Some borrowers attempt to obtain real estate loans by submitting certain information and withholding other pertinent facts. They may not be aware of the online research databases used to verify the borrower’s creditworthiness and security property. Undisclosed pertinent facts may somehow surface with proper research. The borrower may submit a whitewashed loan application to his/her mortgage broker who may or may not be aware of the misinformation. Or, was the mortgage broker involved in the construction of the misinformation? The borrower and his/her mortgage broker should review their respective obligations included in the Fannie Mae/Freddie Mac 1003 loan application form particularly when the loan is a federally related mortgage.
The borrower’s mortgage broker is an agent and the fiduciary of the borrower. The funding lender’s mortgage broker is an agent and a fiduciary of his/her principal in a loan transaction. Sometimes, the brokers may find themselves in a dual agency situation. Therein lies a sophisticated legal analysis of agency and sub-agency relationships and fiduciary duties, and whether the mortgage broker(s) made more than a superficial inquiry into the borrower’s information and representations.
Both the borrowers’ and the broker representing the funding lender must make a reasonable in-depth inquiry. Each broker has a duty to investigate the truthfulness of the info/statements/representations from the borrower, whether received directly or through the borrowers’ mortgage broker. To pick up a written or digital package and send it forward without review, inquiry, and verification of the material facts is not enough. The broker who is the agent of the lender is subject to fiduciary duties when providing the lender with the borrower’s info/statements/representations.
When a funding lender or the broker representing the lender underwrites the package, they will assemble the exhibits, review and ask follow-up questions. The borrower’s broker will then contact the borrower to obtain additional information requested by the lender or the lender’s broker. The borrower may supply either factual or misinformation which may include withholding information.
A few people go through life by functioning between factual and misinformation, assuming that no one will recognize the difference. When it comes to locating a new lending source, some borrowers believe they can fool the next lender into overlooking their past misdeeds and history of credit problems. Does this sound familiar? In a few cases, it may work if the funding lender or his/her broker does not do in-depth research on the borrower and the collateral property. There is a vast junkyard full of litigation on this subject. Each circumstance is fact specific. Call your lawyer, not me!
Here is an example that demonstrates the problem above.
A borrower submitted a loan request to a mortgage broker and requested a second lien of $300,000 behind a $800,000 first. The borrower stated that because the first lien was in the mid 6’s interest rate he did not want to pay it off. The property was supposedly appraised for $1,700,000. A loan with a loan-to-value of 65% might be available if the borrower and the property are reasonably creditworthy. The borrower’s business was a 50% occupant and 50% was leased to third parties. He stated that his/her business was a contractor by trade and is in the process of completing a low-income development project in a local city.
Borrower’s mortgage broker: “My client has approximately $1,000,000 due to him in 6 months when the project is completed. The payout from this finished project will be enough to pay off his loan. He needs short-term gap financing for business operational expenses while he finishes the job.”
So far so good until the funding lender or his/her broker performed due diligence notices a few problems.
Funding broker lender: “What about these liens and judgments that show up on the Lexus/Nexus background search?”
Borrower’s mortgage broker: “Oh, I forgot, the borrower told me that most of his problems were related to frivolously filed litigation against his company.”
Funding mortgage broker: “Can you explain what occurred when a foreclosure transfer deed that conveyed title of the borrower’s property over to the lender through a foreclosure proceeding and successful trustee sale? Why did his lender later convey title back to him? That is an odd sequence of events.”
Borrower’s mortgage broker: “His lender was mad at him because he transferred title of his property from one entity to another of his entities for tax reasons. The borrower also told me that most of his problems occurred because he was a victim of identity theft.”
Funding mortgage broker: “What about the borrower’s 3-year-old Chapter 13 individual re-organizational bankruptcy? The Chapter 13 was dismissed. Thereafter the borrower filed Chapter 11 bankruptcy.”
Borrower’s mortgage broker: “Oh, the 13 and 11 were canceled! These problems were fixed, and it is all better now, so a new lender should have nothing to worry about! The borrower intends to live happily ever after when you make him this new second loan.”
Let’s review the real facts.
- Besides getting a credit report, and a Lexus/Nexus report, the funding lender was smart enough to download the Chapter 11 settlement agreement with the first lien lender from gov.
- No evidence could be found relating to the borrower’s personal identity theft claims.
- When the borrower originally obtained his first loan from the bank, he agreed to sign a personal guarantee.
- The borrower defaulted on his first lien payments and the lender filed a notice of default with intent to foreclose.
- The foreclosure action was contested by the borrower with heavy litigation against his first lien lender.
- The borrower filed a personal Chapter 13 to stop the foreclosure sale. Chapter 13 is an individual organizational bankruptcy filing where a borrow files a payment plan to reorganize his debts with court approval and eventually pays their debts.
- The first lien lender filed a receivership action to remove possession of the building management from the borrower and give it to a 3rd party court-appointed receiver.
- When the borrower dropped the personal Chapter 13, he filed a Chapter 11. Chapter 11 is a business organizational bankruptcy filing where business files a plan to reorganize with court approval and eventually pay its debts and get back on a stable operational basis, with the objective of exiting Chapter 11.
- The first lien lender successfully foreclosed on the property and received title evidenced by a trustee sale guarantee.
- Litigation continued because the borrower had personally guaranteed the debt. The lender was pursuing the borrower on an individual basis.
- After extended litigation, both parties agree to a settlement, and the lender agrees to convey the title back to the borrower, which was reflected in public records. There was a grant deed conveying title from the foreclosed lender back to the borrower.
- The borrower also defaulted on his property taxes each year since 2016.
- The due date of the renegotiated first loan was shortened to less than one year. A new 2nd lien lender would have to consider a short-term due date of the first lien in the credit decision and the investment decision for the lender.
- There was a stipulation in the Chapter 11 court settlement agreement that if the borrower was late, the lender could immediately go to foreclosure, with no further bankruptcy filings allowed.
This may not be a viable loan for most private money lenders. A few bold lenders may take the risk for increased interest rates and origination fees and that they may have to pay off a senior encumbrance maturing prior to the due date of the lender’s loan. Examples like this suggest an unfortunate time-consuming exercise for all parties. Of course, many borrowers do not care if they are successful in obtaining a new loan.
Business and Private Money Finance Consultant
Cell 949 533 8315
I intend this article for educational purposes only and is not a solicitation.