This article discusses the enforceability of the 90-day leaseback prohibition in shortsale affidavits demanded by lenders as a condition of a shortpay. This article is part of first tuesday’s article series on shortsales.
Do you believe seller leaseback arrangements should be allowed on shortsales?
- Yes! (84%, 110 Votes)
- No. (16%, 21 Votes)
Total Voters: 131
Stopped short on acquisition
Consider a homeowner who financed the purchase of his home during the height of the Millennium Boom, and now owes more on his mortgage than the property is worth, a situation called negative equity. [For more information on an agent’s counseling of a negative equity homeowner, see the March 2010 first tuesday article, The underwater homeowner, his future and his agent: a balance sheet reality check, Part I.]
The homeowner has recently been downgraded to part-time employment and slipped behind on his mortgage payments. Wanting to avoid foreclosure, the homeowner consults with his real estate agent. The agent advises the homeowner to negotiate a shortsale approval with his lender. The real estate agent walks the homeowner through the process of collecting and preparing the paperwork required to facilitate the lender’s shortsale approval process. [For more information about the paperwork required in a shortsale, see the October 2011 first tuesday article, How to facilitate a shortsale transaction.]
The agent submits the homeowner’s shortsale application to the lender, and receives an approval (as the homeowner no longer qualifies to make payments on the loan). The agent then lists the property for sale at the property’s fair market value – based on the agent’s comparable market analysis (CMA). The agent receives an offer from a buy-to-let investor looking to build wealth by purchasing real estate to rent out for long-term investment. [For more information about real estate investment as a means of building wealth, see the September 2011 first tuesday article, Boomers bust open doors to real estate investment era.]
The agent submits the offer to the homeowner and discloses his awareness of the buy-to-let investor’s intentions for the property. The homeowner no longer wishes to own the property as it has become a black-hole asset. However, he would like to remain in the property to avoid the additional trauma of having to uproot his family. He thus asks his agent to discuss the possibility of renting the property back from the buy-to-let investor at fair market rents for which he qualifies, called a (sale) leaseback arrangement.
The buy-to-let investor agrees, as the leaseback arrangement not only allows him to immediately begin collecting rents and recouping his investment, but also benefits the homeowner who does not wish to move.
A purchase agreement is entered into between the homeowner and the buy-to-let investor, and is forwarded to the lender. The purchase agreement discloses the proposed leaseback arrangement. [See first tuesday Form 150-1]
To the surprise of the homeowner, the agent and the buy-to-let investor, the lender promptly rejects the purchase agreement, stating the leaseback arrangement violates the lender’s arms-length transaction guidelines for shortpay arrangements. The agent was caught unaware, as prior shortsales he handled had not involved leasebacks, only leases to tenants other than the original homeowner.
The devil’s in the (shortsale) details
It may come as an unwelcome surprise to even the most inveterate of shortsale experts out there, but this prohibition against a leaseback arrangement with a former owner has suddenly become a mainstay in lender shortsale practice. All the Big Lenders (Bank of America, Chase, Citibank and Wells Fargo), as well as the slough of smaller banks researched by first tuesday had a variation of the above prohibition in their Affidavit of Arm’s Length Transaction (affidavit) form, required to be signed by all brokers, escrow and parties to a shortsale transaction before the close of escrow.
Even worse: the prohibition isn’t merely lender collusion to punish homeowners (although that certainly continues), but a reflection of Freddie Mac’s (Freddie’s) policy of abrasively handling owners seeking approval of a discounted payoff on a shortsale. [See Sidebar]
The government (Freddie’s) prohibition against leaseback arrangements with shortsale sellers stems from an implicit unwillingness to stray from the old paradigm of protecting lender interests against adverse public expectations. A moralistic concept persists that negative equity homeowners who obtain shortpay approvals are being given a gift, for what the lender perceives as bad behavior by homeowners in taking out these loans in the first place and then not finding a way to pay them. (Of course, the gift has no value since the homeowner’s credit is destroyed by the lender on the giving.)
And, to lenders and their defenders, the idea of allowing homeowners to remain in the property as tenants is completely untenable — if lenders are taking a loss (covered by the U.S. Treasury), then so must homeowners to the full extent permitted. It’s the same backwards idea behind continued lender and government refusal to re-authorize bankruptcy judges to cramdown loan balances so that employed individuals need not lose the place they call home for loss of its value. [For more information about cramdowns, see the November 2011 first tuesday article, Surprise: Frannie says “no thank you” to cramdowns.]
