It is almost daily that I see a new question or concern about Wraps and Sub2 here. It got me wondering just how many folks are aware of outcomes of some of those practices really are. It also begs the question, just how sophisticated and knowledgeable those deploying (or trying to) are. I suppose if the amount of questions are some quantification of that knowledge, not very is the answer.

So, I am going to re-post a story from the HUD archives that a couple title companies and other mortgage examiners have posted. I am guessing many have never heard this story. I am also wondering, if folks know how to determine an FHA loan from other Mortgagees, perhaps not. Playing with fire?
 You decide.

Anyway the story written by Unknown:

Early on in Allen Clussive’s career he agreed to close a transaction wrapping around an existing loan. The sale price on the transaction was $185,000. The buyer could not qualify for new financing and asked the seller to carryback a new loan in the amount of $180,000. The seller agreed, with the understanding that without the buyer obtaining a new loan he would not have the financial means to pay off his existing first loan in the amount of $157,000. The buyer and seller agreed to wrap the existing $157,000 loan with the new seller carryback loan. The underlying loan was an FHA loan originated after 1989.

At closing, the buyer brought in $5,000 for his down payment plus his closing costs. Allen closed the transaction. After closing, the buyer paid the seller and the seller paid the FHA loan on time every month. Upon receipt of the buyer’s payment the seller paid the monthly principal, interest, taxes and insurance (PITI) payments to the lender servicing his FHA loan, and pocketed the balance. Everything was working perfectly until the 13th month when the buyer suddenly stopped making his monthly payments and abandoned the property.

The seller panicked and started to look for an attorney to start foreclosure in order to take the property back and put a renter in the house. In the meantime, the seller kept fronting the payments to the FHA loan to keep the payments current. The seller was making two house payments — one on his old home and one on his new home. Eventually the seller ran out of money and stopped making payments on the FHA loan.

The lender servicing the FHA loan started foreclosure and took the property back. The lender listed the property as an REO — bank–owned property – and resold it. They resold the property for $107,000, which was $50,000 less than they were owed. The lender filed a claim with FHA to be reimbursed the loss of $50,000. FHA sent the lender the $50,000 to cover their claim and the loan file was turned over to an investigator at the U.S. Department of Housing and Urban Development (HUD), the agency who regulates FHA loans.

The HUD investigator discovered the property was transferred to a new buyer, but the buyer’s funds were not used to pay off the FHA loan. The investigator was curious how that could happen and sent a subpoena for Clussive’s file.

The HUD investigator discovered Clussive had facilitated a closing where title was transferred – yet the new owner’s credit did not qualify for the existing FHA loan. The investigator deemed the act unlawful and debarred Clussive from closing another FHA or VA insured loan transaction.

Now, to be honest with you, the action by HUD did not damage Clussive’s career. He lived and worked in an affluent community where FHA and VA loans were not prevalent due to their low loan limits. Sure, every once in a while one of Clussive’s customers would present a contract reflecting new FHA or VA financing and he would have to steer the customer to one of his associates to close the transaction, but for the most part it had little to no effect on his career. However, Clussive would be the first to tell you it definitely had a psychological effect on him.

Had Clussive known HUD issued a directive in 1990 (see below) banning the wrap of an FHA loan by any means — a land contract, a deed of trust, mortgage — he would have never accepted the transaction and agreed to close it. Unfortunately Clussive’s ignorance of the HUD rules did not exempt him from action by HUD.

In order to ensure Clussive never closed another FHA or VA loan, they placed his name on the Excluded Parties List System (EPLS) and Limited Denial Participation list. By placing his name on the list it ensured Clussive would never be able to close another FHA or VA loan or any other transaction involving the Federal Government, such as a HUD or VA REO sale.

Below is a letter from the U.S. Department of Urban Development issued back in 1990 addressing the ramifications of circumventing the credit qualifying process.