Amortization to Reg Z
Peter Rosenthal
This Real Estate publication is the first outline of the course being presented today. It is expected that this course and outline will change slightly from time to time and any suggestions or criticisms are encouraged.
Several of the following pages are intended as reference material and should be valuable real estate financing tools for future years to come.
Additional copies of this publication may be obtained by sending $29.00 (includes shipping and handling) to the following address:
The V.I.P. Group
P.O. Box 26
Montrose, CA 91021-0026
Phone (818)248-0000 Fax (818)248-3296
or visit our web page at www.viploan.com
THE AUTHOR
Peter Rosenthal has held a real estate license since 1974 and has operated a related group of real estate companies since January, 1976. The V.I.P. group of companies handles all facets of real estate. Two of those companies, V.I.P. Trust Deed Company and Foothill Conveyance Corporation, specialize in first, second and third trust deed equity loans and the servicing and collection of trust deeds for outside beneficiaries.
Peter authored a real estate “question and answer” weekly newspaper column for 15 years in three local newspapers. He presently authors a monthly real estate article in Apartment Management magazine and frequently writes guest columns for a local Association of Realtors publication.
Peter taught real estate finance at Glendale College one night a week for five years and has been called on as a real estate expert witness in dozens of Superior Court cases for some 15 years.
Peter often lectures on trust deed and real estate fraud topics at various Realtor meetings.
INTRODUCTION
Do you own a house, condo, triplex, store or warehouse? Do you own 2-1/2 acres in Palmdale? If so, you are probably making payments on a note secured by a deed of trust. It doesn’t matter if you are paying the previous seller, your uncle or Bank of America–the rules and documents are the same.
If you don’t own real estate, are you planning to buy real estate? How about your relatives? Do you make payments on a real estate loan? If so, do you understand how it works or do you leave all that math up to the lender? You or someone you know will find this text invaluable as a financing workbook for future real estate investments or refinancing of present property.
Even if you are a practicing real estate salesperson or broker, I promise you a few shortcuts to everyday financing.
Now let’s take a deep breath and begin a real estate financing journey.
MORTGAGES VERSUS TRUST DEEDS
Most eastern and midwest states use a mortgage. This is a two party instrument (mortgagee and mortgagor). Upon default a judicial foreclosure is initiated. This is a lengthy, expensive court procedure culminating in a sheriff’s sale and usually allows the property owner one or two years to redeem the property after completion of the judicial foreclosure process.
Most western states, including California, have developed a far superior instrument–a promissory note secured by Deed of Trust. This allows for either a judicial (court) foreclosure similar to the mortgage foreclosure described above, or the far more common non-judicial foreclosure. A non-judicial foreclosure can be as short as three months and 21 days. This is quite inexpensive, does not involve attorneys or courts, and more importantly does not allow the Trustor any right to redeem the property after the property auction (Trustee’s Sale).
The generic name for a real estate loan is a mortgage, and you will often see that word used in lieu of the more correct California term “trust deed.” As an example, the common term ARM (adjustable rate mortgage) is used nationwide though actually a trust deed in many states.
Some types of notes secured by trust deeds allow for deficiency judgments. The lender obtains a deficiency judgment through a judicial foreclosure. If the sheriff’s sale is for less than the amount owed, a “deficiency” exists and the lender is awarded a judgment for the shortfall. A deficiency judgment is NOT available if:
1.The note is a purchase money obligation on a 1-4 unit owner occupied residential property
• A seller carry-back trust deed is involved A non-judicial foreclosure is completed.
THE NOTE
DO NOT DESTROY THIS NOTE: When paid, this note, with Deed of Trust securing same, must be surrendered to Trustee for cancellation before reconveyance will be made.
The promissory note is nothing other than an IOU. The note recites the following items and other details:
1. Loan Amount Place
2. Date
3. Lender
4. Borrower
5. Interest starting date
6. Interest rate
7. Payment amount (if any)
8. Payment period (monthly, semi-annually, etc.)
9. Maturity date
10. Late fees or other required terms
11. Prepayment penalty
12. Acceleration clauses
12.1 Alienation
12.2 Due on further encumbrance
12.3 Due on remarriage
12.4 Due on birthday
13. Attorney’s fees provision
This form can be used for a car loan, a student loan, a personal unsecured loan or a real estate loan
A promissory note used for real estate will also contain a sentence similar to: “This note is secured by a deed of trust to Foothill Conveyance Corporation.” Unless the note is “secured” by real estate or personal property, the only way to collect upon default is to file a lawsuit in a court of law.
USURY
Prior to November 7, 1979, usury laws in California prohibited non-exempt lenders from lending money at higher than 10% interest. Private individuals are the largest groups of non-exempt lenders.
On November 7,1979 the usury ceilings were changed. This much-needed change raised the then ten percent (10%) usury ceiling on many types of loans within the state.
