DUE-ON-SALE-O-METER
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Dion DePaoliPro Member
Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votesThis is indeed happening and I would tell those pursuing the Sub2 and Wrap guru agenda to be warned. I suppose there is a fair amount of irony to it. The folks pushing these continually say something to the likes of "a bank will not call when the note is performing". - Well that is simply not true.
As many of these loans at some point in recent history were distressed, they likely traded into the hands of firms with intentions to re-establish the performance and thereby profit by reselling the loan with a seasoned and established re-performing payment history. In addition, cash flowing whole loan securitization is moving right along again in the private market (non fannie/freddie).
When the loan enters trade, the buyer will will check title. When the borrower is no longer on title, the asset will be kicked from trade. The reason the loan is kicked is revealed to the Seller. In other instances, many firms are looking to put these performing loans back into securitized trusts. As such, they conduct due diligence prior to pooling the loan into the trust. A Borrower not on title would cause the loan to be kicked out of that population as well.
I am guessing not too many folks who like to talk about wraps or sub2 ever mention the legal idea of "Laches" which I am guessing not too many folks even know what it is. (Bill, I assume does) In some of the cases, the legal idea of laches will play in. Becoming aware of claim and not acting on it may prevent the claim from being raised in the future. Factor in loans that may have previously been modified to below market rates, along with geography which is seemingly appreciating and you have an obligation and desire to call these notes due.
The implications, that no guru even begins to understand or wants to talk about, putting a borrower into a situation where they can raise a defense of laches or waiver can also mean the lender is no longer entitle to deficiencies. Not to mention, the Mortgagee's likely violation of their financing arrangements. From a Mortgagee's perspective it looks like someone (the wraper) is skimming, which is what they have done, regardless of the amount of lipstick applied.
Said it before, will say it again Wraps/Sub2 = BAD IDEA - these are not being done by folks who understand the asset class and horrible advice is being passed around like it is proper in guru seminars and websites. I recently commented in a thread where a self-proclaimed expert implies that a borrower's escrow account can be assigned to a wrap borrower. Not even remotely true. I still laugh when I say it as it is such a ridiculous idea.
All that said, both sides of the battle will inch along, continuing on their paths until such time that all parties begin to bump heads in mass. There will be only one winner in that game and it will not be the folks who participated in the wrap/sub2 deal (all 3 of them).
105 Replies
- 12yDion DePaoliPro MemberReal Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
We can certainly float all of these ideas related to Extension Risk, which is the deployment of capital into a particular targeted return only to have that return be exceeded in the market shortly there after. Certainly a common supporting point in these conversations.
That said, we need really only to understand a very simple idea. The loan is defective. How that defect is uncovered or even if it is, does not change the fact the loan is defective. When discovered, a defective loan can not be sold or financed without a discount which means somebody could stand to loss money. A fun exercise would, although likely very difficult, would be take a similar loan and offer it for sale to the folks who promote the Sub2 and Wrap games. See if they are willing to pay par or premium. I think that would flush out rather quickly, what is good for the goose is not good for the gander.
Whether a new origination or a vintage loan, it is the same semantics. If the loan is in transit it has a higher chance of being found. So this leads us to new originations, where they may sit on the warehouse line before finally being sold or they may be sold once or twice before being securitized. Each of those whole loan trades will specifically check title 100% of the time. A security pooling event may only lend to a sample portion and the loan would have to be in the sample portion to be discovered. However, some poolings have 100% DD on every loan depending on the issuer and some other factors.
The distressed market loans are trading several times and the same will apply. Every whole loan trade will include a check on the title. If the borrower is not on title, the investor will typically reject the asset from trade or increase the discount on price.
Unless the Mortgagee allows the formal assumption, the substitute Borrower and underlying Mortgagee are not contractually bound. It is a defective loan. - 12yDion DePaoliPro MemberReal Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
Just like @Ned Carey mentioned. Scrubbing for occupancy can include checking public record with note top line data. It can also include getting Lexus Nexus reports or equivalent. Some firms do some monitoring on utilities even.
