Summary
No consideration was given to a due-on-sale or a due-on-encumbrance provision in the loan documents.
Summary:
A Borrower purchased the property with an existing first lien against it...
The first lien loan documents included a provision called “due-on-sale” or “due-on-encumbrance.” This clause typically allows the lender to demand full repayment of the loan if the property is sold or transferred to a new owner, thereby protecting the lender’s interest in the property.
The real estate broker, acting as the buyer’s representative, arranged the transaction and encouraged the buyer to purchase the property subject to the first lien, intentionally avoiding notification to the lender...
The reason for this arrangement was to capitalize on the benefits of lower interest rates in the past. The property title is now in the new owner’s or transferee’s name, but it is subject to a first lien in the prior owner’s (or another party’s) name. This strategy, although potentially beneficial, also comes with its own set of implications.
The participants in the transaction who were aware of the transgression and material breach of the loan documents were the real estate broker, who arranged the transaction, the escrow officer, who facilitated the closing process, the title insurer, who ensured the property’s title was clear, and the insurance broker, who provided insurance for the property.
Upon closing, the insurance broker and the company merely agreed to add the new property purchasers as additional insureds. Still, they did not forward the new insurance addendum to the first trust deed lender. There was no 438bfu endorsement contained as part of the insurance policy, so the insurance company did not feel obligated to notify the first trust deed lender of the conveyance.
The problem here is that the participants are guilty of defrauding a federally regulated lender, which comes with severe penalties upon discovery. “
"Defrauding a regulated lender, also known as financial institution fraud, is a serious criminal offense that can involve various schemes to deceive financial institutions for personal gain.
Federal Law and Penalties:
The primary federal law addressing this crime is 18 U.S. Code § 1344, commonly referred to as the bank fraud statute. This statute criminalizes executing or attempting to execute a scheme to defraud a financial institution or to obtain money or property from one using false or fraudulent pretenses, representations, or promises. According to the Department of Justice (.gov), Section 1344 is designed to supplement other criminal provisions related to fraud against federally insured financial institutions.
A conviction under 18 U.S.C. 1344 can result in significant penalties, including up to 30 years in federal prison, fines up to $1,000,000, and restitution to victims."
Article:
Borrower mortgage broker comments to the broker/lender:
“My client needs to borrow some cash using his property as collateral and will agree to place a second trust deed on their property. Five years ago, they purchased the property "subject to” a first lien held by an institutional lender, which the prior property owners previously held. The recorded loan documentation reflects the borrowing party as the prior property owner, not the current owner. There has been significant equity build-up because the property has substantially increased in value."
The experienced broker/lender responds:
"The problem is that there may be a due-on-sale or due-on-further-encumbrance clause in the first trust deed. The institutional lender from the prior owner was not notified of the sale transfer. The lender was intentionally not informed to avoid the due-on-sale clause. The first trust deed lender can call the loan due and payable upon transfer to the present owner when they become aware of the action. As interest rates rise, the first lien lender may become motivated to free up capital to lend to another party at a higher rate.
The Garn-St.Germain Depository Institutions Act of 1982, which became effective on October 115, 1982, provided exemptions under which lenders cannot exercise the“ due-on-transfer and due-on-encumbrance" provisions if the collateral property is single-family or one-to-four units, including co-ops and residential dwellings, that are owner-occupied.
https://en.wikipedia.org/wiki/Garn%E2%80%93St._Germain_Depository_Institutions_Act
Due-on-transfer and due-on-further encumbrance apply to all properties other than single-family and one-to-four residential.
The specific provision can be found in 12 U.S. Code 1701J-3. Therefore, if a due-on-transfer clause is mentioned in the first trust deed, the lender may or may not be prohibited from exercising the due-on provisions, depending upon the type of collateral property and the Exceptions.
Exceptions to the Due on Sale Clause and Due on Further Encumbrance:
Transfer to a spouse or children of the Borrower.
Transfer to a relative resulting from the Borrower's death.
Transfer because of the death of a joint tenant or tenant by the entirety.
Transfer to a trust where the Borrower is the beneficiary does not relate to the transfer of occupancy rights.
https://www.law.cornell.edu/uscode/text/12/1701j-3
https://www.fdic.gov/regulations/laws/rules/8000-8300.html
https://www.alblawfirm.com/case-studies/due-on-sale-clause/
In this example, brokers and lenders representing private party investors must assess the risk of proceeding with a second loan Many brokers, lenders, and their private party investors will agree to make this loan (junior lien) because they believe the first trust deed lender is prohibited from calling the loan due The prohibition from calling the loan due and payable on transfer may or may not apply.
Lenders can still call the loan due on any property, except for residential single-family and one-to-four-unit properties where one of the applicable exemptions is in effect.
Part of the lender’s due diligence is ordering and reviewing a copy of the promissory note and deed of trust. His step is crucial in understanding the potential risks and making an informed decision. Additionally, the lender should order a beneficiary statement from the first trust deed lender or obtain 3 to 6 months of payment statements supplied by the Borrower. This thorough process ensures that all aspects of the transaction are carefully considered and evaluated.
Multiple written clauses in the note and deed of trust may increase the risks. The promissory note is a promise to pay. The deed of trust is a legal instrument used to create a security interest in real property. The legal title is transferred to a third-party trustee, who holds the title on behalf of the lender or beneficiaries.
One problematic clause in the deed of trust is the alienation or due-on encumbrance clause. This clause, if present, can significantly increase the risks involved in the transaction. Another problematic clause would be a negative-amortization adjustable-rate mortgage, where the principal balance increases with each payment.t Brokers and lenders need to be acutely aware of these potential risks, as the protective equity erodes when the principal balance increases, creating unwanted risks for the second trust deed investor. This emphasis on potential risks is crucial in maintaining a cautious and alert approach to real estate financing.
Another area for improvement is when there are clauses in the deed of trust that both parties agree to, such as additional advances or modifications of other deferred payments. Further advances and deferred payments would increase the principal balance, eroding the protective equity.
Another example is where the junior lien is at risk in both subject-to and non-subject-to transactions; government-mandated COVID-19 payment deferrals have caused many current pproblemThe widespread impact of COVID-19 has led to a significant increase in the number of property owners defaulting on their llo s All those arrearages of payments were added to the first trust deed balance, reducing the junior liens’ protective equity and safety cushion. This understanding of the broader economic context is crucial in empathizing with the challenges faced by property owners and investors.
An estimated 30-40 million-plus renters and lessees, including commercial lessees in the U.S., were, and may still be, in arrears or in need of assistance with paying their monthly rent or lease oobligations There were, and still are, an estimated 30-40 million property owners in payment arrears or needing help because they were not receiving rental or lease income necessary to pay the debt service on their property loa. There was an estimated separate group of 30-40 million owner-occupied homeowners whose jobs were severely impaired or eliminated in the economic meltdown and claimed to have limited or no ability to pay their loans.
Millions of these individuals were, and still are, not paying or are just barely starting to pay their arrears of rent and house payments again. Of course, this crisis transferred stress and potential losses to the broker/lenders and their private party investors who had made junior loans. At the time, the fallout was worsening.
Other problematic clauses should be addressed, particularly those that impact the risks associated with a second lien. To ensure a secure and protected transaction, only diligent underwriters will review the note and deed of trust and obtain a complete beneficiary statement to address any issues. The broker/lender, an agent of the private party lenders, may request a lawyer’s review of this transaction and the prior purchase transaction to ensure compliance and make an informed decision.