John T. Reed' review of Russ Whitney' book Building Wealth 2 Legal? Is this legal? Whitney says, "all the paperwork was prepared by attorneys so it was safe and legal for both of us." Gimme a break! The mortgages are not safe for any of the three parties. Whitney has overfinanced by putting $25,000 worth of mortgages on a $25,000 house. His total costs of paying two mortgages plus the other carrying costs like property taxes, insurance, repairs, and so forth, mean he and his wife are paying far more to live at 3160 Guilderland than they should. The first mortgage is not safe for the bank. It is well known in the mortgage industry that the main cause of defaults and losses is lack of equity"”not divorce, losing one' job, and so forth. When the homeowner/borrower has equity in the property, he will fight to defend it. When he has no equity, as is the case with Whitney in this deal, the borrower is far more likely to walk away if he has financial difficulty. Also, they seemed to be counting on the installation of the aluminum siding to increase the value and thereby increase the security of the mortgage. Apparently, Whitney did not install the siding. Finally, the deal is extremely unsafe for the second mortgage lender. In the event of a default and mortgage, the property will typically sell for 5% to 20% less than its current market value. That will pretty much wipe out the second mortgage. Another way to look at it is what would the previous owner be able to get for his second mortgage if he tried to sell it for cash. Little or nothing. Indeed, I suspect the prospective buyers would laugh in his face. They would regard the second as a sort of lottery ticket"”worth something, but not much. "Left?" Whitney says, "We closed [the new first mortgage], the banker left and the seller and I went into the next room to complete the deal." I can"t say for sure without seeing the loan applications and talking to the bankers in question, but based on my 33 years knocking around the real estate industry, this sounds like a "sneaky second." A "sneaky second" is a second mortgage which is put on a property, but not disclosed to a first mortgage lender. Why is it not disclosed? Because the first mortgage lender would not make the loan if they knew about it. Whitney says the "banker left." Why would he leave? Because he thought it was over. Why would he think that? Most likely because he was not told that the previous owner was, in effect, going to make a new hard-money, second mortgage loan to Whitney. Whitney says the seller and he, "went into the
next room to complete the deal." Why would they do that? Why not stay in the first room? Title companies usually charge for the rooms. Why pay two room charges? Once again, probably to conceal the second mortgage from the bank. Whitney says the name of this technique is "seller subordination." Bull! Why would we real estate people call it that? The second lender in this transaction is not the seller. He sold the property to Whitney 15 months before. Back then he was the seller. Now he' the former owner and second-mortgage holder. I already told you the real name in the industry for this technique: "sneaky second." Fraud What this appears to be is two illegal acts. 1. Telling the bank that the $4,000 cash-out proceeds were going to be invested in aluminum siding on the mortgaged property when, in fact, they were not. 2. Concealing from the bank the plan to place a $7,000 second mortgage on the property. What laws prohibit this stuff? With regard to the siding, 18 USC 1014 comes to mind first. If the loan involved HUD, like a Title I home improvement loan, 18 USC 1012 comes to mind. When you sign a loan application, these federal laws are generally cited in the statement above where you sign. They prohibit false statements to federal lenders. Banks are generally federal lenders because of federal deposit insurance. With regard to the possible concealment of the second mortgage from the bank, 18 USC 1001 comes to mind. That law is also often cited in the sentence just above where you sign a mortgage application. The app my wife and I signed in 10/02 to refinance our home cited this statute. When the government prosecutes this sort of stuff, they also often invoke the mail fraud statute 18 USC 1341. Mail fraud is a misnomer. You do not have to mail a fraudulent document to be guilty of mail fraud. You cannot avoid mail fraud by using Federal Express or hand carrying everything. All you need to do is commit fraud, and anyone in the deal send or receive anything by mail as part of the transaction. Was anything mailed in connection with his refinancing of his home? Probably. If you commit mail fraud more than once in a ten-year period, you can be charged criminally or civilly under the federal racketeering statutes: 18 USC 1961-4. The bank could actually sue Whitney civilly under 18 USC 1964 if he did two deals that involved mail fraud in a ten-year period. Furthermore, if they win, they get triple damages. Another statute the government frequently invokes with regard to mortgage fraud is 18 USC 371 or conspiracy. This would be a hazard to both Whitney and the previous owner/second mortgage lender. The essential elements of