Since then, the highest interest rate that can be charged by a non-exempt lender is the higher of ten percent (10%) or “five percent (5%) above the Federal Discount Rate on the 25th day of the month preceding the transaction.” For personal purposes, the ceiling is still 10% for a non-exempt lender. The common private party loan (friends) at 12%-18% is therefore usurious (as of January, 1998) and carries civil penalties and possibly criminal penalties unless the lender is exempt from this statute.
The Federal Discount Rate is not the Prime Rate or the Treasury Bill Rate, but is a rate charged by the Federal Reserve System to its member banks. This rate can be found in most financial periodicals or the Sunday finance section of most major California newspapers.
Many classes of California lenders are exempt from this regulation. These exempt lenders include the typical bank, savings bank, credit union, thrift, consumer finance lender (CFL), consumer mortgage lender (CML), finance company, etc. Real estate brokers are also exempt in lending their own funds or funds of others if acting in their brokerage capacity.
Private lenders are often jealous that a broker can charge (perhaps) 17% interest. I have some-times heard the expression “you brokers are licensed to steal.” That may be true, but if so, the emphasis is on the word “LICENSED”. Private parties don’t understand or furnish the dozens of forms and disclosures required when making real estate loans. These forms and regulations include among others: state mortgage loan disclosure forms, federal truth in lending forms, including specifics of the annual percentage rate (APR), finance charge, amount financed, etc. In many cases the borrower has a 3 day or 5 day right to rescind the entire transaction at no cost.
Non-exempt lenders are usually totally unaware of these regulations and are, frankly, a danger to themselves and innocent borrowers.
THE TRUST DEED – SECURITY FOR THE NOTE
The trust deed is used as security for the note and is a three party instrument. For the balance of today we will refer to the:
1. Borrower as the TRUSTOR
2. Lender as the BENEFICIARY or BENE
3. The third party is the TRUSTEE, who actually holds title to the property, “in trust” for the Beneficiary. The Trustee is usually a title company or escrow company.
The correct way to state this is that the Trustor executes a Deed of Trust to the Trustee to hold in trust for the Beneficiary.
Also for the balance of the day, the term “trust deed” refers to a combination of a “Note Secured by a Deed of Trust.
The Trustee performs two basic functions:
1. Upon payment in full, the Beneficiary surrenders the Note and Trust Deed to the Trustee together with a “Request for Full Reconveyance.” The Trustee then records a Deed of Reconveyance which extinguishes the Trust Deed Lien of Record. OR…
2. Upon default by the Trustor, the Beneficiary notifies the Trustee and a “Notice of Default” is filed initiating the foreclosure process–more about that later.
The trust deed is recorded at the County Recorder’s Office in the county where the property is located. The trust deed may be a first, second, third, fourth or fifth trust deed or even an AITD (All Inclusive Deed of Trust). The priority is usually determined by the date of time of recording.
The following gives an example of trust deed priority:
995 Anywhere Street — Property purchased 4/10/82 – all cash
1. 1st trust deed recorded 8/14/85 $110,000 Homeowner in favor of Bank of America
2. 2nd trust deed recorded 6/11/91 $28,000 Homeowner in favor of XYZ Bank (home improvement)
3. 3rd trust deed recorded 10/12/93 $15,000 Homeowner in favor of Blue Pool Company
On 6/11/94 the 2nd trust deed comes due and the Trustor pays this off in cash. In this example, the $15,000 third trust deed is now a second trust deed.
Trust deed priority is similar to a movie line: each subsequent trust deed takes its place in line. The Beneficiary of a trust deed can voluntarily give up their place in line by agreeing to “subordinate” their position with a formal subordination agreement. As an example, the Blue Pool loan above could subordinate its position and allow a new first trust deed. This can be dangerous for the Beneficiary unless the new trust deed has the same or better terms than the trust deed being replaced, i.e. interest rate, term, payment, etc. THINK OF SUBORDINATION AS A FOUR LETTER WORD.
NOTE AMORTIZATION
AMORTIZATION: A fixed periodic payment amount that will usually fully retire the obligation over the term of the loan. As an illustration, we will take a $25,000 loan at 8% interest with monthly payments and a term of one year. The only difference between these four examples is the amount of the monthly payment. The first example is the typical home loan (fully amortized), although the typical 30 year term has been drastically shortened.
EXAMPLE 1: A FULLY AMORTIZED loan will result in no balance remaining at the end of the loan, i.e. “until paid.”
EXAMPLE 2: A PARTIALLY AMORTIZED loan will result in a periodic principal reduction but still have a principal balance remaining at maturity.
EXAMPLE 3: An INTEREST ONLY note has a periodic payment that equals the interest charge for the period and the original principal balance is still due at maturity.
EXAMPLE 4: NEGATIVE AMORTIZATION refers to a note with periodic payments of less than interest only. This type of note will have an increased principal balance after every payment.