- Investor · Central Valley, CA · Member since 2012 · 6k+ posts · 3k+ votes12y
Originally posted by @Dion DePaoli:
A fun exercise would, although likely very difficult, would be take a similar loan and offer it for sale to the folks who promote the Sub2 and Wrap games. See if they are willing to pay par or premium. I think that would flush out rather quickly, what is good for the goose is not good for the gander.
The folks who promote the Sub2 and Wrap Games are selling low/no money investing opportunities as much or more than they are selling the strategy. You can't sell loans, even at a discount, to people who have no cash. I'd buy those kinds of "defective" loans for the right price. And so would you.
- Investor · Central Valley, CA · Member since 2012 · 6k+ posts · 3k+ votes12y
Originally posted by @Dion DePaoli:
Just like @Ned Carey mentioned. Scrubbing for occupancy can include checking public record with note top line data. It can also include getting Lexus Nexus reports or equivalent. Some firms do some monitoring on utilities even.
So while there's no Due on Sale jail or police......it appears there is a Due on Sale Big Brother. Good to know.
- Montclair, NJ · Member since 2014 · 66 posts · 6 votes12y
[ In July 1973, Birdie, Dorothy, and Fred Mans purchased a property in Riverside California for the amount of $19,100 financed with Bank of America with a 30yr fixed rate of 8% (the going rate that month was 8.05%, and the annual rate that year was 8.04%). Secured by a Deed of Trust instrument containing the Due-on-Sale clause included. In July of 1975, Cynthia Wellenkamp purchased the property by assuming the balance of the loan at the 8%. In July 1975 the going interest rate was 8.89% for FHA. The prevailing interest rate from Bank of America would’ve been nearing 9.25%. The Deed was transferred and recorded into the name of Cynthia Wellenkamp on July 10th, 1975. It has been said that Wellenkamp made her July payment and Bank of America returned the payment citing it’s right to accelerate the loan and calling it due. The bank did offer to refinance the loan in her name at the 9.25% rate. Wellenkamp refused and so Bank of America filed a NOD (Notice of Default). ]
This was posted by Nick J in 2009 on BP.
Now it could not be clearer. The Bank's SOLE CONCERN was pulling out an extra point and a quarter on the loan. Nothing about 'Asset Securitization'. Nothing about title transfer causing a 'loan defect'. Nothing even about the 'inherent risk' of a new property owner. The Banks sole concern was pulling out an extra 12% on the loan.
As well look at it from the other side of the coin. Suppose an REI does a sub2 wrap in which a new buyer is faithfully paying on a 5% loan and prevailing rates are 4%. Who seriously expects the bank is going to call the loan due for the privilege of doing a re-fi producing TWENTY PERCENT LESS revenue ?
- Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes12y
The poster above simply assumed (by the way, the correct use of the word "assumed", unlike the post above) the bank's action was "solely based on a higher" rate. The reason for the DOS could well have been the mortgagor no longer being the owner, and if rates were stagnant would have made the same refinance offer, at the same rate. But, none of this really matters, loans are sometimes called for a variety of reasons, and those promoting sub2's will continually try to downplay the risk.....the status quo.
- 12yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
@Account Closed
the danger in Sub 2 is to the original seller IE the person buying it defaults especially if they have then sold it with a wrap or sold it on land contract or lease option and then those people default. Your right the buyer of the Sub 2 has no real exposure unless there is a pattern of defaults or fraud.
For those in the bizz that have the ability to pay off a sub 2 if it gets called that's one thing. But for those using it as a cash flow strategy to make the delta between the original note and the wrap or new sale, those folks usually do not have the kind of wherewithal or ability to pay off the original loan if it gets called. The seller in a Sub too is entering a risky deal for them its not about us the investor buying it its about he seller putting them selves in a precarious situation. As the original note as we all know stays with them and their credit.
In Portlandia I personally created my rental portfolio from 2002 to 2008 using sub 2 exclusively and most were in foreclosure ( before the foreclosure rescue laws changed). and generally I did not buy anything that did not have at least 20% equity. So I would say I had close to 10 million in Sub two debt.. If the odd one got called no problem paying it off.. But if everyone of them got called it would have been and issue for sure. And a liquidation.