federal conspiracy are two or more people not only conspiring to defraud someone connected to the federal government (lenders are connected by federal deposit insurance and federal charters), but actually doing some act to bring the conspiracy to fruition. These federal laws are all felonies. That is, the punishment for violating them is a fine and/or prison time. State law What about state laws? There are two kinds of state law: common law and statutes. Common law is law descended from England. It is based entirely on court decisions. All common laws are civil only. There are no criminal common laws. Statutes are actual laws passed by the legislature and signed by the executive or having enough votes to override his veto. The federal felonies listed above are all statutes. State statutes can be felonies, misdemeanors, or civil violations. Here are some common laws that might be violated by lying to a lender about your intent to put aluminum siding on a house and about concealing your intent to place a second mortgage on the property. "¢ deception "¢ fraud "¢ misrepresentation "¢ negligent misrepresentation "¢ unjust enrichment "¢ fraud in the inducement and inception of a contract "¢ breach of contractual covenant of good faith and fair dealing "¢ unconscionable actions "¢ deceptive trade practices I"ll research the New York Statutes that might be triggered by this deal later. Tax-free cash Finally, Whitney says he, "walked away"¦with $11,000 in tax-free cash." Well, duh. It' an income tax, not a cash tax. All he did was borrow $11,000 more than he needed to pay off the old mortgage. Loan proceeds are not taxable income. And he apparently had to violate multiple laws to do that. He did not "make" $11,000 in any sense of the word. The fact that he brags about "walking away" with the whole $11,000 appears to indicate that $4,000 of it did not end up in the pocket of an aluminum-siding installer as the bank was promised. How-to book It' not just what Whitney brags that he did. This is a how-to book. He is urging his readers to follow his example. If you tried to do what Whitney says he did in this deal, you could lose your credit, reputation, and even your liberty. That is, you could be convicted of one or more crimes and go to jail. Furthermore, it is very likely that you would not be able to make the monthly payments on so much excess financing. So if the legal violations did not get you, inability to make the payments probably would. You would fall behind, thereby lose your good credit, and possibly lose your home to foreclosure. Banks do not turn down loans like this when they know all the facts because they are mean or stupid. They turn them down because they have hundreds of years of experience and know what is likely to work and what is not. Generally, if no lender will give you the loan, you probably shouldn"t want the loan. I cannot say for sure that Whitney broke the law in this deal. I don"t know all the facts. But I know a lot from his books and the public records and normal practices in the real estate industry. I would say the probability is above 90% that he committed multiple law violations in this deal. What I do know for sure is that it is extremely irresponsible to put this deal in a how-to book with no warnings regarding all the legal issues I have just discussed. Sale of the house On 6/29/82, Whitney sold this house on a land contract along with three properties on Eagle Street in Schenectady for a total of $10,000 in cash and he took back a mortgage for $36,500. On October 30, 1985, Whitney deeded the house to the land contract buyers and paid $108 in transfer taxes. A month and a half later, on 12/11/85, the land contract buyers deeded the house to some buyers and paid $170 in transfer taxes"”a 57% price increase in 42 days"”and they took back no mortgage when they sold. Forget Russ Whitney' Building Wealth. Get the book written by the two guys who bought the house from Whitney (One is now a prominent Schenectady RealtorÂ®). Whitney sounds like some inept beginner who got snookered by a couple of guys who really knew what they were doing. On 12/12/85, Schenectady Trust recorded a discharge of their $18,000 mortgage and the guy who sold Guilderland to Whitney recorded a discharge of the $7,000 second. Ultimately, how much Whitney "made" on this deal is the difference between what he bought it for and what he sold it for. He sold the house as part of a four-property package. He got $10,000 in cash for all four properties. If we crudely allocate the cash and mortgage taken back 1/4 to each of the four properties, Whitney got $10,000 Ã· 4 = $2,500 in cash for the home. Whitney put down $4,000 in cash in 1977, says he spent another $1,500 on fix-up, for a total cost of $18,500 + $1,500 = $20,000. So the total cash he put in was $4,000 + $1,500 = $5,500. Since he got back only $2,500, that' a net loss of $5,500 - $2,500 = $3,000 in cash. In the four-property sale, Whitney also took back a $36,500 mortgage. If we again divide by four it means the amount of the mortgage Whitney took back on the house was $36,500 Ã· 4 = $9,125 in 1982. Roughly speaking, he traded the diminution in cash"”$5,500 - $2,500 = $3,000"”for a $9,125 third