EXAMPLE: $25,000 loan @ 8% for one year
1. Fully amortized: Payment $2,174.71
2. Partially amortized: Payment $1,500.00
3. Interest only: Payment $166.67
4. Negative amortization: Payment $150.00
“PAY MORE” — the two word secret to taking over total control of the life of your loan. As you will now see, with these two words you have the power to:
1. Convert a negative amortization loan to an “interest only” loan.
2. Convert an interest only loan to a partially amortized loan.
3. Convert a partially amortized loan to a fully amortized loan.
4. Convert a 30 year loan to a 15 year loan…etc.
COMPARISON OF 15 AND 30 YEAR FIXED RATE LOANS
30 YEAR LOAN:
Amount of loan $182,500.00
Interest rate 7.5%
Term of loan (months) 360
Amount to amortize $1,276.06
Desired payment $1,276.06
Balloon payment $1,282.35
Total payments $459,387.90
Total interest $276,887.90
Finance charges $276,887.90
Amount financed $182,500.00
APR 7.5%
15 YEAR LOAN:
Amount of loan $182,500.00
Interest rate 7.5%
Term of loan (months) 180
Amount to amortize $1,691.79
Desired payment $1,691.79
Balloon payment $1,693.82
Total payments $304,524.20
Total interest $122,024.20
Finance charges $122,024.20
Amount financed $182,500.00
APR 7.5%
Interest paid on a 30 year $276,887.90
Interest paid on a 15 year $122,024.20
Interest saved $154,863.70
REAL ESTATE MATH – UGH!
The following three examples match those shown on Page 13. We will do the simple math for each note. All examples are $25,000 @ 8% with monthly payments. The only difference is the amount of payment. (Most real estate payments are paid in ARREARS; rent is paid in
ADVANCE.)
FULLY AMORTIZED
Beginning balance $25,000 – monthly payment $2,174.71
- 1. $25,000 (principal) X 8% (interest) = $2,000 (interest for one year)
- 2. $2,000 (interest for one year) divided by 12 = $166.67 interest for the first month. Place this in interest column for the first month
- 3. Now take $2,174.71 (monthly payment) minus $166.67 interest charge = $2,008.04 = this month’s principal reduction.
- 4. Now take $25,000 (beginning balance) minus $2,008.04 principal reduction = $22,991.96 remaining balance.
Payment #1
Interest: $166.67
Principal: $2,008.04
Remaining Balance: $22,991.96
Was that too tough? Now let’s do the second month’s payment. Same steps.
- 1. $22,991.96 (remaining principal balance after Payment #1) X 8% = $1,839.36 (interest for one year)
- 2. Take $1,839.36 (interest for one year), divide by 12 = $153.28 interest for second month
- 3. Take $2,174.71 monthly payment minus $153.28 interest charge = $2,021.43 = this month’s principal reduction.
- 4. Take $22,991.96 (remaining balance after first payment) minus $2,021.43 principal reduction = $20,970.53 remaining balance after second payment.
Interest Principal Remaining Balance
Payment #2 $153.28 $2,021.43 $20,970.53
Same steps again for the third payment, and so on until paid in full.
Payment #3:
Interest: $139.80
Principal: $2,034.91
Remaining Balance: $18.935.62
Payment #4:
Interest: $126.24
Principal: $2,048.47
Remaining Balance: $16.887.15
Payment #5:
Interest: $112.58
Principal: $2,062.13
Remaining Balance: $14,825.02
Payment #6:
Interest: $98.83
Principal: $2,075.88
Remaining Balance: $12,749.14
Payment #7:
Interest: $84.99
Principal: $2,089.72
Remaining Balance: $10,659.42
Payment #8:
Interest: $71.06
Principal: $2,103.65
Remaining Balance: $8,555.77
Payment #9:
Interest: $57.04
Principal: $2,117.67
Remaining Balance: $6,438.10
Payment #10:
Interest: $42.92
Principal: $2,131.79
Remaining Balance: $4,306.31
Payment #11:
Interest: $28.71
Principal: $2,146.00
Remaining Balance: $2,160.31
Payment #12:
Interest: $14.40
Principal: $2,160.31
Remaining Balance: $0.00
PARTIALLY AMORTIZED
Beginning balance $25,000 – monthly payment $1,500.00
- 1. Steps 1 and 2 same as before
- 2. Take $1,500.00 monthly payment minus $166.67 interest charge = $1,333.33 = this month’s principal reduction.
- 3. Now take $25,000 (beginning balance) minus $1,333.33 = $23,666.67 remaining balance.
- 4. Same procedure for payments #2 and #3:
Payment #1:
Interest: $166.67
Principal: $1,333.33
Remaining Balance: $23,666.67
Payment #2:
Interest: $157.78
Principal: $1,342.22
Remaining Balance: $22,324.45
Payment #3:
Interest: $148.83
Principal: $1,351.17
Remaining Balance: $20,973.28
Payment #11:
Interest: $ 75.06
Principal: $1,424.94
Remaining Balance: $9,834 54
INTEREST ONLY
Monthly payment $166.67
With an interest only loan, the monthly interest, principal reduction and the remaining balance
will remain constant. Again, follow steps 1 and 2. The remaining balance will be $25,000.00
after each payment and there will be a balloon payment at maturity of $25,000.00.
