Better Business Bureau

PUBLICATION NO. 024
REVISED 11/09

Foreclosure Consultant Schemes

Whenever real estate values decline and market conditions are as they are now, the possibility exists that many homeowners will owe more on their home than the home is worth. If you find yourself facing foreclosure, you may receive a notice in the mail or a visitor at your door, or you may seek assistance on the internet, from a company that tells you that they can “STOP FORE­CLOSURE NOW.” Typically these foreclosure consultants offer to purchase your home, assist with back taxes or mortgage payments, or negotiate with your lender to obtain a repayment plan from your mort­gage company. Often solicitors or solicitations may imply an affiliation to your mortgage company or to a government agency.

They may also tell you that if you lose your home in foreclosure or sell it through a short sale, you can be liable for a substantial amount of income tax on the amount you save through "debt relief." Although the tax liability statement is true, their claim that they can help you avoid these income taxes when you let them help you get out from under your house payments is not.

Trusting homeowners who believe claims such as these and the solutions the companies offer can end up being talked into moving out of their home and deeding their property over to a third party. Or they are told they can choose to rent the property with the option to buy it back later. Unfortunately, the rent payment on the home is often higher than the homeowner can afford, and they may face eviction. Or, if the homeowner wants to buy back the property, the scam operator usually sets the price of the home higher than the homeowner can afford. Signing away your property can result in very serious conse­quences to you and, once the property is out of your hands, can be almost impossible to correct.

Generally, even though it is against California law for foreclosure consultants to charge or accept any compensation until they have fully performed everything they represent they will perform, these purvey­ors of home salvation request that you pay several thousand dollars before performing any negotiation services with your lender. At the same time, they generally make no guarantees of any positive out­come.

Despite their claims, these companies have no affiliation with any government agency and no special relationship with your mortgage company. Nor, as they may imply, have they any more ability to obtain more lenient repayment terms than you, yourself, have by contacting your mortgage company directly.

The consequences of doing business with a foreclosure racket can be heartbreaking. Some home­owners lose their equity and their homes. In some cases the initial mortgage has not been paid off and the deed was never transferred, as promised. As a result, the homeowner can be evicted and still owe the original loan amount. Serious tax consequences for the homeowner can also result, which we'll talk about later. In the end, you are almost certain to find yourself much worse off if you use a foreclosure consultant.

In addition, recent law, enacted to stem the skyrocketing foreclosure rate, attempts to assist borrowers whose residence threatened by foreclosure is their primary residence and whose loans were made between January 1, 2003 and December 31, 2007 and were secured by the residential property.

Briefly, the new law does not allow a notice of default to be filed against the property until 30 days after you've been contacted (provided they are able to contact you) by your mortgagee, trustee, beneficiary, or authorized agent for the purposes of assessing your financial situation and exploring options to avoid foreclosure. At the time of that call or another call or meeting you may request within the next two weeks, you will be given the phone number of a counseling agency certified by the U.S. Department of Housing and Urban Development (HUD), and you may designate such counseling agency or an attorney or other adviser to discuss options to avoid foreclosure with your mortgage holder. Any loan modifica­tion or workout plan offered would be subject to your approval.

You should be aware, though, that this assistance will not be available to you if you have already con­tracted with a foreclosure consultant whose primary business is advising people how to extend the fore­closure process and to avoid their contractual obligations to mortgagees or beneficiaries. It is also not available if a notice of default has already been filed or if foreclosure, rather than loan modification, is likely to cost the lender less.

Since the new law requires consideration of a loan modification in an effort to prevent foreclosure, foreclosure consultants are increasingly promoting these. Foreclosure consultants are prohibited from charging before they have fully performed what they have promised, but until recently, there were exceptions to the law governing foreclosure consultants. These included licensed real estate brokers and licensed attorneys.

More recent law became effective October 11, 2009, prohibiting collection of an advance fee by both licensed real estate brokers and licensed attorneys whose principal business is negotiating loans secured by real property. (Lawyers for whom negotiating such loans is incidental to the practice of law are not subject to this prohibition.) The prohibition also applies to taking any wage assignment, collateral or other security to secure payment. No power of attorney may be taken for any reason. This newest law also redefines “advance fee” to include a fee of any kind.

Real estate brokers and attorneys, as well as anyone else, who charge for their services after completion are required to provide a notice, in larger than usual print, to borrowers, informing them, in specified language, that they do not need to pay a third party to arrange a loan modification for them and that nonprofit housing counseling services will help them for free.

Your least expensive and probably most effective means of dealing with the threat of foreclosure is to work with your mortgagee directly or with a nonprofit counseling agency to which HUD might refer you. Nonprofit agencies may also be able to assist you with loan modification without charging you. (See the last section of this report.)

Some Legal Requirements

To protect consumers, California Law requires foreclosure consultants to register with the California Department of Justice and to maintain a $100,000 surety bond.

