During the era of Prohibition in the 1920’s and 30’s, bootleggers illegally produced and distributed alcohol as a way to meet the unquenchable demand for the banned substance. Gangsters such as Al Capone and Bugs Moran became famous for their involvement in the illegal alcohol trade, which was estimated to be worth billions of dollars by the end of the 1920s.
Today, there is a new form of illicit activity that was also triggered by a form of government prohibition. This new moonshine involves illegal hard-money mortgages. The elixir is being served up to desperate homeowners who are in financial distress and likely facing foreclosure. These under-the-radar loans are being touted by new-age bootleggers as a way for struggling homeowners to easily tap their equity in a foreclosure rescue scheme.
In the end, the consumers of these illicit trades are left with mortgages that have exceedingly onerous terms, illegal provisions and impossible demands – all leading to re-default and loss of the home to the very mobsters who provided the “rescue” in the first place.
What is a Hard Money Loan
Hard money loans are typically short-term loans (1 to 3 years), with high interest rates, that are secured by the borrower's equity in their home. These loans are made by private lenders or investors looking for above-market returns on their money. These lenders ignore the borrower’s credit or ability to repay the mortgage (or lack thereof), focusing almost exclusively on the significant amount of equity in the home. The home serves as the “hard” asset that secures the high rate of return to the lender. This is a type of “loan-to-own” scheme because the lender simply wants to make an impossible loan to the homeowner so it can later become the owner through foreclosure and capture all the equity.
The demand for these loans comes from borrowers who have poor credit, are in financial distress and may be in default or facing foreclosure. These homeowners simply do not qualify for traditional mortgages. They desperately want to save their homes and are seeking any solution, no matter how burdensome. In response to this demand, there are plenty of moonshiners who are willing to produce the product that consumers are seeking.
Are These Loans Illegal?
Private lending is not illegal. In fact, hard money mortgages, in general, are not illegal. However, it is the specific terms and methods used by certain hard money lenders, especially the “loan-to-own” approach, that clearly violate federal law.
To return to the bootlegging analogy, even during Prohibition, the Volstead Act provided certain exemptions which allowed for the production of certain alcoholic beverages, such as “Near Beer,” medical uses, and religious exemptions. However, the outright production and distribution of alcohol remained illegal.
In private lending, there are several ways to make a legal hard-money loan (a “Near Beer” hard money loan, if you will). For example, commercial or business hard-money loans would not trigger the federal laws for consumer protection. Further, a fully-amortized, 30-year fixed-rate mortgage at, say, 5% APR with a payment that was affordable after a review of the borrower’s income and expenses would almost certainly pass all the tests for legality. However, these fair loan terms are of no interest to the common day bootleggers; there simply isn’t enough juice in the deal to spark their attention. Rather, it is the more reckless short-term, high-interest rate hard-money loans that wet their whistle.
Consumer Protections After the Sub-Prime Mortgage Meltdown
It is important to understand where these regulations originated from and for what purpose they were implemented. The subprime mortgage meltdown of 2008 was caused by a combination of factors, including lax lending standards, complex financial instruments, and a housing market that was rapidly overheating. In the aftermath of the crisis, lawmakers and regulators took steps to reform the mortgage industry and protect consumers from predatory lending practices. Several new laws and regulations were enacted, including the Real Estate Settlement Procedures Act (RESPA), the Home Ownership and Equity Protection Act (HOEPA), the Truth in Lending Act (TILA), the Ability-to-Repay rule, the Tangible Net Benefit requirement, and the prohibition on high-cost loan features like balloon payments, default interest, and negative amortization. These new laws and regulations were designed to protect vulnerable consumers from predatory lending practices and ensure that mortgage lenders were making loans to borrowers who could afford to repay them.
Like the bootleggers of the Prohibition era, the lenders of illegal hard-money private mortgages are simply operating outside of these laws, using high-pressure tactics and false promises to convince borrowers to sign on the dotted line. They have made a practice of completely ignoring the warnings and legal restrictions that were put in place after the 2007-2008 mortgage meltdown and the Great Recession, such as making sure the borrower has the ability to repay the mortgage and that the loan provides an actual benefit to the borrower and does not just serve to line the pockets of the mortgage brokers.
The consequences to borrowers who get ensnared with these lenders can be severe. They easily find themselves in a situation where they are unable to repay the loan when the massive balloon payment comes due. This inevitably leads to foreclosure and the loss of their property. In some instances, these hard money lenders are really making a “loan-to-own” with the intent that the borrower will have no choice but to default, and the lender can simply foreclose and take ownership of the home with a large amount of equity remaining for them.
Schemes to Evade the Law
The schemes these lenders use to evade consumer protection laws are numerous. Most use falsehoods such as claiming the borrower’s home is actually a rental or that the borrower is using the money for a business rather than to cure the default and stop a foreclosure. In these situations, the lender requires the homeowner to sign documents which falsely claim that the loan is for a business or for a vacant home. Desperate homeowners facing foreclosure agree to sign in order to save their home. More elaborate schemes make the loan appear to be an ‘”equity sharing” agreement or some type of sale/rent back structure.