Payment #1:
Interest: $166.67
Principal: $-0-
Remaining Balance: $25,000.00
Payment #2:
Interest: $166.67
Principal: $-0-
Remaining Balance: $25,000.00
Payment #3:
Interest: $166.67
Principal: $-0-
Remaining Balance: $25,000.00
NEGATIVE AMORTIZATION
Monthly payment $150.00
1. Steps 1 and 2 same as in “Fully Amortized” section .
Take $150.00 monthly payment, subtract the interest charge ($166.67) and record the negative
amount in the principal column. This negative will then be added to the balance of the loan and
future interest due will increase accordingly.
Payment #1:
Interest: $166.67
Principal: -$16.67
Remaining Balance: $25,016.67
Payment #2:
Interest: $166.78
Principal: -$16.78
Remaining Balance: $25,033.45
Payment #3:
Interest: $166.89
Principal: -$16.89
Remaining Balance: $25,050.34
Payment #11:
Interest: $167.81
Principal: -$17.81
Remaining Balance: $25,189.57
EVERYDAY FINANCING
Now that we have passed through the “UGH” phase, let’s explore your actual financing or refinancing options.
ADJUSTABLE RATE MORTGAGES (ARMs)
This loan’s interest and payment adjusts at fixed intervals (monthly, semi-annually or yearly) based on an index and a fixed spread or margin. There really is no mystery here. Various margins are used by lenders. The most common are TREASURY BILL INDEX, LONDON
INTER-BANK OFFERING RATE (LIBOR), PRIME RATE or the 11TH DISTRICT COST OF FUNDS. Historically the 11th District has proved to be the least volatile margin and the most widely used. Here’s how this works:
7/95 11th District Cost of Funds 5.14%
Fixed margin 2.25%
Rate charged or TRUE RATE 7.39%
7/96 11th District Cost of Funds 4.82%
Fixed margin 2.25%
Rate charged or TRUE RATE 7.07%
7/97 11th District Cost of Funds 4.86%
Fixed margin 2.25%
Rate charged or TRUE RATE 7.11%
The interest rate simply moves up or down at each interval, based on this simple formula.
TEASER RATES
A teaser, or initial rate, is simply a rate that is artificially low to lure you into the loan. Unwary borrowers usually concentrate on the initial low interest and initial low payment. “Tomorrow is another day.” Teaser rates were first used to lure borrowers away from fixed rate loans. Also, it was easier to qualify a borrower with a lower initial payment. Even lenders believed “tomorrow
is another day.” The theoretical concept is that borrowers will get raises in the future to help pay for payment increases.
When teasers were first introduced I used to call them “sucker rates.” In my newspaper articles in the late 1970’s I used to offer (tongue in cheek) teaser rates of 4%. In those days fixed rates may have been 9% and teaser variable rates at 7%. I would offer 4% and would then claim, “Don’t worry, the loan can only go up one tenth of one percent per period–every hour.” REMEMBER, LIARS CAN FIGURE AND FIGURES CAN LIE.
Teaser rates really do have a legitimate place in real estate financing, however. If you plan to fix up the property and resell in 1-2 years or more, simple math may show that a teaser with semi-annual or annual adjustments is the way to go–At least be aware.
FIXED VS. VARIABLE
Many factors are involved here, but the most obvious is time. How long do you plan to own the property? I am conservative and have never considered anything other than a fixed rate loan for my home and I have now lived in it for over 20 years. I have refinanced twice.
Though adjustable rate loans have lifetime caps, that cap will always be higher than the fixed rate loan. Perhaps you like roller coaster rides–Take out your crystal ball and take your best guess at future interest rates.
NO POINTS, NO FEES
Do you really believe in the tooth fairy? This gimmick is “the teaser rate of the ‘90’s.” Obviously the interest rate on a no fee loan will be higher than a loan with a one point loan fee and closing costs. Calculate this like a teaser rate. If you are going to sell the property in a year or two this may be a good idea. This is obviously a disaster over 15-30 years.
15 YEAR FIXED VERSUS 30 YEAR FIXED
Use your “Handy Dandy Tables” to calculate the difference in these two payments on the loan you will apply for. Often the interest rate offered on a 15 year loan will be 1/4% to 1/2% lower than a 30 year loan. If you are SURE you can afford this, GO FOR IT.
I have a 15 year 7% fixed rate loan on my home. Be aware, however, that the payment is higher and a partial loss of income may get you in trouble. If you are not 100% sure, take the 30 year lower payment and use the two magic words: PAY MORE when you can.
THE BI-WEEKLY PAYMENT GIMMICK
“Pay me a $400 set up fee and I’ll show you how to save $10,000 to $100,000 in interest on your loan and with magic, pay off your loan in 18 instead of 30 years. If your payment is normally $1,000 per month you pay $500 every two weeks and this really works like magic.” It does, but there is no magic: We have already covered this, i.e. PAY MORE.
$1,000 per month = yearly payments of $12,000
$500 every two weeks = $500 X 26 (52 weeks in one year) = $13,000
This is simply a cute way of coaxing one extra payment per year. Do you really need to pay $400 for the privilege? Take that $400 and pay it to the lender next month–MAGIC! Then PAY MORE whenever you can.
