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M O R E    R E S O U R C E S

Article by William Bronchick

Can Foreclosure Investing be Criminal?

  I recently attended a "free" seminar on how to "get rich quick" in foreclosures. The speaker had a different angle than the usual "steal it from the homeowner" method.

  The speaker suggested that you approach the homeowner with the following plan:

  1. Tell the homeowner you will make up his back payments and give him some cash
  2. Take title to the property.
  3. Lease it back to the former owner with an option to buy it back for one year.

  The speaker suggested that after one year, the house would be yours if the former owner didn't exercise his option. Sounds great doesn't it? You could beat out all your competition who are trying to "steal" the same house.

  Well, here's the catch. The poor homeowner in foreclosure will be your best friend when you make up his back payments. However, when the year is up and he can't get his house back, the trouble will begin.

  In a number of cases, these homeowners will go to court and claim that the "sale/leaseback" was really just a disguised loan. He or his attorney will ask the court to "re-characterize" the transaction as a loan and place title to the property back in his name (for an in-depth discussion of sale/leaseback re-characterizations, read "How to Structure Sale-Leaseback Transactions"). If the court agrees, the loan is illegal, since it is usurious.

  Here's how it works: Let's say that you find a house in foreclosure worth $100k. The balance of the loan $50k, and the homeowner is behind $5k. You agree to make up the back payments of $5k and take title. You then lease it back to the homeowner with an option to buy it back for $100k, its fair market value. What's the problem?

  The problem is that if the court re-characterizes the transaction from a sale/leaseback to a loan, you have loaned the homeowner $5k at 1000% interest! Think about it . . . you give him $5k, and he has to pay $50k ($100k option price minus the $50k loan balance) to get his equity back. 1000% interest is usury, and the court will set aside the loan. You will lose the house AND your $5k.

  If you're not familiar with the word "usury," it means charging more interest than permitted by law. The consequences of a usurious loan are usually civil; the court will declare the loan void and the borrower won't have to pay it back. If you get caught making usurious loans on a regular basis, you'll be hearing the words "loan-sharking" and "racketeering." These are CRIMINAL acts that will get you in jail. Many foreclosure real estate investors have been indicted on racketeering charges for doing exactly what I described above.

  The Better Way to Do It

  The safer way to deal with someone in foreclosure is to buy him out and get him to leave. If a person is in serious financial trouble, chances are he will get into trouble again. Thus, you will end up with a messy eviction and a court battle when the tenant/former owner. If homeowner insists on staying in the property, then simply lease it to him without an option to purchase.

  If the homeowner is not willing to be just a tenant and has significant equity in the property, offer a partnership arrangement wherein the partnership will own the property. Your contribution to the partnership is the money to cure the back payments due on the loan. The homeowner’s contribution is the equity in his home. The partnership will lease the property to the former homeowner for market rent. If he defaults on the rent payments, the partnership evicts him. The former homeowner still has a partnership interest, but he does not have possession. At that point, you can buy him out of the partnership.

  The partnership approach should not be approached without the assistance of qualified legal counsel.

Copyright 1998 All Rights Reserved.  No part of this publication may be copied
or reprinted without the express written permission of the Author.

William Bronchick, Esq.
Legalwiz Publications
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