Many recent media reports have covered criminal prosecutions involving alleged ‘equity stripping scams'. But when you take a closer look at the circumstances of each case, it becomes much more difficult to separate the victim from the villain.
The typical case involves a homeowner who is down on his or her luck and behind on his or her mortgage payments. The homeowner's mortgage lender has started foreclosure proceedings. The borrower's circumstances always evoke sympathy. They may be elderly, suffer health issues or be unemployed. In any event, the homeowner is desperate to stay in the home and likely to lose his or her equity in foreclosure. The homeowner is unwilling or unable to sell the home because of its condition. Other than potential home equity, the homeowner is broke and no bank will loan him money. The homeowner's existing debt often includes high interest debt.
Enter the investor, or the so-called ‘equity stripper.' The investor is often an ordinary full-time employed person looking to get into the real estate market. Often a broker or ‘consultant' is involved in putting the investor and the homeowner together. The investor and homeowner enter into a deal that consists of two transactions. First, the investor buys the property for appraised value, takes out a new mortgage on the property from a bank using his good credit, and uses the new lower interest loan to pay off the homeowner's debt. Next, the investor immediately re-sells the property to the homeowner, usually for the same price by contract for deed or a lease-to-own contract. Down payments on the two transactions offset each other. The investors are lured to the investment because it represents an opportunity to invest in real estate using only their good credit, and little or no cash. Nine times out of ten, the homeowner's only other option is to move out of his home and lose all of the equity.
This is an expensive transaction for the homeowner though. Out of the equity that comes available from the loan taken out by the investor to buy the property, the homeowner typically pays all closing costs for both transactions and an up-front fee to the investor and consultant.
These agreements almost always provide the homeowner an opportunity to stay in their home for a significantly longer time. Unfortunately though, the new agreement often only postpones the inevitable, because the homeowner's circumstances do not improve to the point where they can afford the home. More often than not, the investor is eventually left with the property and the burden of payments on the new mortgage.
So how is the investor suddenly an ‘equity stripper'? Well, no business is complete without its bad eggs. Some notable investors took advantage of the initial surge in foreclosures by seeking out the high equity properties, making false promises, taking excessive fees and essentially setting the homeowner up to fail. For their behavior, the Minnesota Legislature punished all investors by passing a new law called the Mortgage Foreclosure Reconveyance Act, which virtually outlaws this type of transaction.
There are unresolved questions about the constitutionality of the statute. As a result of the new law however, most investors today are unwilling to re-sell properties they buy to the existing owner under any circumstances.
If you are considering such a transaction as an investor or a homeowner, consult a lawyer immediately. This consultation might help you better understand the new law and save you money and possible disappointment down the road.