WHEN TO REFINANCE
This is a very common problem for those of us who own real estate. This is also a very simple math problem–It’s no big deal. One simple guide is “2 and 2.” If the new rate offered today is 2% less than your existing rate and you plan to keep the property for 2 or more years, it usually is the right thing to do. Just take out a pencil and paper and do the math. This is just like fixed/variable or points/no points–How long will you keep the property?
PAYMENT VERSUS INTEREST
Low monthly payments are desirable but far from the full story. As an example, I offered to lend John $100,000. All he cares about are low payments.
I offer a fully amortized 10 year payment at 6%, $1,110.21 a month. “The payments are way too high,” says John.
Okay, how about $898.03 a month “That’s better” (7% 15 years)
How about $836.44 a month “That’s much better” (8% 20 yrs. amortization, due in 10 yrs.)
How about $810.06 a month “Great” (9-1/2% 40 yrs. amortization, due in 5 yrs.))
How about $500.00 a month “Unbelievable (18% 40 years, negative amortization, HUGE balloon payment [$147,775.96] due in 3 years)
How about $-0- a month “Impossible” (24% no payments – all due in 2 yr.)
THINK INTEREST, NOT PAYMENTS.
FIRST HALF REVIEW
By now we have explored a Promissory Note which can be used with real property security, with personal property security or unsecured. This is a formal “IOU.”
“Due on sale” and “alienation” are no longer alien terms.
We have discussed the Trust Deed–the real estate document given as security for the Note, the parties to this document and its difference to a mortgage.
If your eyes were not closed during the math portion you can now check your lender’s figures on a monthly basis. If you are a lender, you can now figure out your own principal and interest breakdowns. Amortized, partially amortized, interest only, negative amortization–You are a whiz!
The term “usury” is no longer mysterious. You understand that negative amortization is not an uncontrollable roller coaster ride. You know two simple words (PAY MORE) that can retire a loan sooner and can save thousands of dollars in interest.
Everyday financing should be an available topic at cocktail parties. Adjustables, margins, teaser rates, bi-weekly mortgages–whatever–you will now be able to hold your own.
Now take a break and realize how much real estate information you have digested in one sitting. I promise the balance of the day will be far more interesting.
SECOND HALF INTRODUCTION
“This math deal is great, but I took this seminar for “practical stuff…”
We will discuss the concept of dealing with your lender if you are “upside down” with your loan. We will also fully examine the actual mechanics of a non-judicial foreclosure. Once we become a “one hour foreclosure expert” we will explore the relationships between the Trustor, Trustee and Beneficiary during this process. Can this process be delayed, canceled or cured? What are TSG’s, “REO’s” and all those other terms the experts use? Let’s not forget the “B” word: bankruptcy. Finally, we will visit the actual Trustee’s Sale and explore conduct at that very unusual event.
The sale antics of the 40 thieves will get a few laughs even though those tactics are usually fraudulent in nature. The actual Trustee’s Sale is the culmination of someone’s property owner-ship and was originally designed to be the end of this course, however a bonus section was added for students interested in attending Trustee’s Sales for fun and profit.
Hopefully I will pique your interest and you will attend a sale or two, even if you have no real reason to do so. If you are an experienced real estate licensee or property owner you may wish to start attending those sales for profit. Fortunes have been made at these sales. You have seen many advertisements in newspapers and on television offering “get rich quick” seminars involving these Trustee’s Sales, however this is not a way to buy a new Mercedes in one week.
WARNING: This course will warn you about the many dangers that await an unwary sale buyer. In no way is this short overview intended to prepare you to actually buy real estate at these sales; that is the subject of a totally independent course
UNDERWATER — DEALING WITH YOUR LENDER
Example:
You paid $200,000 for your property in 1990. The first trust deed is $180,000 (seller carry back) at 10%, due in 2 more years. The property is worth $160,000 but with selling costs and commissions you would net only $148,600.
This is very simple if your personal credit is not A+ and not crucial to you. This is simply a game of poker. You get a chance to see the lender’s hand at no cost.
Speech 1: “If I sold the property today I would only net $148,600. I owe you $180,000. I will give you a deed to the property (Deed in Lieu of Foreclosure) unless you reduce the principal balance to $155,000, reduce the interest to 7%, reduce the payment accordingly and extend the term for five years. I have paid promptly every month for many years and will continue if you will modify your note.”
Speech 2: “My mother will lend me money. I can pay off $145,000. That is all we can come up with and it is far more than you will get if you foreclose.”
Either approach is really a win/win deal for both you and the lender.
If you are dealing with a large lender this will usually not work. Large lenders have servicing departments, foreclosure departments, bankruptcy departments, asset management departments, etc. Common sense really doesn’t work with most large lenders.
