Equity skimming is a type of fraud that consists in the practice of defrauding homeowners of their equity, usually when they default on their mortgage or real estate taxes.
Often this involves schemes from mortgage brokers looking for uneducated people who have equity in their homes. Homeowners end up refinancing into mortgages they can’t afford. When payments are late, these unscrupulous lenders get creative. They may refinance again and again every few months taking more closing costs and points until there is no equity left in the property. Others persuade the borrower to sign a deed in lieu of foreclosure, essentially giving the lender the property.
Other times, it involves people calling themselves investors who see large piles of equity in properties headed for foreclosure. They approached the landlord and told them that by selling their residence to the “investor”, it would clear the blackboard and the “investor” would assume all debts and obligations related to the homeowner’s property. The homeowners complied and lost all of their equity in their property.
This sounds like theft, but before we judge “investors,” it may be the only possibility for a homeowner to save himself from financial ruin. Let’s face it – if the property is foreclosed on, the homeowner will be evicted. He and his family may separate or end up in a homeless shelter. If the property is sold for less than what is owed to the lender, the lender will go to court and accept a judgment against these poor homeless people. The decree is valid for twenty years and can be extended twice. The lender can receive any salary the borrower may get in the future including tax returns and lottery winnings. To get out of paying the verdict, the borrower files for bankruptcy (if he can afford it). Then, the IRS came looking for him. The loss that the lender incurs at the auction, including all legal fees, is considered an income gain for the borrower. This gain is a taxable event. The IRS won’t stop until they get their taxes and penalties out of these defaulting borrowers. The borrower loses his house and must pay taxes on the loss. Now the picture might be a bit clearer for you.
Does this sound like a fair trade – all equity in the house for a “fresh start” in finances, credit and life? Possible. However, the question remains: When is this procedure fair and when is it robbery (ie equalization of equity)?
There are many factors that must be considered. The biggest consideration is the proximity of the foreclosure date. If the foreclosure process is still in its early stages, there are at least eight options a homeowner has to alleviate the problem. A conscientious professional investor should use his knowledge to help calm the homeowner and explain in detail all of his possible options. Most of the time, a call to an honest real estate broker and the problem is in the process of being resolved. Sell the house and use the cash to start over.
Conversely, if an investor finds out about the property two or three weeks before the auction, it is nearly impossible for a real estate broker to find a qualified buyer who is ready to close before the auction. In this case, no other options are available. The homeowner will be lucky to accept any offer, and would be wise to take it. Usually, first, last, and security for the new apartment and access to the moving van will be generous for an investor to offer. If there is substantial equity in the property, a future chunk of cash may be appropriate.
The main thing to remember here is that like in every encounter you have in life, you must always remember to structure deals so that everyone wins. You as an investor may get equity, but you have to handle these sensitive people with kid gloves and ensure that they also benefit from the transaction – and are satisfied with your proposed solution.