evidence in my litigation practice, the licensing of real estate appraisers appeared to result in the decline of lawsuits against appraisers after 1989. I handled a number of such cases for a mortgage company and a S&L before 1989, but none in the 1990's after licensing became mandatory.

Unfortunately, the recent decline in the housing market has again exposed problems caused inflated residential real estate appraisals. So two months ago, the California Legislature made it illegal to pressure an appraiser to reach a inflated opinion of value. And a new California law effective January 1, 2008 has substantially increased the educational requirements for certified appraisers.

How does "the market" pressure appraisers to inflate appraisals? Will the new laws have any effect on the appraisal industry? How widespread is the problem of inflated appraisals? A recent article in the Los Angeles Times tackles these questions. To read the article, click here.

Nontraditional Mortgage Products -- The Slippery Slope Became an Avalanche

On December 28, 2006, in my second post on this Blog, I wrote about the foreseeable and serious problems that would result from the boom in "creative" financing (sub prime loans, loans made with no down payment, ARM loans with low teaser rates that would reset in 2007 & 2008). I called the post, "'Creative'" Financing -- The Slippery Slope in 2007." This became the biggest economic and real estate story of 2007, as the slide turned into an avalanche.

But this blog is not about economics or predicting the future. So what really changed in the area of real estate law as a result of the creative financing fiasco?

As discussed in my last post, borrowers who negotiate a loan reduction or lose their homes to foreclosure will not be required to pay federal income taxes on phantom income.

The California Legislature has enacted a new law to warn borrowers about "nontraditional mortgage products." After January 1, 2008, Senate Bill 385 will require additional written disclosures for nontraditional mortgage products (e.g., loans that negatively amortize or bear interest only). The additional disclosures must be made in both disclosure statements and advertising. A violation of the new law may be a crime. Unfortunately, a mortgage broker cannot determine the content of the additional disclosures by reading SB 385 itself. Rather, the mortgage broker is referred to various guidelines and regulations to learn what he must disclose. SB 385 also broadens the definition of a real estate broker for lenders. This is significant because it is a crime in California to act as a real estate broker without a license. To read the highlights of SB 385, see Business & Professions Code section 10240.3 and Financial Code sections 215.5 and 22171.

In an apparent attempt to curb mortgage fraud, in California effective January 1, 2008, a notary public who acknowledges a document must certify under penalty of perjury under the laws of the State of California that the facts acknowledged by the notary are true and correct, including that the signer has presented documentary proof that he is who he says he is. (It is no longer good enough for a notary to state that they personally know the signer.) Civil Code section 1189.

That's about it. The other laws regulating brokers, lenders and borrowers are pretty much the same. And there are no new laws against financial institutions, lenders and borrowers from "creatively" finding new ways to lose money.

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.