Data point I only had one get called and that was because it was a local credit union and the borrower went in and told his loan officer that he sold the property to me.. We paid it off.
So then you take the original seller and if they can't get control of the property in the case of a default of the next parties in interest, and these next parties squat in the house, they may not have the money to make the payments their credit gets trashed by no fault of their own the middleman like you said can't go to Sub 2 jail they just bail .. And in a state like Texas Mississippi and others that have dual action foreclosure rules they could very well end up with a judgment against them for a deficiency within 6 short months or less. Foreclosures in those states happen in 60 days... Then chancery court for the judgment 30 days hence .. Now the bene has to establish a deficiency through current appraisal but that's not hard as many of these deals are under water to start or the house has major issues and is underwater for those reasons. I have gotten many judgements from my borrowers in those states, Not that they were worth anything but they last for 10 years and I know who they are and I have an Accurant account so I can find them 7 to 9 years down the line when they have forgotten about me !!!
- 12yDion DePaoliPro MemberReal Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
Originally posted by @Robert Carpenter:
[ In July 1973, Birdie, Dorothy, and Fred Mans purchased a property in Riverside California for the amount of $19,100 financed with Bank of America with a 30yr fixed rate of 8% (the going rate that month was 8.05%, and the annual rate that year was 8.04%). Secured by a Deed of Trust instrument containing the Due-on-Sale clause included. In July of 1975, Cynthia Wellenkamp purchased the property by assuming the balance of the loan at the 8%. In July 1975 the going interest rate was 8.89% for FHA. The prevailing interest rate from Bank of America would’ve been nearing 9.25%. The Deed was transferred and recorded into the name of Cynthia Wellenkamp on July 10th, 1975. It has been said that Wellenkamp made her July payment and Bank of America returned the payment citing it’s right to accelerate the loan and calling it due. The bank did offer to refinance the loan in her name at the 9.25% rate. Wellenkamp refused and so Bank of America filed a NOD (Notice of Default). ]
This was posted by Nick J in 2009 on BP.
Now it could not be clearer. The Bank's SOLE CONCERN was pulling out an extra point and a quarter on the loan. Nothing about 'Asset Securitization'. Nothing about title transfer causing a 'loan defect'. Nothing even about the 'inherent risk' of a new property owner. The Banks sole concern was pulling out an extra 12% on the loan.
As well look at it from the other side of the coin. Suppose an REI does a sub2 wrap in which a new buyer is faithfully paying on a 5% loan and prevailing rates are 4%. Who seriously expects the bank is going to call the loan due for the privilege of doing a re-fi producing TWENTY PERCENT LESS revenue ?
Robert just for the sake of details. Wellenkamp made the July payment to the bank. The bank was made aware of transfer of title. Not necessarily in that order or by those means. The payment was returned with a formal assumption agreement and a letter stating the bank would waive it's right to accelerate provided Wellenkamp execute the assumption agreement. The rate of interest for the assumption was 9.25% and the underlying loan was 8.0%. Wellenkamp refused to execute the assumption agreement. The matter went to court. Please note, there is no "refinance" offer. It's an assumption, not the same thing really. Anyhow, Wellenkamp won, not BOA. The court held that unless default was imminent, the bank couldn't use DOS as a means to alienate the Sellers right to sell. If merely on the idea of extension risk, the bank should have issued an adjustable rate loan.
I do not fully understand where you got 12% form but the annual rate increase of 1.25% is present. As Wellenkamp became scrutinized many other ideas/concerns came up as a function of the ruling. One interesting one was the disadvantage of other Sellers in the market place who did not have a loan attached to their property, thereby not being able to offer a quasi assumption (whether approved or not) at lower rates of interest. So a Seller who owned free and clear was disadvantaged since any financing attaching to their property would be at the higher prevailing rate.
So, we can see, originally the bank was held to not be able to trigger DOS for the simple sake of rate. In the next idea, we can see, it's not that simple. Since other parties, i.e. other Sellers, could be disadvantaged.
