Q: A recent Washington Post column listed the following real estate transaction:
Mr. X sold a house at (street address) for $239,000 to Mr. Y. XYZ Mortgage Co. placed a mortgage of $185,000 at 18 percent for one year. The sellers took back a note for $119,000 for 13 years.
There must be a story here. Mr. Y's activity does not appear to make economic sense, and perhaps your readers should be alerted to these kinds of transactions.
A: Although I have deleted references to the names and addresses of the parties, you are correct in your observation that the purchaser's activities do not appear to make economic sense--for the seller. They make excellent sense for the purchaser, and it is my understanding that this kind of transaction is being done all over town.
Let's look at the transaction a little closer. The purchase price was $239,000. The first trust was $185,000, and the second trust, which the sellers took back was $119,000. If you add the first and second trusts together, this totals $304,000, or $65,000 more than the sale price of the house.
I suspect that the transaction took place as follows. The purchaser most likely approached the seller and offered the full price of $239,000. The purchaser further offered $120,000 in cash plus a second trust for the balance--namely $119,000.
The benefit to the buyer is that he walks away from the transaction with $65,000 in cash. And even if, a year from now, he is unable pay off the first trust, he can let the house go to foreclosure and still keep the $65,000. Since the house is clearly worth more than the first trust, it is doubtful that the purchaser would have any personal liability.
The sellers either did not know that they were being asked to take back a second (possibly thinking that they were taking back a first trust) or just did not comprehend the fact that the purchaser was placing such a large first trust on the property.
In either situation, the seller now faces serious problems. If the purchaser does not make payments on the first trust, that trust holder can foreclose on the property, thereby totally wiping out the seller's second trust. Indeed, the seller might not even be aware of a possible foreclosure, since they probably are not aware of the existence of the first trust lender.
Under D.C. law, there is no obligation on the part of a first trust lender to notify junior lien holders (second, third or fourth trust holders) of the possibility of foreclosure.
A properly drafted second deed of trust will require notice by the first trust holder prior to foreclosure and will also contain a cross default provision, guaranteeing that a default on the first is also a default on the second.
These are legal technicalities which will assist the second trust holder--in this case the seller--but will not adequately protect the seller. Even with full notice, if the first trust holder forecloses, unless the seller is able to come up with the amount of the first (or assume that first trust) the seller will be totally out of luck.
Sellers are urged to be very careful when confronted with this type of transaction. If a prospective purchaser makes an offer requesting that the seller take back secondary financing, the seller should insist that the contract spell out the terms and amounts of the first trust. If the amounts do not make sense, sellers should refrain from signing such a contract.
If a contract is in fact signed, when the settlement takes place the second trust holder (in this case the seller) should also see the first trust, obtain a copy and have the information put on the settlement sheet. Sellers should insist on seeing a complete copy of the settlement sheet, listing both sides of the transaction.
In my opinion, this kind of transaction leads only to disaster. Sellers should be very careful when approached with such offers. Check out the credit standing of the purchaser and discuss the entire contract with the appropriate advisers (financial and legal) before the contract is signed.
These past few years have been difficult for sellers. Nevertheless, all sellers should be on their guard, not to be taken advantage of in troubled economic times.