Legal Tip 236: What happens to the equity in a property if bank Sells a security property?

Discussion in 'Legal Issues' started by Terry_w, 4th Sep, 2019.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Someone asked me, the other day, what happens if a bank uses its powers of sale to sell a property when the borrower has defaulted on their loan if there is equity in the property.

    .i.e. The owner of the property has mortgaged it as security for a loan but can no longer meet the loan repayments. The lender takes the property using their rights under the mortgage and sells it to recover the money owed to them – what happens if there is money left over from the sale?


    Well, the bank, the mortgagee, certainly doesn’t keep that money. It belongs to the former owner, the mortgagor. The bank can only take what it is owed. Any excess ‘equity’ will be ‘refunded’.


    For Victorian property see s 77(3)(d) Transfer of Land Act 1958 (VIC) TRANSFER OF LAND ACT 1958 - SECT 77 Power of sale under a mortgage or charge

    For NSW property see s58(3) Real Property Act 1900 (NSW) REAL PROPERTY ACT 1900 - SECT 58 Power to sell

    For QLD property see s88(1) Property Law Act 1974 (QLD) PROPERTY LAW ACT 1974 - SECT 88 Application of proceeds of sale


    Other states have similar legislation


    Example
    Homer borrows $400,000 to buy a property for $500,000.

    It is an interest only loan so when Homer can no longer afford to pay the loan after 4 years he still owes $400,000. Homer might have had a medical issue or other family issue which prevents him from being able to work for a while.

    Homer defaults on the loan and the bank takes control of the property and sells it at its market value of $800,000. By this time the bank is owed $480,000, with interest and fees, so after the sale Homer will walk away with $320,000 ($800k - $480k) – less bit more perhaps due to sales expenses.

    Just before the bank took possession Homer was approached by a person who offered to buy the property from him for $550,000. Homer laughed and said “I can’t afford to pay the loan, but I am not going to give the property away”. Lucky for Homer he didn’t agree because he walked away with about $250,000 more than he would have if he had accepted that offer.
     
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  2. Trainee

    Trainee Well-Known Member

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    Wonder if people seriously take lowball offers before foreclosure because they think the bank just takes it all?
     
  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Some poor battlers do.
     
  4. d_walsh

    d_walsh Well-Known Member

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    Worth noting this scenario is only if the property is not cross-collaterised with anything else i.e. related business, another property etc otherwise bank can apply surplus proceeds against your other facilities
     
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  5. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    It actually applies to cross collateralise security too. If a bank takes possession of security property (whether one or 2) they can sell these and apply the funds to what is owed and any left over will go back to the owner, or other creditors if any.
     
  6. d_walsh

    d_walsh Well-Known Member

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    Yep, intention was just to clarify cross-collaterisarion scenario that equity from 1 property won’t be released from the sale if that particular asset if used to secure other facilities.
     
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  7. datto

    datto Well-Known Member

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    It would be a bit rude if the owner was then left with a CGT bill after the bank sold him up.
     
  8. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    That will still easily happen.

    e.g. $400,000 purchase price.
    $300,000 loan
    can't pay
    bank sells it for $700,000, takes the loan and costs of $350,000 and leaves him with $450,000.
    His capital gain is $700k - $400k - loan costs not paid and stamp duty etc say $70k = 230k capital gain. he might still pay $50k in CGT
     
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  9. G..

    G.. Well-Known Member

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    What are the obligations of the bank to reduce the owner's losses when selling the property? I know that they need to get a fair price and that's why they usually end up at auction, but what about forcing the owner to vacate the house and pay rent when they are still liable for the payments and interest on the property that they own.

    I have heard stories of WA and mining towns where a family has been booted out due to mortgage arrears on a property with negative equity. The family then pays rent to a landlord in order to live in a rented house whilst the bank sits there with an empty house until it sells. The bank (or mortgage insurer) then ends up being owed money by a bankrupt family. Wouldn't it be better for everyone if the bank didn't boot people out until it sold? They may not get the full mortgage payments but at least the rent would be a lot better than nothing.
     
  10. d_walsh

    d_walsh Well-Known Member

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    If the owner is co-operative, sometimes they can stay but they’d need to agree to provide vacant possession if purchaser requires (most of the time either the bank or purchaser wants vacant possession to avoid any issues).

    If owner isn’t co-operative, Bank will obtain vacant possession first through the court so they can actually sell it and recover money.

    What they don’t want is to try sell, owner resists, the sale fails because owner won’t leave, then court process etc and then start again. Just increases costs for everyone and delays what could have been a simpler / smoother process.
     
  11. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I wouldnt put it past the ATO to access data from lenders on default sales. The revenue risk for people who cant afford to pay a bank is probably a risk indicator for evasion or non-compliance to pay taxes due. For some (eg farmers, commercial property) could even be a GST issue.

    I have also seen garnishee notices issued to buyers. ATO notice requires the buyer not settle a cent in favour of the vendor (after paying usual settlements to payout etc) and to remit any payment to the ATO. Usually when vendor has a large tax debt rather than a unrealised possible tax bill coming. Buyers get panicky but I just refer them back to their solicitor. Often if its a conveyancer it needs extra legal advice.

    If they were financially unable to pay the tax due ATO may approach it as a bankruptcy issue. ATO dont just waive tax. They can on application however. I have had a few wins in the past under their hardship policy which is pretty tough but can be fair. They wont bankrupt someone for the fun of it. Terry example had equity but I have seen many cases where the payout after sale means there is nothing in cash and yet taxes can still be liable. Usually long term cases where arrears of taxes incl rates, land tax etc and loan amounts have compounded.
     
    Last edited: 12th Sep, 2019
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  12. datto

    datto Well-Known Member

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    Imagine if some unfortunate individual has a serious accident or illness and can't afford to make loan repayments.

    First the bank sells them up, then the ATO comes in with a flying kick to the guts. "Come on Sunny Jim, pay your tax debt or we'll sell that bed you're recuperating on".
     
  13. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Thats nothing. I had a mate who had a heart attack, his wife left him, his business collapsed and the bank foreclosed on his 3 cross collateralised properties, one of which had dropped in value - bankrupted him. Not sure what order it all happened, but think the heart attack first.
     
  14. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Sounds like a county and western song
     
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  15. Username86

    Username86 Well-Known Member

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    Good tip.. I have heard of a well known property educator who advises her students to tell people in mortgage stress that this will not occur in order to get them to sell or hand over thier property prior to the foreclosure.
     
  16. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    There would be many legal issues with that. It is misleading and deceptive for starters. Hope the students have received legal advice.
     

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