(Excerpted from "The Simple Man's Guide to Real Estate" by Bill Vaughn)
HOW TO STOP FORECLOSURES AND REPOSSESSIONS
Foreclosure or repossession can cost you your family home, business or some other valuable asset. And if the subsequent auction does not pay off your note, it can leave a large deficiency that you will still owe the lender, which may jeopardize even more of your hard-earned assets. In addition, if the balance is discharged, you will owe the IRS for taxes on the amount of the discharge. When the secured lender forecloses or repossesses, your debt is not cancelled, as many believe. The collateral is usually auctioned off, often for less than the amount you owe, in which case you still owe the lender that remaining balance. Moreover, foreclosure and/or repossession need not be caused by non-payment of the secured debt - it can also become a result of a judgement against you by another party.
If the debtor files bankruptcy, the secured creditor still maintains all rights to the collateral for the debt.
However, under some circumstances it is possible for you to negotiate a deal with the lender when you cannot pay your loan as agreed. Lenders want their money, not your collateral. Both the lender and borrower can work out a compromise until they reach a mutually acceptable solution. Such compromise copuld include new terms, new financing or the debtor's voluntary surrender (to avoid a repossession on his credit profile) of the collateral to the lender.
There are many ways to convince a lender that you are proceeding in good faith and trying to protect the lender as much as saving the collateral. However, a borrower must protect himself from his secured lender. And many lenders are unreasonable, so you must know when to cooperate and when not.
First, you must realize and understand that lenders are less forgiving of borrowers who hide from their problems. They cooperate more if you meet with them at the first sign of trouble, to discuss possible interim arrangements while coming to agreement on long-term solutions which are advantageous to both parties.
Most default situations require a significant loan restructuring, which will either reduce the debt or extend payments to be more in keeping with the debtor's financial abilities. If you find yourself in a position of having to re-negotiate a debt, here are some tips to follow:
The fair, current market value of the collateral always determines the maximum amount of your loan. Secured lenders negotiate debt-restructuring agreements that are primarily based upon the collateral's liquidation value (as opposed to market value) plus any recovery available from any of the loan's guarantors.
There will usually be a substantial difference between what you and your lender estimate the worth of the collateral is, in the event of a forced sale. The type and condition of the collateral, as well as demand for the collateral are two factors that influence what lenders will recoup through a forced sale. Lenders also must pay for liquidation costs, auction and attorneys' fees and other unexpected expenses which can significantly reduce the amount actually recovered in a forced sale. For example, if they can expect to auction the property for $60,000 and their costs to do so run up to $6,000, their actual recovery is $54,000. This, then, would be your basis of any offer you would make for debt-restructuring.
As a rule, lenders will resist re-negotiating loans for many reasons. But if you understand the lender’s position and can structure a deal that will meet his needs, it may be possible to save your asset. It is important that you understand the needs of the lender, and any offer you make should at least minimally meet those needs.
For example, if your current loan is at 7% interest but current new loan rates are at 8.5%, the lender may be more than willing to renegotiate a lower loan at the higher rate. It can net them the same amount of money over the term, and offer you a “second chance”. If given a choice between a new loan at a higher interest rate and an old loan tied up in a bankruptcy court, most lenders would choose to make the newer loan, provided you are in a position to pay.
Lenders will rarely reduce their loan balance. They would rather extend the payments to eventually receive full payment. Therefore, it may behoove you in certain circumstances to use the poverty angle. If the lender cannot see that it is likely that you can pay off the entire amount by extending payments, only then might he consider reducing the balance. But note that the poverty angle can easily backfire, and give the lender the impression that you may not be able to repay even a lowered balance, resulting in his decision to refuse your offer of compromise.
CONCESSIONS LENDERS COMMONLY MAKE
While these four points can be successfully used even after your debt has gone into arrears, it is often much easier to negotiate with your lender at the first sign of trouble. Here, then, are a few things that you and your lender can quickly work out when you are unable to make timely payments:
1. The lender can extend the loan. This is the most likely concession the lender will consent to because your loan must still be paid off in full. Though they will not admit to how often they will do this, lenders often extend loan payments well beyond their original term in order to assure full payment. A longer term will ordinarily reduce the monthly payment.
2. Lenders may consider deferring payments on the principle of the loan. If your loan is at least one-third paid off, this could reduce your monthly payment enough to give you breathing room. If your loan is new, almost all of the payment is interest, and this strategy will not be of much benefit to you.
3. Lenders can reduce the interest rate on your loan. But don’t plan on it, particularly if the term of the long is long, such as with a mortgage. Interest is the bread and butter of lending institutions, so they won’t give it up unless the situation is severe. On the other hand, a lender may reduce the balance enough so that it can be paid in full, immediately. While the latter is not likely in the case of a high balance loan (such as a mortgage on a home), it can work for you in cases where the loan balance, if reduced, will be low enough for you to pay off immediately.