Though this may sound cynical, the only way to deal with most major lenders is to stop paying and ride out a long foreclosure “rent free.” Or stop paying and arrange a “short sale” with them. In most cases you have to stop paying just to get their attention (If you have good or excellent credit this can be a major setback, but it will not stop you from buying real estate in the future.) What a waste! If your credit is paramount, you will have to keep on paying and wait out the next real estate cycle or sell now and put in the cash difference to close the escrow.
Try to find the “man in the basement with the green eyeshades.”
Talk to a real estate broker who specializes in short sales.
Good luck
NOTICE OF DEFAULT
Hopefully you will never receive one of these with your name as Trustor. If you do receive one, the world has not come to an end. This document is merely the start of the non-judicial foreclosure process and is usually “curable.”
Prior to the execution of this document, the Beneficiary has given the Trustee a “Declaration of Default” outlining the exact reason for the default and the figures involved.
The Notice of Default (NOD) is recorded at the County Recorder’s office. The Notice of Default clearly spells out the “breach” or default. This default might be ”a failure to pay the installment of principal and interest which became due August 1, 1997 and all subsequent installments of principal and interest, late charges, delinquencies on prior encumbrances, advances, delinquent real estate taxes, attorney’s fees, if any, plus fees and costs.”
The default might also be “a failure to pay the principal sum (balloon payment) which became due August 1, 1997 plus interest due thereon plus late fees, plus fees and costs.”
The default may be “non-monetary,” such as unauthorized transfers, further encumbrance, waste, etc.
The Trustee orders a Trustee’s Sale Guarantee (TSG), which is similar to a title policy. It insures the Trustee and Beneficiary and provides the Trustee with the necessary lien mailing and publication information. Using this TSG, the Trustee sends the NOD by certified and first class mailings within ten days of filing the NOD. The NOD is sent to the Trustor at the address listed on the Trust Deed. The NOD is also sent to anyone of record other than the Trustor who has
recorded a “Request for Notice of Default.”
A second set of mailings is sent to other parties of interest within 30 days of the NOD recording. These mailings are sent to the Beneficiary of any recorded junior trust deed, recorded leaseholders, creditors with recorded judgments, etc.
The first stage of the three part foreclosure process has now been completed. This is sometimes called “the curing period.” If the default is “curable,” the Trustor may pay all amounts due at that time, including all foreclosure fees and costs. The Beneficiary pays nothing if the foreclosure is cured.
Nothing further happens for the three month period following the recording of the NOD.
NOTICE OF TRUSTEE’S SALE
Three months after recording the NOD, the Trustee records a “Notice of Trustee’s Sale” (NTS). This document sets out the date, time and place of the upcoming sale (auction). The Notice also states the TOTAL amount of the obligation, including unpaid principal, all accruals, fees and costs expected at time of sale.
The Trustee now sends a new set of mailings (NTS) to all parties previously notified. Additional mailings are sent to the IRS if there is a Federal Tax Lien on the property. The Trustee also advertises the NTS in a general circulation newspaper once a week for three consecutive weeks, in addition to posting a Notice of Trustee’s Sale on the property itself AND in a public place, usually a courthouse.
It is significantly more expensive to cure the default at this stage, as the Trustee’s fees are increased at this point in addition to greatly increased costs for mailings, advertising, posting, etc.
At this point the foreclosure is still “curable” assuming the actual default is curable. Historically, the Beneficiary did not have to accept curing after three months; they could demand payment of the entire obligation. Foreclosure statutes were amended in recent years to allow curing up to five days before the actual sale.
BANKRUPTCY — THE “B” WORD
Filing bankruptcy is a very drastic step and should not be taken without a lot of thought. Bankruptcy will not stop or cancel a foreclosure, only delay one. In fact, the legal fees incurred by the lender will be added to the debt and the Trustor in bankruptcy may only achieve a two or three month delay. Does the Trustor really have a lot of equity, or is this just a delay of the sale? It can be a very expensive delay.
Try to work with the lender instead. “Work Out Agreements” can be a “win/win” deal for both Beneficiary and Trustor. As an example:
1. Trustor to make one and one half payments per month until current.
2. Pay a sum for a one week or one month delay in sale date.
3. The Trustor can give the lender additional security in the form of a third party guarantee, a
Deed of Trust on another property or even sign over the title to a car.
If there really is substantial equity to protect and the lender refuses to work with you, the “B” word is certainly an option. This delay, though costly, will give you an extra 2-5 months to sell the property. Why did you wait so long in the first place?
TRUSTEE’S SALE — THE BIG EVENT
We are now at the actual sale, which can be held anywhere in the county where the property is located. This can be at the Trustee’s office, but is usually held at the front, side or rear steps of a local courthouse.
Remember, this sale is ALL CASH OR CASHIER’S CHECK. Armed guards and armored trucks are not necessary, as most bidders come with cashier’s checks.
The Trustee or an agent of the Trustee conducts the sale. Usually many sales are scheduled for the same day and the person conducting the sales usually announces all the cancellations and postponements first. Sometimes only a few spectators or bidders are present. At other sales ten to twenty people may show up. I conducted a sale on the front steps of the Glendale courthouse over a decade ago and nobody was at the sale. It amused me to stand there, all alone, reading the Trustee’s Sale spiel out loud to a few pigeons. I have not personally conducted a sale in many years.