I am making this point and not trying to dis-value the point that DOS is all about extension risk and rate. Certainly that plays into it, however, I think, it shows the disadvantage is not only held by the bank but can have implications on the broader market. That idea seems to never be mentioned by those promoting such transactions, yet it seems to be a clear tangible affect.
Lastly, I think we must be cautious when looking back too far in time as the mortgage market has evolved in the manner in which loans are financed. In the 1970's we didn't have securities as a primary method of financing of loans like we do today. So, today is different and securties do apply as a matter of concern albeit, not the only concern. In addition, we must be careful in assuming that the Investor whose current interests are secured in the underlying mortgage would benefit by a new loan with the new borrower. That's not true since a borrower could choose to finance with any lender and not necessarily the Mortgagee who currently holds said interest. In other words, acceleration because of DOS does not mean a 'new' loan with the new borrower on the same property for the same Mortgagee. - Rental Property Investor · Cincinnati, OH · Member since 2013 · 292 posts · 280 votes12y
Originally posted by @Dion DePaoli
I guess from a security standpoint for yourself, why wouldn't you just do a lease option and avoid the risk altogether? Seems like that would be better for you.
I would be inclined to simply offer a lease option or have him cash out your mortgage and hold the rest, if it pleases you.Dion, thanks for your insight. I really appreciate it. I didn't even consider a lease option. The $250K up front money would serve as my security deposit.
The sticking point would be the commissions paid to the two realtors. Maybe they would accept a Lease Commission now in a lesser amount than the full commission in 24 months when and if the sale actually went through.
thanks again.
DL
- 12yDion DePaoliPro MemberReal Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
I made a post in this forum related to Wraps and Sub2 on FHA loans. You can find it HERE
- Residential Real Estate Broker · Birmingham, MI · Member since 2014 · 179 posts · 54 votes12y
Valid points. I should have qualified my observations in experience indicating the asset class; specifically, auto ABS (retail, wholesale, and lease). My only knowledge of MBS has been academic as I recently complete coursework in an exec MBA program on RE finance taught by an expert on MBS and former HBS instructor. The securitization process seemed very similar but we didn’t spend a lot of time on due diligence. I will concede not all ABS is alike..
- Residential Real Estate Broker · Birmingham, MI · Member since 2014 · 179 posts · 54 votes12y
The quote function didnt work properly. I meant to quote @Dion DePaoli and his comments about not ABS being created equal, and the level of due diligence on MBS.
- 12yDion DePaoliPro MemberReal Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
Originally posted by @Account Closed:
The quote function didnt work properly. I meant to quote @Dion DePaoli and his comments about not ABS being created equal, and the level of due diligence on MBS.
I saw it. I made a alert for my first name so I get notice when it is typed. Not too many "Dion"'s walking around.
Auto loans, possibly the next problematic asset class. Doesn't make you want to be GMAC right now. If their auto loans look anything like mortgage loans, they have some work to do. - Residential Real Estate Broker · Birmingham, MI · Member since 2014 · 179 posts · 54 votes12y
GM just got a subpoena from the Justice Department related to their securitization practices and subprime lending. Tough road ahead for them.
http://dealbook.nytimes.com/2014/08/04/focusing-on-g-m-unit-u-s-starts-civil-inquiry-of-subprime-car-lending/?_php=true&_type=blogs&_r=0
- Investor · Orlando, FL · Member since 2014 · 5 posts · 7 votes12yAnother big risk to wrap/sub2 transactions are rising interest rates. A bank will be highly motivated to exercise due on sale clauses on a loan @ 4% when interest rates rise to 5%, 6% or more. The bank can then re-lend this money and make more money. These due on sale options will be highly correlated so if you have many wrap/sub 2 deals, they all could be called at the same time. Unless you have the cash to pay off the mortgages you could be in a major bind.
- Rental Property Investor · La Quinta, CA · Member since 2014 · 1k+ posts · 779 votes11y
I've read this thread in it's entirety a few times now, it's extremely educational. It still makes me sooooo curious though as to how many often mortgages are being called due via the due on sale clause / title transfer. 1%? .1% 10%?