Government leaseback prohibitions
Freddie Mac’s (Freddie’s) government guidelines are the main culprit behind the stringent leaseback prohibition:
[The parties to the shortsale attest under penalty of perjury that:] there are no agreements, understandings or contracts between the parties that the Borrower will remain in the Mortgaged Premises as a tenant or later obtain title or ownership of the Mortgaged Premises, except to the extent that the Borrower is permitted to remain as a tenant on the Mortgaged Premises for a short term, as is common and customary in the market but no longer than ninety (90) days, in order to facilitate relocation. [Freddie Mac Single-Family Seller/Servicer Guide, Servicing Nonperforming Mortgages B65.40]
The Federal Housing Administration (FHA) guidelines for preforeclosure sales (their term for shortsales) are far more vague. The FHA’s definition of arm’s-length transactions doesn’t mention leasing at all:
Mortgagors and mortgagees must adhere to ethical standards of conduct in their dealings with all parties involved in a preforeclosure sale transaction. The preforeclosure must be between two unrelated parties and be characterized by a selling price and other conditions that would prevail in a typical real estate sales transaction. [HUD Mortgagee Letter 2008-43]
Fannie Mae (Fannie) has the most liberal of the policies. Fannie’s servicing guidelines do not address leasebacks in shortsale transactions, but Fannie launched a deed-for-lease program in 2009 which allowed distressed homeowners meeting certain criteria to complete a deed-in-lieu in exchange for a one-year lease. [For more information on Fannie’s deed-for-lease program, see the November 2009 first tuesday article, Fannie Mae announced a sale leaseback program for a deed-in-lieu.]
Editor’s note — Unfortunately, deeds-in-lieu are an extremely rare occurrence, with Fannie only reporting 4,249 such transactions nationally from January 1, 2011 to June 30, 2011. The actual statistics for the deed-for-lease program are unavailable, but would comprise a percentage of the deeds-in-lieu — a miniscule number in light of the 2.5 million underwater homeowners in California, not to mention the nation.
A pound of flesh
Of course, the dyed-in-the-wool lender response is that prohibiting leasebacks helps cut down on shortsale fraud schemes in which the homeowner enters into a leaseback agreement with an “investor” who also promises to later transfer title back to the homeowner once a sufficiently egregious amount of profit has been paid by the homeowner —profit the lender believes it is entitled to (and it is). Make no mistake: these so-called “lease-options” are bad business and the government is right to protect vulnerable and desperate homeowners from entering into these abusive arrangements.
Editor’s note — Shattered promises of housing relief, exorbitant fees strung out over time so as to mask true intentions and a quick and unpleasant wake-up call: this writer can’t help but notice that these predatory sale-leaseback scams have all the hallmarks of a good, now-fashionable temporary loan mod…
But, by that logic, a resale prohibition alone is sufficient to keep these bad actors (private lenders) from plying their nefarious sale-lease-option trade. Why extend it to simple leaseback arrangements? Leaseback arrangements not only allow a homeowner to avoid displacing his family and incurring the costs involved, but create a viable means of spurring investor activity in the market to clear out the delinquencies (by shortsale) and foreclosures — not to mention the business generated for struggling real estate professionals. The restriction is especially baffling given that Fannie Mae (Fannie), the other government-sponsored (owned) entity (GSE), has been offering a deed-for-lease arrangement for two years. [See Sidebar]
Yes, but is it enforceable?
To dissect the lender’s enforceability of the leaseback prohibition, close attention must be paid to the wording of the affidavit. Freddie Mac’s version of the affidavit (which is copied, more or less verbatim in many of the big lenders’ affidavits regardless of who owns the loan) contains a survival clause. It states “the [affidavit] will survive the closing of the transaction.” In absence of more explicit wording, the controlling case law interprets this broad survival clause as an extension of the period in which the breach of promises in the affidavit can occur. [Western Filter Corporation v. Argan, Inc. (9th Cir. 2008) 540 F4d 949]
In plain language, when attesting to the fact that no such agreement or understanding to leaseback exists, a party to the shortsale who signs the affidavit is, in effect, making a promise that he will not enter into such an agreement or understanding to lease the property back to the seller. And some of the lenders have drafted explicit instructions to this effect:
Buyers further certify and affirm under penalty of perjury that […] the property will not be rented to the Seller after the closing of the subject real estate purchase contract. [Wells Fargo Shortsale Affidavit]
Repugnant though the prohibition is as an absolute interference with an owner’s right of alienation, it appears there won’t be any getting around these promises by entering into an understanding after the close of escrow.