Most sales will not be held on the original day of sale. The sale may be postponed by “beneficiary’s request”* or by “mutual consent.” The sale may be postponed by bankruptcy or other “operation of law” or sometimes solely “at Trustee’s discretion.” For whatever reason, it is common to observe 2-10 postponements before the actual sale is held.
* If the Beneficiary postpones the sale more than three times, the entire posting and publishing process must start all over again. More on this in the “40 Thieves” segment.
Finally the person conducting the sale announces the sale on the property you are interested in. “Does anyone wish to qualify to bid?” One or more people may wish to bid. The person conducting the sale will talk to each bidder separately and actually check the bidder’s funds and note the amount, the bidder’s name and dollar amount. The amount shown is meaningless as long as it is higher than the opening bid. The opening bid may be $181,545.76. To qualify, the bidder must have at least $181,545.77.
As an example, an experienced buyer may show a $200,000 check and bid no higher than $182,000. On the other hand, they might qualify at $182,000 and requalify (show more money) as the bidding goes higher.
The Trustee now “cries” the sale and announces “on behalf of the Beneficiary an opening bid of $181,545.76.” In the event there are no overbids, the Trustee cries the usual “going once, going twice, sold to the Beneficiary for $181,545.76.” If other bidders are present, the next bid will usually be + one penny. Heaven forbid that the pros would overbid by $1.00 and waste 99 cents!
The person conducting the sale sets the pace. Finally, the property is “SOLD.” The person conducting the sale collects the money if the property was sold to an outside bidder, and gives them a receipt.
To complete the foreclosure process the Trustee now issues a Trustee’s Deed to the Beneficiary or outside bidder. In the case of an outside bidder, the Beneficiary is paid in full and the fees and costs are paid as the bid included these fees and costs. In the event of an overbid, junior lienholders are paid excess funds in order of priority as long as there are sufficient funds. Any remaining funds are remitted to the Trustor.
The foreclosure action extinguishes any junior lienholders and even the IRS (if properly notified). The IRS, however, has the right to “redeem the property” within 120 days.
CHART
1st Trust Deed, $105,000, Recorded 8/17/73, Unpaid balance now $58,488
2nd Trust Deed, $40,000, Recorded 12/14/94, Unpaid balance now $25,550
3rd Trust Deed, $25,000, Recorded 1/15/95, Unpaid balance now $24,000
4th Trust Deed, $20,000, Recorded 3/15/95, Unpaid balance now $20,000
Real Estate Taxes owed 1995, 1996, 1997
NOD 2nd Trust Deed 4/11/97
NTS (2nd Trust Deed) 7/15/97 $26,985.70
Sale to outside bidder 8/14/97 $31,000.00
Trustee’s Deed recorded
New buyer takes title “subject to”:
1. All unpaid real estate taxes
2. First Trust Deed
Buyer needs to contact 1st Trust Deed lender and make arrangements to pay off 1st Trust Deed or assume balance.
Balance of cash: ($31,000 minus $26,985.70) paid to 3rd Trust Deed holder
3rd Trust Deed holder partially wiped out
4th Trust Deed holder completely wiped out.
In some cases, wiped out junior trust deed holders can sue in court on their now-unsecured promissory note.
THE FORTY THIEVES
This is a term that has been common for decades. There is a group of professional “sale chasers” who make a very good living dealing in foreclosure properties. This is a broad area. These “bottom feeders” work during the curing period or purchase the property at the actual sale.
Some examples of these dealings with the property owner after the filing of an NOD:
1. “I’ll give you $500 for a Quit Claim–You are going to lose it anyway.”
2. “Deed the property to me. I’ll refi and sell it back to you.”
3. “Deed the property to me. I’ll cure the default and rent back to you.”
4. “Deed your rental property to me and I’ll cure your default and save your credit. Remember
to pay me the security deposits.”
Some examples at the sale are:
1. “You’re a nice couple. Pay me $500 and I won’t bid on the Maple Street house.”
2. “Give me $5,000 and I’ll bid on the property for you and sell it back to you.”
3. Actually buy the property and resell it at a profit.
Foreclosure laws were amended almost 20 years ago to counter some of the homeowner ripoffs outlined above. Foreclosure consultants laws were enacted to make it unlawful to take “unconscionable advantage” of a homeowner in foreclosure.
Before those laws, beneficiaries were able to postpone sales at will. Now posting and publishing of the Notice of Trustee’s Sale must be started all over again if the beneficiary postpones the sale more than three times. This was necessitated because of a somewhat humorous scam. Let’s assume that an unscrupulous beneficiary had a $10,000 first trust deed on a $50,000 house in foreclosure. They didn’t want to be paid off by an outside bidder; they wanted to steal the property. Since the sale can be held anywhere in the same county as the property, Catalina goat pastures became the place of choice for crooked beneficiaries. If outside bidders came to Catalina the sale was postponed continuously until nobody else showed up. Then the property would be “sold to the beneficiary” — no outside bidders.
