THIS IS MY 93RD BLOG ON UNDERSTANDING MONEY TOOLS
I write these blogs for the general understanding of various
finance topics, trying to make them practical and understandable for the common
person.
My mission is to present financial information where hopefully
the reader will be able to take away at least one piece of information that may
be constructive and informative to them.
In this blog we will cover a hard learned and costly banking
experience that could happen to anyone.
I will try to keep this concise. A person had a close relative come to them to borrow
$100,000 to start a new company.
The person didn’t have that amount of money available, but had various
real estate, free and clear of any loans, including a home valued at
approximately $300,000. After
reviewing various possibilities to assist, it was decided that the relative
could borrow this amount of money using a low interest “home equity line of
credit” on the primary home/residence.
A line of credit can be used up to the maximum amount
approved and paid down at any time without penalties. There is a set duration for the loan. Interest is calculated only on the
outstanding loan balance. To make
this loan there are two possibilities within reason. The homeowner could borrow the money, sign the promissory
note and lend the money to the relative thus hurting his credit score or
another possibility. The latter is what was done. The homeowner would deed part of the home to the relative
for a period of time, the relative could then borrow against the asset where
they held an ownership position and because of this they could deduct all the
interest paid on their tax returns.
The homeowner would not be on the loan, not be negatively affected on a
credit score, and only give permission for an “encumbrance” of up to $100,000
maximum, which in the worst-case scenario he could afford to lose.
Here is the learning experience. The active loan was assumed by one of the large banks in
Chicago through a bank buy-out.
The new bank called all their home equity and commercial loans due and
payable at once. The homeowner and
relative didn’t have cash on hand or other liquid assets to payoff the topped
off line of credit of $100,000.
The relative never told the homeowner what was happening until the bank
foreclosed. The homeowner was
never notified by the bank of a foreclosure as they were not on the loan. First necessary step was to call his
lawyer, which was done. The lawyer
advised the “clock was clicking” fast on total foreclosure proceedings, no time
for a short sale of the home, therefore it was listed at a greatly reduced
price. In a real estate listing
agreement if a property is in foreclosure it must publicized as such. This is
when the vultures come out of the woodwork.
A contract was accepted at an extremely low price within a
week. Through this process all
parties concerned including the law firm representing the bank had to meet in
court in front of a judge for approvals to proceed.
After the buyers of the home were approved the title company
ran a title search. It came out
that the relative had another large loan that was in default and a judgment
against him in another county. A
judgment is “all encompassing” as to a person’s assets, not just a particular
pledged asset to a loan. That bank’s law firm took the action to court for
permission to “piggy-back” the Chicago bank’s loan. A new judge granted
approval.
Adding up the demise, the homeowner originally assumed that
the worst case scenario would be a loss of $100,000; wrong. Totaling up costs it was the original
amount of $100,000 plus court costs and all legal fees for the Chicago bank’s
law firm plus the second banks defaulted upon loan, court costs and second
bank’s legal fees. On top of that
there are bank loan penalties and interest accrued to date of close. Then, the
homeowner needed to pay his law firm for the representation and time in court.
What did we learn here?
- Be
careful when lending any amount of money.
- What
you think may be your top loss can be significantly different.
- Judges
can rule the way they want. There was no reason for the judge to permit the
second loan amount and judgment to go against this home, although it was the
most liquid asset and ready to close.
- Don’t
grant a loan where the encumbrance is more than 125% of loan amount. In this
case, an asset with significantly more value was lost.
- This
is a good way to create ill feelings between relatives.
- Lines
of credit normally can be called due and payable at any time.
In the end, the total value of the home was gone. And, the worst was that the homeowner
was me!
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