Affordable Housing Payoff Issues

There are various public entities that provide down payment and loan assistance to first time home purchasers which help many folks achieve the American Dream of home ownership. However, when those purchasers later want to refinance or sell their home, there can be issues involving the payoff of the public entity’s secured liens against the realty. We have several claims filed each year concerning these payoffs and it is our understanding that the title companies have similar claims experience concerning these loans.

The primary issue is that the public entity’s secured loan is often in a second position behind a first deed of trust which has been funded by a commercial lender. Generally, the public entity does not service its own loan, but enters into a servicing agreement with the commercial lender to assist the entity in servicing the monthly mortgage payments. The problem arises when the realty is sold or refinanced, and the closing attorney contacts the commercial lender for the payoff of both loans. Under the servicing agreement, it is usually the commercial lender’s responsibility to provide the payoff of not only its loan, but the loan of the public entity’s loan as well.

The claim often arises when the commercial lender does not include the payoff of the entity’s loan when providing the payoff of the commercial loan to the closing attorney. We even have a situation where the entity itself made both the first and second mortgages, yet failed to include the payoff of the second, but asserts that it was the closing attorney’s responsibility for not paying off its second lien. That eventually leads to the entity asserting a claim against the closing attorney that he or she failed to pay off the entity’s lien.

Naturally, it is our position that the entity needs to look to the commercial lender because of its responsibilities under the servicing agreement or the homeowner who is liable on any promissory notes to the entity. However, it is not unusual for the entity to disagree with our position and to make several attempts to first collect the payoff from the closing attorney (or title company).

If you have a closing where a public entity has a second mortgage behind a commercial first lien and the commercial lender is also responsible for providing the payoff of the second, do not rely solely on the verbal assurances of the commercial lender contact that the payoff they are providing is inclusive of both loans. Quite often, the contact at the commercial lender will verbally assure the closing attorney’s office that the payoff provided includes both loans, while not double checking to make sure that it does. Try to get a commitment in writing, such as an email, that the payoff includes both loans. That written documentation makes it easier for LML and the title companies to push back on the entity’s demand, asserting that they should be looking to the commercial lender under the servicing agreement for their funds, not the closing attorney, malpractice carrier or title company for the payoff.

Also, if possible, try to obtain a copy of the entity’s promissory note. The entity will initially demand a full payoff. However, there are often favorable terms within the note which provide us with ammunition that the entity is due less than a full payoff. For example, there may be terms where the note states that if the homeowner has been in the property a certain number of years, the debt is either automatically forgiven or reduced by a certain percentage depending on the years of ownership. There may also be provisions that the entity will accept the borrower’s net proceeds from the closing as a payoff, even if those proceeds do not fully cover what is owed to the entity.

Almost always it is our position in these transactions that the facts indicate that the failure to pay off the entity’s loan is due to an error made by the entity itself or the commercial lender servicing the loan. We also point out that the party who owes the entity is its borrower. However, the affordable housing entities still assert the payoff claim first against the closing attorney, often disputing our position, at least for the first several rounds of communication between us and the entities. Even if we successfully push back the claim onto the entity, borrower or commercial lender, the closing attorney loses potential billable time in reporting the matter to us, reviewing the file, copying documents for our investigation and searching for emails with the entity, borrower or commercial lender. We also sometimes need to respond to these claims financially depending on the underlying facts, triggering the closing attorney’s deductible. A little bit of risk management in these transactions on the front end can help eliminate lost time and money down the road if you recognize these transactions as higher risk which can lead to a potential future claim.