4. While this strategy is rare due to lenders aversion of it, a lender can freeze loan payments. If the lender feels reasonably certain that your cash shortage is temporary and that he will get all that he is entitled to, he will be more willing to suspend payments as long as they are adequately secured and the freeze is only temporary in nature.
THE OPTION-TO-EQUITY SOLUTION
Here is a possible solution when youhave a property with a negative cash flow. For instance, your rental property rents for $750 and your mortgage costs $950 monthly. You must either come up with the $200 short-fall out of your own pocket or lose your property.
If $750 a month is the highest possible rent you can get for your property, your tenant may be in a position to cover the deficit provided the property becomes more than a rental. By drawing up an “option-to-equity” agreement, your tenant could pay $950 monthly provided in a year or two your tenant owns an interest in the property, paid for by the extra $200 a month. You can even offer the tenant complete ownership of the property by letting him finance the balance at the end of the term of your agreement. This is nearly identical to a lease option. Because of this, it MIGHT trigger a due-on-sale clause, but perhaps not. Two ways around this: let your lender know your situation and what you want to do. If the tenant can qualify, the lender may give you the go-ahead. Otherwise, the option-to-equity agreement would have to be a separate, personal agreement between you and the tenant, with the tenant prohibited from recording any interest in the property. The latter strategy may not be wise, as this has not been tested in any court as to whether or not such an agreement violates the due-on-sale clause.
This technique is not limited to real estate. It works equally well with other assets. Perhaps someone would be willing to pay something each month to occasionally use a valuable piece of equipment, boat or other asset if they could later purchase it (or part ownership in it) by applying part of the rental payments to the sale price. Assets can produce income to cover loan payments and you avoid losing your asset by utilizing an option-to-equity agreement.
REFINANCE YOUR WAY OUT OF TROUBLE
If you have enough equity in your property to support additional borrowing you might consider efinancing your property as a way to save property from foreclosure. Proceeds from a new second mortgage can pay the arrears on your first mortgage. Or refinancing with a larger first mortgage could produce enough excess funds to cover future payments on your new loan until cash flow becomes stabilized.
Refinancing is most sensible only when present interest rates are lower. Why replace a 7 percent mortgage with a new 9 percent mortgage, unless this is your only viable alternative? Refinancing with a lower interest mortgage can considerably ease cash flow, even if you do not refinance for more cash.
If you are in financial difficulty and you have a second mortgage on your home, the person who has that second mortgage has a vested interest in you keeping that property. If you default on the first mortgage your subordinate or secondary lenders can lose their interest. Under foreclosure, they must pay the first mortgage or lose their own mortgage. Therefore, subordinate mortgage holders may be willing to help you and themselves by helping to subsidize your first mortgage.
But to gain the cooperation of the second mortgage holder, you may have to offer him a bonus, such as some equity, a higher interest rate or a shorter term on his mortgage. Negotiate!
Remember - if you might lose your asset(s) through foreclosure, it can adversely affect others who may depend on you, your business or the property. They share your problem. Ask them to become part of the solution.
USING CASH-RICH PARTNERS
Sometimes an agressive investor will tackle a property that ends up putting him in financial difficulty, as often happens with large projects, developments etc. The investor can often receice relief from wealthy investors seeking tax breaks and long-term capital appreciation. This can be accomplished through a temporary limited partnership, with you as the general partner.
Even properties operating in the red can be appealing many passive real estate investors. By letting your accountant show the benefits that investors may reap, you will know the benefits you must sell. Unfortunately, real estate limited partnerships are not nearly as attractive an investment after the 1986 Tax Reform Act, but a creatively structured deal can still attract investors because there are far fewer deals now available for interested investors.
Many investors want the tax benefits of real estate but have neither the time nor expertise to find and manage investment properties. To find investors to save your property from foreclosure, you can follow these simple steps:
1. Advertise. Doctors, lawyers, executives, business owners and anyone else with high income levels are good candidates to invite.
2. Form the limited partnership. A limited partnership, or limited liability company, limits the investing partners' liability to the loss of their investment while they fully participate in profits and the tax write-offs.
3. The investors should receive 100 percent of the tax benefits generated by the property. By deducting the entire loss on their tax return, they have a huge tax savings to justify their investment.
4. Any negative cash flow should be covered by your passive investors. Upon reselling the property at some point in the future (or refinancing it) all profits should be split 50/50.
As the general partner you would receive a fee for management of the properties. This increases your own portion of the profits.
STOPPING FORECLOSURE WITH BANKRUPTCY
Bankruptcy creates an automatic stay that stops creditor lawsuits, collections and/or repossessions, as well as stopping all pending or future collection and debtor-creditor cases from other courts.
