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Foreclosure Rates

Buying Property at Foreclosure Sales: a Deal or a Dud?

If you ever watch late night television, then you have seen those infomercials touting the ability to make you an overnight millionaire by purchasing financially distressed real estate.  There are many individuals and companies who have built successful lives and businesses through the acquisition of financially distressed real estate.  However, unless the process is fully understood and the risks are knowingly accepted, the purchase of financially distressed property at a foreclosure sale is not necessarily for the cash rich novice.  The following legal and practical issues should be considered prior to acquiring property at a non-judicial foreclosure sale held under a Texas deed of trust.[1]

A deed of trust is the document that a borrower gives to a lender to secure the repayment of a loan with real estate.  In a typical Texas mortgage, the parties involved are the borrower, the lender, the trustee, and the owner of the real estate pledged as collateral (“mortgagor”).  The borrower is the party responsible for the repayment of the loan.  The lender is the party who funded the loan and is the beneficiary of the pledged real estate.  In Texas, a trustee performs the duties and responsibilities contained in the deed of trust when the borrower defaults on the loan.  The mortgagor is the party pledging the property as collateral for the loan.[2]

It should be noted that non-judicial foreclosures in Texas are generally governed by (i) Chapter 51 of the Texas Property Code, and (ii) the documented agreements between the lender and borrower [3] contained within the loan documents.  Certain publicly filed documents which should be reviewed are the deed of trust, renewals/ extensions of the deed of trust, Notice of Trustee’s/Substitute Trustee’s Sale, and any other document affecting title to a mortgaged property (such as easements, leases, liens, restrictions, covenants, estates, and mineral interests, just to mention a few).  Unless a purchaser is adept at researching property titles, it is advisable to purchase an abstractor’s certificate from a title company.

There may be other issues which will affect title to the property being foreclosed which do not appear in the public real property records.  Some of these issues include encroachments, protrusions, overlapping improvements, set-backs, zoning, platting, building ordinances, flood zones, drainage, utilities, bankruptcy filings, lawsuits, and probate records.  Issues which are located on the ground can be addressed by ordering a current survey of the property.  However, permission from the current owner must be obtained before legally entering the property to conduct a survey.  This can be very difficult, if not impossible.  Other issues may be addressed through inquiries of public officials and employees.   While information obtained through governmental offices can be valuable, such information may not be completely reliable, and the persons supplying it are typically not liable for inaccuracies.

Except for warranties of title contained in the foreclosure Deed (from the mortgagor not the Trustee/Substitute Trustee), property purchased at a foreclosure sale is sold “AS IS” without any other warranties and at the purchaser’s own risk.  The purchaser will acquire the property subject to all physical and title conditions which exist on the date of the foreclosure.  Any tenants or occupants of the property on the date of the foreclosure sale may also have rights as parties in possession of the property.  Even if the purchaser acquires a meaningful warranty in the foreclosure Deed, enforcing such warranty may be impractical since the mortgagor is usually in dire financial straits.

A foreclosure sale may be set aside for various reasons within four years of the date of the sale under state law and within two years under federal bankruptcy law.  Any title insurance policy acquired by the purchaser will usually exclude any defects associated with the foreclosure process and any liens or encumbrances which were not removed by the foreclosure sale.  A purchaser at a foreclosure sale is also not a “consumer” relating to the protections afforded by the Texas Deceptive Trade Practices – Consumer Protection Act.

A purchaser should identify these issues, determine acceptability or cost to resolve, and calculate a  purchase price accordingly.  Resolving an unidentified issue post-purchase may cost tens of thousands of dollars.[4]

Purchasing distressed property at foreclosure typically requires a high degree of risk tolerance.  Anyone willing to accept those risks may also want to consider going to Vegas.  At least in Vegas, the drinks are free.


[1] As opposed to foreclosure sales by Court order or for unpaid ad valorem taxes which may have different considerations.

[2] While the borrower and the mortgagor are typically the same party, it is not necessary that they are the same.

[3] The third-party mortgagor’s agreements should also be considered, where the borrower and mortgagor are not the same.

[4] Legal fees necessary to clear up a contested title matter can sometimes exceed $100,000.00.