So, what kind of trouble can the seller and the buyer get into for breaching the affidavit?
In keeping with Freddie’s verbiage, these affidavits are signed under penalty of perjury. If a broker, agent, seller or buyer signs the affidavit attesting to the fact that no such arrangement or understanding exists, it had better be true. Perjury is a crime, punishable by fine and/or imprisonment. [Calif. Penal Code §§ 118, 131]
Additionally, any servicer (lender) who knowingly approves and allows a shortsale to close under conditions in violation of the affidavit provisions will be required to repurchase the mortgage and be forced to bear Freddie’s losses for the violation, including the shortpayoff discount. The Freddie guidelines also threaten individual violators (read: affidavit signers) with regulatory action. [18 United State Code §1014; Freddie Mac Single-Family Seller/Servicer Guide, Servicing Nonperforming Mortgages B65.41.1]
The California Department of Real Estate (DRE) also has the authority to revoke a DRE license for crimes committed relating to the practice of real estate, which addresses the perjury issue, not the regulatory action. [Calif. Business and Professions Code §490]
A challenge to lawmakers
A ray of hope exists for those who are willing to take arms against the onerous prohibition set by lenders and the government. It lies in the answer to this question: does the lender/servicer actually experience a loss when the property is sold at fair market value to a buy-to-let investor and is later rented back (usually commenced by buyer solicitation) to the seller under a rental or lease agreement at fair market rents, i.e., an arms-length transaction?
No! The lender and servicer receive their agreed-to shortpayoff at fair market value, and the buy-to-let investor reaps investment income from a tenant at fair market rents — just as he would if the tenant had been any other fair market renter. The lender and servicer cannot show a loss, and thus have no claim for damages due to the breach of the continuing promise in the affidavit not to rent to the seller.
If, however, any portion of the full market value of the property goes to anyone other than the lender, whether in the form of an artificially low purchase price for the buyer in exchange for artificially low rents for the leaseback seller, there is a loss for the lender and all bets are off. The lender then has recourse to claim a loss under the broad mortgage fraud statutes. [See the above reference to regulatory action under 18 USC §1014.]
This lack of loss is critical to a challenge against the affidavit’s prohibitions. Since there is no explicit, specific regulatory penalty of a monetary nature for a bonafide leaseback arrangement on a shortsale, no loss means no claim. While there is no case law (yet) which sets precedent for this analysis, a challenge of the status quo favoring lenders is ripe — just ask our Attorney General. [Calif. Civil Code §711; for more information about California’s Attorney General refusing to negotiate with lenders for a watered-down settlement over foreclosure crisis, see the October 2011 first tuesday article, Secession of California proportions, catalyst for change.]
Advocacy is your business
The government and the people, in conceiving regulations to protect the housing market from abuse, must rebuild with the idea of protecting the population’s housing rights. The nation’s housing policy cannot be allowed to sell the idea of homeownership with one breath, and stand with lenders to declare war on it with the next when the limitations are not reasonable. This all is parallel to the due-on enforcement Congress allowed lenders in 1982 ending an owner’s right to sell a property subject to the real estate loan encumbering it. [For more information about the due-on clause inhibiting California real estate, see the March 2011 first tuesday article, The due-on-sale clause: barricading homeowners since ’82.]
Thus, brokers and agents, as gatekeepers to real estate, must join in with the chorus of those demanding change. Make your voice heard by your Congressional representatives, and get out there and do your part to support the rights of the 99% against rentier oppression! [For more information about joining the movement to even out the power between Main Street and Wall Street, see the October 2011 first tuesday article, Unions occupy Wall Street — where are the Realtors?]
With your seller, disclose the hurdles in the path to a leaseback arrangement, and make sure they understand that a leaseback arrangement is a tenancy, not a path with an option to regain ownership of the property.
What are your experiences with shortsale leaseback prohibitions? Let us know!
Stay tuned for the next installment in our shortsale article series, which will discuss private mortgage insurance (PMI) shortsale approval requirements.