Too often I am asked to help a real estate investor (“Investor”) enter into a transaction with a Home Buyer that includes the Investor going into title on a newly purchased property and then “selling” the property to the Home Buyer by way of a contract for deed or lease option because the real estate consumer does not qualify for a traditional loan. (This transaction should be differentiated from the Investor who previously owned a property and selling that property on a contract for deed or lease option). Though on the surface this transaction may look innocent enough and may actually aid the Home Buyer in eventually obtaining title to the home, I encourage the Investor to run, not walk, from these transactions.
These transactions can be attractive because they usually include a large payment up front, monthly payments that will cover the Investor’s mortgage loan and provides a relatively quick method (cancellation of contract for deed or an eviction on a lease option) to eliminate the Home Buyer’s interest in the property if the Home Buyer does not pay. If the Home Buyer fails to make payments, the Investor believes he/she can quickly retake possession, keep the Home Buyer’s payments and can then rent or sell the property to a third party. If the Home Buyer makes the payments, the Home Buyer can build equity and use that equity later to obtain a traditional mortgage and payoff the contract. Investors believe they can enter this transaction with little or no risk. However, Investors should be aware that any such transaction is a financing vehicle for the purchase of a home and may be considered by Minnesota courts to be an equitable mortgage.
An equitable mortgage is a transaction that purports to convey title to real estate (like an outright sale) but actually is intended by the parties as an alternative method of financing. The courts inquire into the real purpose of the transaction in recognizing an equitable mortgage. If the transaction is, in essence a mortgage, the court can apply all consumer protection legislation to the Investor who made the “mortgage”. And, rest assured, no matter that the Investor used an entity to enter the transaction, the lawsuit will name the Investor personally.
A finding that a transaction is an equitable mortgage can lead to claims by the Home Buyer that the transaction violates federal consumer protection legislation against predatory lending including the Truth in Lending Act (“TILA”), the Home Ownership Equity Protection Act (“HOEPA”) and the Real Estate Settlement Procedures Act (“RESPA”). There are also Minnesota consumer protections which may be implicated including usury. The potential for being a defendant in such an action and incurring attorney fees by the Investor should be enough to deter them from entering these transactions. Action taken against the Investor’s real estate license may affect other sources of revenue.
Congress passed the Truth in Lending Act (TILA) in 1968 as part of a broader Consumer Protection Act. TILA gives a homeowner a right to rescind a loan secured by his or her primary residence. This can include home equity loans, home improvement loans, and refinances. If the lender does not provide the correct notices and the homeowner exercises the right to rescind, it can result in the party providing the loan to forgive all payments made, interest and require the security released from the mortgage.
The Home Ownership and Equity Protection Act (HOEPA) is an amendment to TILA. It requires lenders to make additional disclosures to borrowers, such as the annual percentage rate (APR), at least three days before the loan closes. The real estate consumer may recover statutory and actual damages, court costs and attorney’s fees as well as rescind the contract for up to three years.
Still another protection in federal law is the Real Estate Settlement Procedures Act (RESPA). This law requires lenders to fully disclose all costs and fees related to the loan. Borrowers are entitled to challenge any illegitimate or undisclosed fees, including kickbacks and dubious referral fees. A RESPA violation has criminal and civil repercussions. A criminal conviction may result in up to one year in jail and a $10,000.00 fine per each party violating a RESPA provision. The real estate consumer is entitled to bring a civil action for triple the charge improperly paid in violation of RESPA, where the consumer would be entitled to reasonable attorney’s fees and costs if he or she prevails.
Usury violations can require the Investor to forfeit all payments made and the principle of the underlying “mortgage”.
These transactions are much too risky to undertake. Leave these transactions on the table no matter how attractive they appear. Ultimately, the only investment you may be making is in the livelihood of someone like me.