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Compulsive-Obsessive Disorder or Valid Concern?

By Terry Hunter

Real Estate Agent with Hunter-Broker

November 09, 2011 05:53 PM

What is YOUR take on brokering property "subject to" existing loans which have a due-on-sale clause (for a long-term hold)?

It has gotten to the point that I am beginning to see FRANCHISES, for goodness' sake, for specializing in these kinds of deals.

Some local lenders are trying to endear themselves to Realtors by giving classes in taking long-term title to properties subject to existing loans (again, loans that have due-on-sale clauses, as permitted by federal law... Garn St. Germain, in particular).

In short, the practice seems widespread...

As a practical matter, per federal law, an option longer than 3 years, or an option of any duration, coupled with the homeseller vacating the property, triggers the due-on-sale clause.

If the bank calls the loan, and if the property cannot be refinanced by the person who "bought" the property with an option (likely, since if they could have financed it, given today's interest rates, they probably would have financed it), then they could lose their up-front (option) money and any payments they made which were more the fair market rent for the property (assuming they were occupying or renting out the property).

The seller, whose credit rating is held hostage by the transaction, would likely be powerless to do much under most agreements of this nature if the bank calls the loan. Even if there were reversion provisions covering the loan being called, the "seller" may not be able to refinance, either, for a variety of reasons. So, the seller could lose whatever equity had not been collected by the time of the loan acceleration by the lender, plus end up with a foreclosure on his credit.

As a legal matter of potential concern for agents, I wonder what the liability might be of a licensee who knowingly conspires to hide the transfer from the bank (the usual approach, through the use of trusts and the like to "cover up"). Even if the agent is not conspiring to hide the transfer (say, if a simple AITD/wrap-around is used, for example) would it still not be the case that the agent is conspiring to assist the breach of contract between the bank and the original borrower?

And, here is the $64,000 question (perhaps literally a "$64,000 question"):

Might the courts find the agent liable for the losses of the lender by virtue of the cover-up/assisted breach that the agent participated in? Interesting question, no?

At some point, rates are going to rise. (I spent most of my career wishing for 10% rates.) At that point, if the number of distressed properties has declined, it may be VERY worthwhile for the lenders to have attorney strike forces hunt down all the unauthorized transfers... could be an interesting time.

What are your thoughts on the matter?

Terry

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Elite Home Sales Team

Elite Home Sales Team OC - Corona del Mar, CA

A Tenacious and Skilled Real Estate Team

The due on sale clause is not triggered if the property is put into a trust and the seller maintains at least 10 percent. There are ways to do what you are trying to do. I do not see the wisdom in it because the underlying loan is usually too high and with to high an interest rate.

Nov 09, 2011 06:00 PM

Terry Hunter

Hunter-Broker - Newport Coast, CA

MS Economics

Thanks for your comment.

I am not trying to do this... I avoid it like the plague, because I wouldn't know how to explain the possible losses to the principals involved. It seems that there is almost always one participant who is significantly less knowledgable than the other, and therein lies the root of potential difficulties, I think.

There was a local outfit that had (has?) a detailed explanation of the "10% trust concept" on a CD they distributed.

I looked it over in thoroughly, and totally understand it.

However, I could not find, and they could not provide any real support for that position.

In fact, here is a quote from Garn St. Germain which gives the trust exclusion. There is no numerical specification of what interest the borrower must maintain, and perhaps 10% would be adequate.
However, the clause that seems to shoot this down (whether the borrower retains an interest or not) is the last part of the exemption from the due-on-sale clause:

Specifically, Garn St. Germain says the due-on-sale provision is NOT triggered by "... a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property..."

There is virtually always a transfer of occupancy in the property.

So, it is hard for me to see how moving title to a trust helps.

Nov 09, 2011 06:33 PM

Pamela Seley

West Coast Realty Division - Murrieta, CA

Residential Real Estate Agent serving SW RivCo CA

Terry, this was a very interesting and informative post. I am not at all familiar with this type of transfer. Sounds dicey and not something I would get involved with unless I knew all the legal liabilities. I would hope agents would get legal advice before participating in this, even if the how-to is sold on a CD.

Nov 09, 2011 09:01 PM

Pamela:

Thanks for your response.

In the "old days" :-), properties could be bought "subject to" the existing loan, and so when we did these kinds of transactions (essential when the interest rates hit 21%, and there was essentially no institutional financing available), the dangers to the participants were minimized.

Even the "hit" on the seller's credit if things went wrong with the new buyer was not a major problem for the seller then, because purchases "subject to" the existing financing were accepted. Simply explaining to the next lender that the seller was not in title when the problem arose was sufficient to clear the credit problem. Obviously, this is not the case now.

So, it appears to me that "gurus" have seized upon what USED TO work, and are trying to apply it to properties with loans that have an enforceable due-on-sale clause. It seems to me that this can only "work" if one is not caught doing it. :-)

Nov 10, 2011 05:35 AM

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Terry Hunter

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