The ruse is quite easy to uncover, yet the proliferation of phantom business loans persists because enforcement and punishment is hard to come by for a homeowner in financial distress. They can’t afford to hire an attorney and the matter is too complicated for a pro bono legal services clinic to handle. There is little recourse for them, even when these criminals are caught. And even when legal cases are brought against the lender, the borrower is forced to pay back certain amounts of the loan that were used for the borrower’s benefit.
Many times, these modern era bootleggers and moonshiners threaten the very homeowner they victimized with counter lawsuits if they speak up. The perpetrators claim that the borrower committed fraud when they signed the “business purpose” statement when, in fact, the mortgage broker and lender instructed them to do so. What’s even more egregious is that these mortgage brokers have a fiduciary duty to the borrower which is completely ignored since the broker is focused solely on securing the commission.
Homeowners Beware
Dishonest private hard-money lenders are offering products that are not only too good to be true but are designed specifically to take advantage of homeowners who have run out of options. Their goal is to orchestrate a money grab, foreclosing on the home and pocketing a huge profit when they sell it. While hard-money mortgages may seem like a good option for borrowers who have poor credit or who do not qualify for traditional mortgages, they can be extremely risky and typically violate several federal lending laws. Borrowers who are considering a hard-money mortgage should be aware of the risks and should carefully review all terms and conditions of the loan before agreeing to it. Additionally, if a borrower believes that their hard-money mortgage has violated any federal lending laws, they should seek legal advice and file a complaint with the CFPB.
Like the bootleggers of old, these unscrupulous schemers will eventually be caught and punished for their illegal activities and gangster-like tactics. Knowledgeable consumers are increasingly fighting back by reporting them to government authorities and filing suit against them in state and federal courts.
Help is Available
If you have been victimized by a hard money lender, there is help available. By working with established and reputable companies like Lawyers Realty Group, homeowners can protect themselves from fraud and find the mortgage relief they need.
Contact Lawyers Realty Group Today at (949) 264-0966
Never let anyone pressure you into a loan you don’t understand and can’t afford. Speak to an attorney immediately before you sign anything. Reach out to our expert Attorney/Realtor today at (949) 264-0966 for a free legal analysis of all of your options. We will outline the best course of action for you without any cost or obligation.
Lawyers Realty Group was established over 20 years ago to provide a higher level of professional representation for homeowners in difficult situations. By combining expert legal representation with comprehensive real estate transactional services, homeowners receive unparalleled service and protection.
Additional Resources:
The real estate laws and regulations can be found below:
Real Estate Settlement Procedures Act (RESPA): 12 U.S.C. § 2601 et seq.
https://www.consumerfinance.gov/policy-compliance/rulemaking/regulations/1024/
Home Ownership and Equity Protection Act (HOEPA): 15 U.S.C. § 1602(aa) and 12 C.F.R. Part 1026
https://www.consumerfinance.gov/policy-compliance/rulemaking/regulations/226/
Truth in Lending Act (TILA): 15 U.S.C. § 1601 et seq. and 12 C.F.R. Part 1026
https://www.consumerfinance.gov/policy-compliance/rulemaking/regulations/1026/
RESPA is a federal law that requires mortgage lenders to provide borrowers with certain disclosures and protections. Among other things, RESPA requires lenders to provide borrowers with a Good Faith Estimate (GFE) of the loan costs and a HUD-1 settlement statement at closing that shows the actual costs. RESPA also prohibits lenders from paying kickbacks or referral fees to real estate agents or other parties involved in the transaction.
HOEPA is a federal law that applies to high-cost mortgage loans. HOEPA requires lenders to provide borrowers with certain disclosures and protections, including a notice that the loan is high-cost and the right to cancel the loan within three days of closing. HOEPA also sets limits on the fees and charges that can be associated with high-cost loans, as well as the interest rate and points that can be charged.
TILA is a federal law that requires lenders to disclose the terms and costs of a loan in a clear and understandable manner. TILA requires lenders to disclose the Annual Percentage Rate (APR) of the loan, as well as the finance charges, the total amount of payments, and the total amount of interest paid over the life of the loan. TILA also gives borrowers the right to rescind certain types of loans, such as home equity loans, within three days of closing.
The Ability-to-Repay rule is a regulation issued by the Consumer Financial Protection Bureau (CFPB) that requires lenders to make a reasonable and good faith determination of a borrower's ability to repay a mortgage loan. Under the rule, lenders must consider the borrower's income, assets, debts, and other financial obligations when making this determination. Lenders must also verify the borrower's financial information and document their decision-making process.
The Tangible Net Benefit requirement is a requirement that some states have imposed on lenders. This requirement mandates that lenders must provide borrowers with a tangible net benefit from refinancing their mortgage, such as a lower interest rate, a shorter loan term, or a lower monthly payment. The requirement is designed to protect borrowers from being pressured into refinancing their mortgage when it is not in their best interest.
