The Five Principles of Advising Distressed Real Estate Clients

This article previously appeared in The Marin Lawyer.

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For many attorneys today, it seems like a day doesn’t go by without a call from a client seeking advice related to distressed real estate. Often the problem is that the client has fallen behind in mortgage payments, or a family home is seriously “underwater” (worth less than the debt on it), or an adjustable rate mortgage is about to increase dramatically.  These clients usually need advice on a range of issues – i.e. how to get their bank to change the terms of their loan, whether to seek a short sale, the consequences of foreclosure or strategic default, and the pro’s and con’s of submitting a deed in lieu of foreclosure or even filing bankruptcy.

The clients usually need all the help they can get, because the truth is many of these clients are seriously outgunned when negotiating with their lender.

Unfortunately, most homeowners are left to their own devices.  In October, Gov. Schwarzenegger signed SB 94, which prevents both attorneys and non-attorneys alike from collecting any pre-performance compensation (such as a retainer) for the purpose of performing any services related to a loan modification.  As a result, many homeowners are unable to find an attorney who will take on their matter, especially when the homeowner is facing foreclosure or bankruptcy.

The good news, however, is that many clients need no more than an hour’s worth of advice to figure out a good strategy, and that hour does not violate SB 94 as long as the attorney only provides general advice and does not perform any loan modification services.

At my firm, rather than turning these potential clients away, blaming SB 94 and wishing the client good luck, we decided to create 45-minute, flat rate general consultation for a fixed fee of $150 (approximately half our regular billing rate) where we advise on issues touching on short sales to foreclosures to bankruptcy. We have found that clients are extremely grateful and get most of their questions answered, allowing them to avoid major, expensive mistakes.

When advising these types of clients, I have found that there are five essential principles or “lessons” which are key to advising clients who need advice regarding distressed real estate.

1.  Up is down, down is up.  According to mortgage brokers, usually high credit ratings and a record of on-time mortgage payments is a good thing. That is not necessarily true these days.  Clients who need a short sale approved or want a loan modification don’t have much of a chance if they aren’t at least 3-6 months late on their loan.  In today’s bizarre economic climate, those who have not performed are more likely to receive lender approval and those who are current are ignored by the lenders.

2.  Strategic Defaults Are a Roll of the Dice.  Some clients want to walk away from a property, even if they can afford the payments, because the value has dropped so dramatically it shows little chance of recovery. Right now, a strategic default is a risky proposition, simply because it is unknown at this early stage whether banks will aggressively pursue owners of foreclosed properties.

3.  Banks Are Overwhelmed.  Throughout the years of escalating property values, banks had little use for their departments which process foreclosures and short sales, and staffing levels fell to a minimum. As the numbers of distressed properties skyrocketed, the banks struggled to hire and train staff to manage the deluge. As a result, homeowners need to be even more diligent in following up with their bank.

4.  Short Sales Are a Good Alternative to Foreclosure. I frequently advise clients who are months behind on their mortgage to attempt a short sale or deed in lieu of foreclosure, rather than allowing the property to go into foreclosure.  Having a short sale on your credit record may be like a “C-” grade whereas a foreclosure is more like a “D” or an “F” grade.

5.  Bankruptcy is an indirect threat. Many clients ask if they can use a bankruptcy filing as a “threat” to force banks to grant relief.  Bankruptcy may have no effect on a real estate issue, because first and second mortgage lenders have a secured interest in the property. However, a second mortgage lender whose only recourse after a foreclosure may be to go after the defaulting customer may be persuaded to accept a short sale offer if they know there’s a serious risk of the client filing for bankruptcy protection.

The most important lesson is to instruct these clients to make sure that they investigate their options and take the time to consider them. No decision should be made rashly or without thoroughly considering the options.

John Corcoran is an Associate with Plastiras & Terrizzi in San Rafael, focusing on real estate law, small business counseling and advising, and general civil litigation. He also provides advice to clients on general foreclosure/short sale/bankruptcy law in one-time, 45-minute consultations for a $150 flat fee. He can be reached at (415) 472-8100 or [email protected]