Scott Alagood is Board Certified in Commercial and Residential Real Estate Law by the Texas Board of Legal Specialization and may be reached at alagood@dentonlaw.com or www.dentonlaw.com
 

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photoOwner financing in Texas has historically been a valued tool to sell real estate to parties who for various reasons couldn’t qualify to borrow from institutional lenders.  However, in 2008 and 2009, owner financing was directly affected by federal and state regulatory changes.  In 2009, Texas was directed by federal law to adopt Chapter 180 of the Texas Finance Code, now better known as the Texas SAFE Act.  The acronym “SAFE” stems from the Secure and Fair Enforcement for Mortgage Licensing Act which was part of the federal Wall Street Reform Act of 2008.  These Acts were spurred by the belief that the liquidity crisis in the financial markets was caused in part by mortgage fraud and subprime mortgage loans.

One of the objectives of the federal SAFE Act was to provide uninform requirements for State licensed loan originators, or what we in Texas formerly referred to as mortgage brokers.  The Texas SAFE Act renamed the mortgage broker as a “residential mortgage loan originator” or “RMLO” and broadened the State licensing requirements necessary to perform certain functions associated with the issuance of a residential mortgage loan.  This is where the problem arose for Owner financed transactions.

The Texas SAFE Act defines a RMLO as any individual who for compensation or gain, or the expectation thereof, either takes a residential mortgage loan application or offers or negotiates the terms of a residential mortgage.  Certain exclusions and exemptions from licensing are provided in the statute, including licensed real estate brokers and salespersons, licensed manufactured housing brokers, no interest/fee loans, loans to an immediate family member, and loans involving the sale of the Owner’s homestead.  Even licensed attorneys may be subject to further licensure where the negotiation of a mortgage loan is not an ancillary matter to the attorney’s representation or the attorney takes an application and offers or negotiates the mortgage terms.  Any Owner financing transaction which does not otherwise fall under one of the exempted categories will clearly meet the definition of an RMLO and require licensure by the party offering or negotiating the mortgage loan.

The Texas agency responsible for enforcing the SAFE Act is the Texas Department of Savings and Mortgage Lending.  Violations of the SAFE Act include license suspension, a fine of up to $25,000.00, and restitution to the Buyer.  At this point, it is unclear what “restitution” means.

Fortunately, the Commissioner of the Department of Savings and Mortgage Lending issued a notice in August of 2010, setting forth a seller financing “de minimus” exception to the Texas SAFE Act.  Before the federal and Texas SAFE Acts, Section 156.202(a)(3) of the Texas Finance Code exempted from licensing “an owner of real property who in any 12 consecutive month period makes not more than five mortgage loans to purchasers of property for all or part of the purchase price of the real estate against which the mortgage is secured. “  The Commissioner pointed out that in adopting Chapter 180 of the Texas Finance Code, the legislature had amended Section 156.202, but left Section 156.202(a)(3) intact.  Since the amendments to Section 156.202 were passed after Chapter 180, the Commissioner determined that the legislature intended that the de minimus exception remain.  Unless there is a subsequent statutory amendment  or rule, or the U.S. Department of Housing and Urban Development issues a conflicting ruling, the Commissioner has stated that the de minimus exception will continue to be allowed by the Department of Savings and Mortgage Lending.

In considering whether or not a transaction falls within the de minimus exemption, the 12 month period is a rolling period, and not determined on the basis of a calendar year.  Also, for business organizations, the term “owner” will in all probability be viewed at the ultimate ownership or control level.  This means that a person will not be allowed to transfer ownership into separate business entities (i.e. corporation, partnership, LP, LLC, etc….) for purposes of eluding the 5 transaction limit in any 12 month period.

Clearly, financing the sale of your own property is now more tricky than it used to be.  For situations where a transaction clearly falls within the licensing requirements of the SAFE Act, you are advised to seek the services of a licensed RMLO and/or an experienced attorney.  With some careful planning and consideration of the transaction, the regulatory pitfalls of the SAFE Act may be avoided.

Scott Alagood is Board Certified by the Texas Board of Legal Specialization in both Commercial and Residential Real Estate Law and may be reached at alagood@dentonlaw.com and www.dentonlaw.com.
 

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