I've been reading about taking title 'subject to' and wrap loans. It is an intriguing strategy but one aspect seems to give me pause. The worst case scenario: The Acceleration / Due on Sale Clause.
For the purpose of this thread, let's please ignore the various crafty ways to lower the chances that the bank finds out and accept that the risk exists that the bank could act upon their right to call the loan and demand full payment.
Key players: Sally Seller - Luis Buyer - Charlie the Investor
("Luis" because the show specified focus on Hispanic neighborhoods.)
The example used on the podcast is that Sally gives title to Charlie for her $100,000 FMV house, subject to the $100,000 six percent loan. Charlie then sells/transfers title to Luis for $110,000 under the following terms:
$10,000 down payment due at closing, plus a $100,000 eight percent mortgage
Charlie's profit is the initial down payment, plus the ongoing 2% spread in the two loans.
If interest rates rise then it is reasonable that banks will become more aggressive about acting upon DOS clauses. I've read that in the early '80s that is what transpired. Again, for the sake of this argument let's please assume rates rise and the banks actively seek out properties that have transferred, demand payment in full, and initiate foreclosure action if payment is not received.
In that scenario...
Charlie walks away unscathed and the bank forecloses. He has no equity invested, is not in title, and does not reside in the property. Charlie operates out of an LLC and has no personal risk.
Sally is better off than before because even though her loan is being foreclosed, it has been paid down further so the judgment amount will be smaller. Plus she has already moved out of the house so her residency will not be disturbed.
Luis cannot qualify for a refinance which is why he originally went the seller-finance route. Even though Luis has never been late on a payment he loses his home, is out his down payment, and has lost any equity built up since closing. Plus, he has zero recourse because he signed a full disclosure. Even if he does sue and somehow wins, Charlie's LLC holds no assets so he will never see any money.
Charlie operates in good faith and has enough cash to cover the full payment in the unlikely event that a couple of his loans were called. But he cannot afford to cover all loans if interest rates rose and calling loans became the banks' standard operating procedure.
It has been a very long time since banks actively enforced DOS clauses but it seems that is very likely due to the fact that rates have been on a near perfect downward path since 1982 and are now at historic lows. As long as payments are current it does not make sense for a bank to call a 6% loan, only to then lend it back out at the 4% current market rate. It would be good business to do so if rates were on the upswing.
Average rates since 1971: http://www.freddiemac.com/pmms/pmms30.htm
On to my questions:
1. Am I missing something? This business model seems unsustainable in the long term.
2. Is there a risk that this could be considered predatory lending? I am not well versed in what qualifies, but as long as everything is fully disclosed it does not look like it.
3. If Charlie uses a mortgage loan originator (MLO) would that put predatory lending accusations on the MLO?
4. Are people just making hay while the sun shines? Luis is a big boy and knows what he is doing?
5. Are there ways to minimize this all from imploding?
6. Why not enter into a 60-day option or lease option, put the bank on notice of the deal via certified letter, and then close? I guess the obvious answer is that they may call the loan and kill the deal. But if they do not call it, you have a much stronger future legal position.
7. If rates rise and home prices fall and the banks did call several of Charlie's loans and he can't afford to pay them off, are there any other options available to keep the deal together?
Still with me? Thanks for reading this loong post! Didn't know it would end up that way.
This falls under the categories of lease option, sub2, and CFD.