Has anyone on this thread actually had a mortgage called due?
How many mortgages are you involved with where tile has been transferred, what is the average time elapsed since transfer, and how many have been called due?
Is this thread truly useful without an understanding of the ballpark odds? Even with the understanding that the ballpark odds change with market conditions?
- Real Estate Broker · Provo, UT · Member since 2013 · 689 posts · 511 votes11y
Originally posted by @Ned Carey:
@k. Marie Poe, @Wayne Brooks @Dion DePaoli Thanks all
I never considered the resale of the mortgage as a trigger to discovery
I hope I didn't miss something in this thread - it's pretty lengthy and gets a little deep, so correct me if I'm wrong here or if I'm missing something in my thinking.
Wouldn't the recordation of a deed serve as notice of the change of interest? The resale of a the loan may bring it to the attention of a lender, however at the time a document is recorded it is said to have given legal constructive notice to the world.
Example- if a sub2 deal takes place and a conveyance is recorded on January 1, 2010, then fast-forward 5 years and the loan is set to be transferred and the portfolio is researched, and on April 21, 2015, the lender learns of the change, laches might be a pretty good defense because the lender was constructively noticed when that deed was recorded on January 1, 2010. However this does not take into consideration specific provisions are in the original loan agreement - so either side could be right or wrong.
Again, correct me if I'm wrong. The more I think about this the messier this could get. Ouch, I'm glad I've not got myself into any sub2's or wraps.
If this really is happening I'm sure we'll be hearing about it first hand on the forums here pretty soon. I can imagine the fuss it's going to cause in the general population so it would make sense that somebody or some organization comes up with some stats telling what's actually going on, how many are getting called, etc... I guess time will tell.
- Rental Property Investor · Plant City, FL · Member since 2015 · 1k+ posts · 379 votes11y
I have never done a Sub2 and haven't been able to 100% wrap my head around them because every time it's explained to me it sounds a little shady. I've read through most of this long over my head thread and it backs up my thinking more. A question I've had is why not leave the deed in the seller's name with a well written contract as a lease option to the new buyer? Or add the buyer's name to the deed without taking the seller's name off and have a well written contract?
- 11yDion DePaoliPro MemberReal Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
Neither a mortgage or deed of trust contain a provision or clause which grants power to the Borrower to assign their obligation to a non-exempt third party. (unless otherwise approved, typically in writing, by the Mortgagee) Most mortgages and deeds of trusts contain a "no waiver" clause which specifies that any action or lack of action is not a waiver of the rights created in the security instrument. It is meant to prevent rights from expiring or being vacated by time.
A mortgage/deed of trust is more than just an obligation of payments from the Borrower to the Mortgagee. The Borrower establishes credit with the Mortgagee in order to negotiate the loan. A substituted non-exempt third party does not.
The recording of a transfer may not be sufficient to create a latches defense. In some situations it has been viewed that the DOS does not alienate the Borrower. The DOS does not prevent a transfer it is merely an option that can be acted upon as a result of transfer. So the Borrower is 'free' to transfer. The Mortgagee enforcing a DOS has a similar idea to it in the sense that a Mortgagee triggering a DOS does not create an event which is un-equitable to the Borrower (original) since DOS enforcement is by way of a proper foreclosure (judicial or non). Any and all foreclosure proceedings provide a redemption period. It is a long standing belief in our system of mortgages/dot law that the redemption period is what creates an equitable (fair) remedy to the event regardless of outcome (redemption or sale). So a Borrower is 'free' to convey as much as a Mortgagee is 'free' to enforce the idea of only being in contract with the party they contracted with.
My opinion (for what is worth) would be that the majority of defenses against DOS, including one which rests mainly on the idea that constructive notice (the recording of the deed) will be sufficient to defend against a Mortgagee's option on DOS is wishful thinking. The process to enforce a DOS includes acceleration and foreclosure. The idea of constructive notice working would be predicated on removing the option all together from Mortgagee (aside from the no waiver arguments) which creates an un-equitable position for the Mortgagee. That is since, in the event the loan is accelerated and foreclosure commences, the Borrower and any other interested party (like that of a new owner) has a legal right to redeem the property of the debt. So allowing such a defense is more favorable to the Borrower/Buyers than to the Mortgagee. I do not see our system allowing such an idea any time soon.