In addition, representatives of foreclosure consultants (a representative is anyone who solicits, induces, or causes a California residential property owner to contract with or pay any consideration to a foreclosure consultant) are required to hold a valid California real estate sales license and to have a bond from a surety company in an amount equal to at least twice the fair market value of the real property that is the subject of the contract. The representative must notify the con­sumer, in writing, under penalty of perjury, and send proof, that they are properly licensed and bonded. Failure to com­ply with these requirements will allow the homeowner to void the contract.

By law, the contract (which must be in writing) must also provide for a five-day cancellation right. If it does not, you may demand your refund or cancel your contract at any time, without regard to the five-day time limit. Despite the law's protections, though, if you are not dealing with a reputa­ble company you may find it difficult to enforce this right.

Nevertheless if the foreclosure consultant violates any part of the laws relating to foreclosure consultants, the homeowner may file a lawsuit seeking damages, attorney's fees and court costs, and any appropriate equitable relief. The court may award exemplary damages of three times what you paid the foreclosure consultant as well, and certain violations may result in an award of three times actual damages.

Damage to your Credit Report

Damage to your credit report is one of the worst consequences of letting your property goes into foreclo­sure or of trying to avoid foreclosure by deeding it over to some company that has given you unrealistic promises. First, if the lender doesn't agree to the assumption of your loan by whomever you've deeded your property to, the lender will not regard the transfer as a bona fide sale but will simply continue to look to you for repayment of the debt. It follows, then, that negative credit information, such as late payments or a foreclosure, received by a credit reporting agency from the lender, will become part of your credit record, not that of the company that acquired the property.

The "legally-permitted strategies" some companies claim they use to lessen or eliminate "potential future effects" appear to be only, in the case of a foreclosure on your credit record that results in your being denied credit, to provide a letter for you to submit to the credit reporting agency to explain that at the time of foreclosure you did not own the property.

Some of these companies offer supplemental credit repair services at extra cost. In case their origi­nal claims of protection against negative credit report information don't give you the assurance you want, you can, supposedly, make doubly sure no negative information will appear on your credit record by taking advantage of this service.

Whatever their claims, it's not likely that your credit report will remain free of the adverse informa­tion. The Better Business Bureau reminds you that no one can cause accurate negative information to be removed from your credit report before the time allowed by law has expired. (In most cases, this is seven years.)

Thus, in spite of claims to protect you from taxes for which you may not be liable in the first place, you may give up your property--and pay a hefty fee to do it--only to retain the tax liability you thought you were avoiding and to risk damage to your credit.

Short-sale and Foreclosure Tax Fallacies

Companies that make these offers may promote their services by sending you a free video or by offering financial counselors a commission for referrals. Their pitch is that if your property is no longer worth the amount of the loan against it, you have two choices: you can negotiate a short sale (a short sale occurs when the lender releases its collateral interest for less than your indebtedness to accommodate a sale of the property to a third-party buyer), or you can allow the property to go into foreclosure. Either way, they predict dire tax consequences.

The companies' plans provide for you to deed your property over to them and pay them a small per­cent­age of your original loan balance. Thus, they negotiate the short sale or allow the foreclosure. The 1099 form (the form used to report this and certain other kinds of income) for the amount of debt relief that represents taxable income, will be issued to them, not you.

The Better Business Bureau cautions homeowners against accepting at face value the representa­tions of companies offering plans such as this. First, these companies imply that whenever your property is worth less than what you owe on it, you will owe tax on the debt relief that results from either a short sale or a foreclosure.

The fact is that you may owe tax, or you may not, depending upon the circumstances. For example, fed­eral legislation enacted late in 2007 may exempt you from tax on up to $2 million of debt forgiveness on your principal residence for 2007, 2008 and 2009. Your best option would be to consult a tax adviser to determine what would be the case for you.

Not only, then, are there cases where you might not owe tax, but when you do, you may also be eligible for a federal capital gains tax exemption of up to $250,000 if you are single or up to $500,000 if you are married and filing a joint return. Whether and to what extent the exemption may apply depends upon the type of loan you have and such other factors as the property's fair market value and the amount of your equity and outstanding mortgage. Again, a tax adviser can help you with this.

Who's Liable for the Tax? You!

If you do owe tax, it's important not to accept as true the representation that the company you pay to buy your home, rather than you, will become liable for taxes if you deed your property to them. First, the Internal Revenue Service cautions that deeding your property to one of these companies does not con­stitute a bona fide sale. Rather, the IRS views the company as an agent, working for a fee, to help sell the property. And even if the IRS accepted it as a bona fide sale, the transfer of the property would con­stitute, for income tax purposes, a sale by you to the company, resulting in tax liability to you, not to the com­pany as the buyer. Furthermore, if you underpay your income tax because of this plan, the IRS says you will be liable for the tax deficiency plus interest and penalties.

The company may not receive the 1099 form after you deed your property to them because federal regu­lations do not require issuance of 1099s to corporations. But unless the mortgage holder is willing to

Foreclosure damages your credit record and can be one of the most stressful experiences you can face. By taking action early, you may be able to avoid it, whether you want to keep your house or move on.

Rev 11/09