mortgage. He also spent a lot of his own labor and that of his brothers in law fixing the place up. If he had put the $5,500 in risk-free, hassle-free, 5-year Treasury bonds in 1977 instead, when the going rate was 6.99%, he would have ended up with $7,710 in cash in 1982. If he had also spent the hours he worked fixing this house at a salaried job, he probably would have made another thousand or two. When you take the extra risk and hassle and time consumption of rehabbing a house, you ought to get more compensation than if you invested in Treasury bonds and took a job cleaning office buildings. Whitney did not get adequately compensated for the extra risk and time he devoted to this property. In other words, this was a lousy, inadequately profitable real estate deal. So what really happened to the $11,000 Whitney claimed he "made" within three weeks of reading Haroldsen' book. It was just a loan. He had to pay it back and did just that on 12/12/85. Between when he "made" the $11,000 and when he paid it back, he paid interest on it. But that fact has not stopped him from citing his "making" $11,000 in his first three weeks in real estate to prove what a real estate genius he is and thereby sell millions of dollars worth of books, cassettes, seminars, and consulting services. Unbelievable. "Financial independence" On page 18 of Building Wealth, Whitney says, "By the time I turned 23, I was able to quit my job, because I had become financially independent." What a guy! But then this is the same guy who told us he "made" $11,000 within three weeks of getting into real estate. Maybe we"d better check out his claim of "financial independence." First, let' define it. Whitney' definition is that you are financially independent when you are self employed. By that definition, shoe shine guys are financially independent. I thought financial independence meant you didn"t have to work any more. A lot of guys seem to think they"re financially independent when they can live off a woman. I would call that being a kept man. He says he met his wife at Tobin Packing where they both worked. In 1980, when he was about to turn 25, he hit a pedestrian at around 2:30 in the morning. He testified in court in conjunction with that incident that his wife was at work when he got home"”at 3 AM! He also testified that he drove a "78 Toyota pickup and that his wife drove a "75 Plymouth. This would be two years after Whitney says he became financially independent. Apparently, he was financially independent, but his wife was not. Was he loafing? No. Spinning his wheels would be a better description. The night he hit the pedestrian, he was coming home from his own job that finished at 2 AM. The attorney of the pedestrian he hit tried to prove that Whitney was working too hard and not getting enough sleep and fell asleep at the wheel. Some financial independence. Confederation of Organized Purchasers, Inc. What job was that? He was a salesman for what he described as a furniture co-op. Actually, it was the Confederation of Organized Purchasers, Inc., which appears to me to be a scam. The initials spell COOP, but in a news story on page 9 of the 1/26/82 Schenectady Gazette, their attorney claimed they were not a co-op, but rather were merely a corporation. That story said the attorney general had issued a subpoena for COOP' records and was investigating it. They went bankrupt on 1/29/82. In bankruptcy, the owners filed suit against former officers alleging that they had mishandled assets. At the time of the bankruptcy, they closed the store where Whitney had worked. The phone company cut off their lines because of bad debts. Whitney says he invested and lost $12,000 in it. Plus his job was to get consumers to pay $550 to join it, which he apparently did. Presumably, they lost their $550 "membership" fees, too. An officer of the company who insisted on anonymity in the Gazette story said, "A lot of people invested because of me. I lost a lot of my own money, and my parents lost money." That person could be Whitney, although he would have had to be referring to his in-laws with the word "parents." 455 Hulett So what real estate did he own on 11/18/78, the day he turned 23, the day he claims to have been "financially independent?" He bought the aforementioned 3160 Guilderland Avenue, a single-family house in Rotterdam, NY on 3/11/77 for $18,500. Around August of 1977, he says he bought a duplex at 455 Hulett Street in Schenectady. Actually, that' not in Building Wealth. In Building Wealth, he claims , "I made my first fortune in upstate New York," but refuses to name the city (Schenectady). You can only get the details of this "first fortune" by going to Schenectady (which I did) or by reading his 1984 books about Overcoming"¦ (which I also did). On 6/9/78, he paid $6,500 for 455 Hulett"”a slum duplex"”putting $1,500 down. As far as I can tell, that is the entirety of Russ Whitney' real estate dealings before his 23rd birthday on 11/18/78. So how did he become financially independent "by the time [he] turned 23?" He bought a house for $18,500, then refinanced it for $25,000 and bought a slum duplex for $6,500. That' it, folks. Does that sound like financial independence to you? Me neither.