LIFE AFTER FORECLOSURE
ARE YOUR REAL ESTATE DAYS OVER?
NO!
Fortunes have been made in real estate. The typical homeowner has traditionally built up a substantial portion of their net worth just by owning their own home. Don’t give up because of a foreclosure.
Lease Option
This is the easiest, most available way to “come back.” Don’t be too choosy; remember, location, LOCATION, LOCATION. Try for 2-3 years; you do not have to exercise the option to make $$$. There are many ways to pay for the option.
Seller Carry Back
You can purchase another home the day after foreclosure. Yes, you really can. Find a way to offer them a decent down payment or use some common creative financing techniques.
Hard Money Loans
Do you have a good down payment or will the seller carry back a second trust deed with very little down? A hard money lender will easily lend you 60-75% of the purchase price. The purchase has to be “under market” to absorb the higher interest rate.
Equity Sharing (Mouse and Elephant)
The real estate market is making a strong comeback and this option is again available. Lock in a great deal and find a financial partner to arrange 100% of the financing. Using this arrangement, you will live in the property (if single family) and sell or refi in 3-5 years. The profits are then split. Find the elephant through the classified ads.
BONUS SECTION
(Making Money With Foreclosure Properties)
Buying at the actual sale
This is not for novice real estate investors. Buy a property or two on more conventional terms to gain real estate experience. If you have experience and financial backing, follow ten NOD’s all the way to sale and actually attend the sales for experience. If you take this advice you will do a lot of legwork and discover that you would have only had a chance to acquire one or two properties. I said only a chance. If you’re still ready after ten dry runs, pick out another ten properties; this is the real thing. You will discover this is not a part time job. Be prepared for last minute payoffs, bankruptcies and multiple postponements. You now realize how frustrating and expensive it is to attend sale after sale with $50,000-$100,000 in cashier’s checks, only to hear the words, Postponed due to…”
Make a good title company contact. Better yet, take on a partner with experience in buying foreclosure properties or title company experience.
If you don’t have the stomach for all-cash offers, attend the sale and make an offer to the top bidder:
a) If one of the 40 thieves acquires the property at sale, a quick turnover would be okay. Make an offer to repurchase the property.
b) If a bank lender acquires the property (REO), contact them immediately and make an offer.
c) If a private party lender acquires the property due to no overbids, they will be very receptive to your offer and they will usually offer great financing.
Purchasing the Trust Deed before the sale
Many lenders will sell the trust deed at a discount while it is in foreclosure. This also requires “all cash” but is a great way to acquire a property. For instance, a lender may have a $200,000 note on a property valued at $220,000. The note and trust deed are purchased for $172,000 and you take the place of the original lender. When the property goes to sale you will either own the property or be paid off by an outside bidder at the sale. You will either get the property or $200,000 for your $172,000 investment.
The most important point: YOU ARE A LAMB! A TRUSTEE’S SALE CAN BE A SLAUGHTER.
SALE CHECK LIST
Remember, this is a very risky business. Do your homework and then keep your fingers crossed.
Are you sure the property is in good condition and doesn’t need thousands of dollars in repairs? Leave ample room in your bid to cover many unexpected repairs.
Are you sure this is a first trust deed? Check title for subordination agreements. If this is a second or third, what is the status of the senior trust deeds?:
1. Due dates on senior trust deeds
2. Delinquencies on senior trust deeds
3. Due on sale clauses on senior trust deeds
How much are the real estate tax delinquencies? Remember, they are senior even to the first trust deed.
How about federal tax liens? Remember, the IRS can redeem the property for 120 days.
If the property is occupied, how long will it take you to evict the occupants and how much will it cost? If the occupant is a tenant, check for rent control and leases.
Check priority again–This is a bidder’s worst nightmare.
Check title chain and compare ownership against names on the deed of trust. This sale could be a partial ownership only.
SOURCES OF MONEY FOR BUYING FORECLOSURE PROPERTY AT THE SALE
1. Take out an “equity line of credit” on your home. This can be the best bet because you can withdraw the money and redeposit it repeatedly with just a daily interest charge.
2. Borrow money against stocks and bonds at a low rate.
3. Convince a parent, friend or relative to finance your first purchase. If you are the successful bidder you can then quickly refinance the property.
4. Arrange the financing with an equity lender. The lender will usually take the property in their name and then resell it to you with a profit. This can be very expensive due to the postponements often encountered. The lender will charge to attend the sale and charge for the use of the money even if the sale is canceled or postponed.
5. Offer a percent of equity ownership to a financial partner with a SAM (shared appreciation mortgage). This type of financing includes interest at a reasonable rate and a share in the profits.
THE END
I will be happy to answer your real estate questions or at least refer you to the best sources.
PETER ROSENTHAL
THE V.I.P. GROUP
3450 North Verdugo Road, Glendale 91208
Telephone: (818)248-0000
Fax: (818)248-3296