Just as importantly, it also suspends a creditor's right to repossess collateral. However, a secured creditor such as the mortgagor on your home can petition the bankruptcy court for permission to foreclose by requesting adequate protection.
When a secured creditor requests and obtains adequate protection, the bankruptcy court must protect the creditor so his collateral is not jeopardized by the automatic stay. This is important when collateral can depreciate, as with an automobile or boat. The bankruptcy court will then require enough payment to the secured party to at least cover any likely depreciation. The creditor can repossess or foreclose on the collateral if there is no other way to protect the creditor.
Bankruptcy, therefore, will not always protect against foreclosure or repossession. By filing Chapter 11, for instance, you can delay foreclosure, giving you the opportunity to sell or refinance the property or to come up with a plan to resolve the problem loan through reorganization. But your plan must be a realistic plan on how you will protect your secured creditor(s) on assets you want to retain. If you want to keep a secured asset, brush up on the intricacies:
1. You can file bankruptcy immediately before foreclosure. But to avoid foreclosure, you must be able to show the court why the secured creditor will not be hurt if he cannot foreclose. Will you partly or fully pay the loan? Can you prove to the court that the asset will not lose value and that the secured creditor would recover as much (if not more) later as they would today? If you cannot show these things to the court, foreclosure will not be stalled.
2. If your secured creditors are uncooperative, you may file for a cramdown petition. With this, the bankruptcy court reduces the amount of the secured debt to the actual current value of the secured property. Any balance of the debt is considered unsecured debt. For example, let’s say you have a $125,000 balance on your mortgage, but the property is now only worth $85,000. With a cramdown, the court will reduce the mortgage to the actual $85,000 value, and the remaining balance of the mortgage ($40,000) will be treated by the court as unsecured debt, which gets discharged through the bankruptcy. The cramdown works wonders when you are overfinanced and the secured lender threatens foreclosure.
3. Bankruptcy gives you the chance to cure loan defaults. A Chapter 13 bankruptcy, for example, will provide you with five years in which to bring any delinquent payments up to date, even on secured debts.
RECOVERING YOUR PROPERTY EVEN AFTER THE FORECLOSURE
Just because foreclosure has been completed does not necessarily mean you have lost the property. Even after foreclosure you may be able to convince the lender to sell you back your property. Why would he do this after incurring the expense to foreclose? Here are three reasons why a lender just might consider this:
1. Perhaps the lender expected to sell the property for much more than was offered at the auction. If the auction bidding price was far below acceptable, the lender may now consider selling the property back to you for what is owed, or maybe even less. Remember - banks are limited by federal law as to how much real property they can hold at any given time. If the lender is already approaching that limit, he may be much more interested in dealing with you.
2. Perhaps the lender now sees you as a better credit risk, particularly if the foreclosure eliminated other liens against the property, or if you filed bankruptcy or otherwise cleared yourself of other debt problems.
3. The lender does not want to incur further losses. A vacant property that is not being maintained will quickly fall into disrepair, and be subject to vandalism. Continuing insurance costs add to the expense.
If you are to recover your property, you must convince the lender that you will not default again. If the property is your home, the lender can rent the house to you for the mortgage payments until you prove your future ability to pay. Timely payments will give the lender sufficient confidence to deed you back your home or other property. Hence, a property you would otherwise have considered to be lost might well be yours once again.
CREATING & PROTECTING WEALTH WITH LIMITED PARTNERSHIPS
The limited partnership (LP) or the family limited partnership (FLP) is the foundation for most domestic asset protection plans. The (F)LP is a valuable and most likely necessary part of building your financial security because:
1. an (F)LP allows you to control your assets without the liability of owning them;
2. judgements cannot reach to the debtor's limited partnership interest;
3. a properly structured (F)LP can possibly protect transfers made even after a claim arises and also protect against IRS claims;
4. an (F)LP is tax-neutral;
5. an (F)LP provides maximum operating flexibility; and
6. an (F)LP gives you the opportunity to better plan your estate and reduce estate taxes.
Because of its versatility and protective functions, most comprehensive asset protection plans include at least one limited partnership in one form or another.
STRUCTURING A LIMITED PARTNERSHIP
Partners in a limited partnership can distribute their ownership interest as they choose, which is an important feature for asset protection purposes. For example, you can contribute personal assets to the partnership and obtain in exchange receive only a small interest in the partnership. The remaining partnership interest can be owned by other family members. However, if the other family member is not your spouse, this can constitute a taxable gift. For example, if you contribute $50,000 to the limited partnership and your partner contributes nothing but receives an equal share, then your partner has in effect received a $25,000 gift. Have your accountant check the structure of your limited partnership to avoid tax problems and also to determine that the LP is your best choice from a tax standpoint.