@Adrian SmudeIf we look to the text of the clause found in most conventional mortgages we can see that is takes steps to cover much of what you are thinking:
Transfer of the Property or a Beneficial Interest in Borrower
“Interest in the Property” means any legal or beneficial interest in the Property, including, but not limited to, those beneficial interests transferred in a bond for deed, contract for deed, installment sales contract or escrow agreement, the intent of which is the transfer of title by Borrower at a future date to a purchaser.If all or any part of the Property or any Interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender’s prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if such exercise is prohibited by Applicable Law.
So with the words "If all or any part of the property or any interest in the property" we cover much of the ideas that you are thinking of.
There is no "safe" way to defend against the Mortgagee's option. They are not new to creative ideas which pop up from time to time. At the very least we can say they are not likely to be found in a position where they do not have a very strong argument for enforcement.
Further food for thought, a legitimate case defending against DOS would be 'vigorously' defended. A loss in such a case by a Mortgagee would have damaging affects on much of its portfolio and business not to mention all the other Mortgagees who operate with the same ideas. I would not bet too many chips on Sub2 Promoter vs JP Morgan (or whomever) the latter party there has some pretty deep pockets and talented attorneys. - Real Estate Broker · Provo, UT · Member since 2013 · 689 posts · 511 votes11y
Thanks for taking the time to respond. This is very good information to know. Again, thanks for going into the details on it.
I've never seen the DOS actually called and enforced on what I would consider regular activity (asset protection reasons to a LLC or trust held by the borrower, from husband to wife, etc), but I'm sure if it starts happening regularly on sub2's we're going to start hearing horror stories here on the forums.
- Investor · Central Valley, CA · Member since 2012 · 6k+ posts · 3k+ votes11y
Originally posted by @Blair Poelman:
Thanks for taking the time to respond. This is very good information to know. Again, thanks for going into the details on it.
I've never seen the DOS actually called and enforced on what I would consider regular activity (asset protection reasons to a LLC or trust held by the borrower, from husband to wife, etc), but I'm sure if it starts happening regularly on sub2's we're going to start hearing horror stories here on the forums.
Blair: there is a relatively recent thread where a BP member was contacted by his lender re DOS based on a transfer to his LLC. Not exactly a horror story, but pretty sobering on the topic. The member posted the text of the letter and expressed enormous frustration that this might be standard protocol. The letter basically said transfer or it back or we'll call it. I'll try to find the thread but the search function on BP is not my strong suit.
- Investor · Indialantic, FL · Member since 2013 · 111 posts · 76 votes11y
@Account Closed
is this the thread? http://www.biggerpockets.com/forums/311/topics/183...
- Investor · Central Valley, CA · Member since 2012 · 6k+ posts · 3k+ votes11y
Originally posted by @Michael Olesky:
@Account Closed
is this the thread? http://www.biggerpockets.com/forums/311/topics/183...
That's the one. Thanks you so much for finding it.
It all seems pretty basic and not that far out to me. There's so much theorizing on the subject on BP: it's based on interest rates, it's based on random audits, it's based on changing the insurance policy. Such a waste o'time. It's the lender's loan, they make the rules. Transfer the property or don't. But be prepared for a call based on DOS if it happens. Talk about no guarantees in life......why would anyone think that a lender is looking the other way or owes anyone the opportunity to tack on to the qualifying credit of another.
- Rental Property Investor · Rockford, IL · Member since 2014 · 4k+ posts · 2k+ votes11y
I'm hearing lately that BofA - including all the other banks it's acquired - are getting more aggressive about DoS.
I have, however, heard of a way to deal with that: sandwich lease option. Title remains with the original owner, you take a lease with right to sublet and a purchase option, then lease-option with the end person.
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