LP’s for families are known as Family Limited Partnerships, or FLP. Usually formed by a husband and wife, they would contribute various income-producing or business assets in exchange for their respective partnership interests. While this is normal, it may not be the best strategy for an FLP. By its nature, an FLP is used to protect a family’s assets. Business interests, as well as automobiles and other “dangerous” assets should be left out of the FLP, to prevent contamination. For example, if the family car is transferred into the FLP, and is later involved in an accident, any judgement resulting from that accident can be attached to all the assets in the partnership. For this reason, an FLP should only hold “safe” assets - those assets that are unlikely to be involved in creating a lawsuit, or creditor. There are other ways to protect those assets that are left out of the FLP.
In the usual FLP, Mom and dad, for example, may each receive a one or two percent interest as the general partners (general partners can be held liable; limited partners cannot). As co-general partners they would equally control the partnership the same way they controlled the assets prior to the FLP. Mom and dad may then receive, as limited partners, the remaining in the limited partnership. This allows mom and dad exclusive and equal ownership as well as control of the partnership, just as they had enjoyed with their assets when they were titled in their name. The one difference is that their assets are now fully protected. Judgements and creditors can only reach the one or two percent allocated to the general partners, and in cases where the FLP agreement prohibits it, said creditors may not assume that ownership interest nor any control over the assets of the FLP. Remember - an FLP should only include safe assets, such as cash, rare coins, art, collectibles, personal belongings - any assets that are not likely to cause any judgement that could taint the remaining assets.
Dangerous assets can be separated from all other assets by using a Limited Liability Company (LLC). If you own rental properties (dangerous asset due to lawsuits, fires, flood etc.), each unit should be transferred into it own, separate LLC. If a judgement is found against that property, only that property is vulnerable - all others have been insulated. Note that all LLC’s can be owned by your FLP without contaminiating the FLP, provided the FLP merely owns the LLC, and not the LLC’s asset(s).
Hubby and wife may later change their limited partnership interests. Perhaps the wife will obtain the greater interest. Or hubby and wife may gradually gift their limited partnership interests to their children or to a living trust, children's trust, dynasty trust or other type of trust or entity, which may also own a portion of the limited partnership. The FLP can work very well for family estate planning, The FLP structure is never permanent. Partners in an FLP can always sell or gift partnership interests, subject only to those restrictions in the partnership agreement, and thereby reduce estate taxes.
THE ROLE OF LIMITED LIABILITY COMPANIES
A limited liability company, like the LP and FLP is tax neutral. Transfers can be made in and out of it without tax repercussions. And, like the (F)LP, the partners control the assets with limited liability.
An LLC is most useful for insulating dangerous assets from safe assets. A rental property, for example, can increase the possibility of judgements. Injuries to tenants, for example, can result in judgements that far exceed your insurance. If the rental is transferred into an LLC, any judgement brought about from ownership of that rental is limited to that rental and cannot affect any other assets you may own. Therefore, each dangerous asset - rentals, business interests etc. - should each be placed into a separate LLC. All LLC’s can be owned by your (F)LP without placing the (F)LP assets in jeopardy.
Example: you own your own home, $100,000 in safe personal assets such as cash, stocks, bonds, rare coins, jewelry and collectibles, as well as other valuable personal assets. You also own your own construction business. In addition, you have managed to accumulate two rental properties. In this case, you may first want to form an FLP and transfer all safe assets into it. This should not include vehicle or your personal residence. Next, form three different LLC’s - one each for the two rental properties and one for your construction business. Set up your FLP to own all the LLC’s. (Your vehicles will not be in any of these entities - keep them separate, as they are the most likely candidates to result in a judgement). Your home can be placed into a trust, as recommended by your accountant, and based on your personal needs and goals. Your assets are now nearly 100% protected against judgements and creditors.
If you are involved in a motor vehicle accident, for example, and the other party sues you, there is nothing for them to go after. All your assets are no longer yours - they belong to either an LLC or an FLP. Therefore, the person suing has no choice but to accept a settlement from your insurance company. If a tenant gets injured and sues, they cannot attach any assets except the property in which they were a tenant, because they can only sue the LLC that owns it. Since that property is likely mortgaged to the hilt, and has debts, it is unlikely they would go after it - their legal costs would exceed the amount they would receive. If your business gets sued, you and your other assets are insulated, and only your business is at risk, With no other assets owned by the business - and many debts - your business would simply file for bankruptcy, and once the judgement and debts are discharged, you start another business LLC under a new name, free of debts. The bankruptcy does not affect your personal credit, or that of other LLC’s or FLP’s owned by you. It only reflects on that now defunct business.
If you choose to pursue wealth, do so wisely, and with good planning. Because once you begin accumulating wealth, there will be no shortage of unscrupulous people who will try to take it from you.
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