Are Russ Whitney' property improvement loan techniques illegal? by John T. Reed 1 Russ Whitney brags about and advocates what he calls "overfinancing" techniques in his various books. One of the two categories of this are property improvement loans. I understand from his promotional material, he and/or his instructors do the same at some of his seminars. Are these techniques legal? Probably not. I will address the issue from two perspectives: 1. Did Whitney break the law in the deals he tells about? 2. Should you do what he advocates? I researched this by interviewing some of the top experts in the nation on improvement loans. I also let Whitney' attorney read an advance copy to see if it had any errors or omissions. Two fundamental principles of improvement loans There are two bedrock principles when you apply for a property improvement loan: 1. You must tell the truth, the whole truth, and nothing but the truth on the application and in any related discussions. 2. The loan proceeds must be used only for improvement of the property in question. Did Whitney break the law? I think Whitney almost certainly did break the law, but I cannot say for sure without seeing the loan applications and interviewing the loan officers and such. Also, if your definition of breaking the law is being convicted, I am not aware of any prosecutions of Whitney for mortgage law violations. (He was convicted of second degree robbery and did time in state prison in New York for that. He also lost a million-dollar lawsuit with regard to hitting a pedestrian.) That he has not been prosecuted with regard to his "overfinancing" techniques may just mean the prosecutors are too busy or are not aware of what he did. There is a lot more law breaking in the world than there are prosecutions. Having noted that some of the pieces are missing, let me go ahead and analyze the pieces we do have. HUD Title I improvement loans Whitney is a big advocate of Department of Housing and Urban Development Title I improvement loans. He claims to have obtained them on a number of occasions. The starting point for ascertaining whether someone broke the law is to ask, "What, exactly, is the law?" In the case of Title I improvement loans, it is 12 USC 1703. The original name of the law, as it was going through Congress, was the National Housing Act (1934). Title I, Section 2 of the National Housing Act as amended is another common citation for this law. The basic idea of HUD lending is that the federal government"”that is, the taxpayers"”insure such loans in order to encourage private lenders to make them. If the borrower doesn"t pay the loan as agreed, and the lender suffers a loss, they can file a claim with the federal government to get reimbursed for their loss just as you might file a claim with your car insurance company after an accident. HUD makes a federal case of everything"”literally So although you get the loan from a local bank or savings and loan, the loan is a federal matter because of the insurance provided by the federal government. The fact that it is a federal matter means that the law enforcement authority who gets called when the law may have been violated is the FBI. If the FBI does, indeed, find evidence of a violation of the law, they refer the matter to the United States Attorney"”that is, the U.S. Department of Justice' local prosecutor. If they decide to indict you, the case will be tried in federal court. In the citation of the law above, 12 USC 1703, USC stands for United States Code, which is the official name for federal law. As is often the case with federal laws, the Congress and President put a phrase in the law that tells the cabinet department in question to create regulations to enforce the law. In 12 USC 1703, it says, (h) The Secretary is authorized and directed to make such rules and regulations as may be necessary to carry out the provisions of this subchapter. "The Secretary" refers to the head of the Department of
Housing and Urban Development. To see whether Whitney' "overfinancings" break the law, we must look at those regulations. In the case of HUD Title I improvement loans, they are at 24 CFR Part 201. "CFR" stands for Code of Federal Regulations. The section that is most pertinent to Whitney' "overfinancing" is 24 CFR Part 201.20. To qualify for a Title I loan It says, in part, to get a HUD Title I improvement loan: "¢ you have to own at least a half interest in the property in question ('§201.20(a)(1)(i) or a half interest in a land contract to buy the property in question ('§201.20(a)(1)(iii) [emphasis added] "¢ "The loan proceeds shall be used only for the purposes disclosed in the loan application." ['§201.20(b)(1) emphasis added] "¢ "If the borrower plans to carry out the improvement work without the services of a dealer or contractor, the borrower shall be required to furnish a detailed written description of the work to be performed, the materials to be furnished, and their estimated cost." ['§201.20(b)(1) emphasis added] Less formal articles by HUD on the Internet (e.g., https://www.housingall.com/STEPUP/FinImprovements.htm) state in plainer English, that if the improvement in question is do-it-yourself, you can only borrow the materials cost. On the other hand, the regulations say, "If the borrower plans to use a dealer or contractor to carry out the improvement work, the lender shall obtain a copy of a proposal or contract that describes in detail the work to be performed and the estimated or actual cost." ('§201.20(b)(1) [emphasis added] Whitney' approach Russ Whitney' approach appears to be as follows: 1. Think up a contracting company name that does not contain the name Whitney. 2. Buy blank "proposal and contract" forms from a stationery store. 3. Fill out such a form using the name of Whitney' contracting company. 4. Obtain actual costs of each part of the improvement. 5. Mark the actual cost of each item up between double and six times the actual cost. 6. Add the marked-up costs to the "proposal and contract" form. 7. Submit an improvement loan application for the total amount of the "proposal and contract" form, which is attached to the loan application. Assumed name Is this legal? I think not. You are entitled to form a contracting company"”although state law typically requires that you register it as a fictitious name, "doing business as," or assumed name with the county clerk. That' true unless the name of the company is your real name"”like L. L. Bean or your real name and the nature of your business"”like "Russ Whitney Contracting" or my "John T. Reed Publishing." The purpose of the registration is to tell the world the real people behind that particular company name. Of course, if your "contracting company" consists only of you or you and your wife, and you only work on your own properties, what do you need a company name for? Whitney used the names R&I Enterprises and R&I Contracting Company according to his books (e.g., Building Wealth pp. 89, 123). Because those names do not contain the name Russ Whitney, they must be registered as assumed names. I checked the Schenectady County Clerk' office. He did not register those names. In addition to other penalties, if you do not register, you may not file a lawsuit with regard to anything you did under that name. For example, if R&I Contracting Company agreed to build a garage for someone and the customer did not pay when they were done, R&I could not sue for breach of contract because they failed to register their assumed name. Contractor' license As far as I know, all states require building contractors to be licensed with the state. One guy told me that Texas may allow unlicensed contractors. As far as I know, Whitney never obtained a contractor' license. On page 68 of Building Wealth, Whitney says, ""¦anybody can act as his own contractor without a license as long as he owns the property." I"m not sure it' that simple. With rental property, there are safety considerations. Some contracting work can cause injury if done incompetently, like collapse of heavy or high structures or unsafe electrical work which can cause shock and/or fire hazard. Some plumbing mistakes can lead to disease or structure collapse. Do-it-yourself only Whitney says on page 69 of Building Wealth that, "As long as you are working exclusively on your own properties or properties you co-own in a partnership or joint venture, it isn"t necessary to formalize your business by filing a company name or "˜doing business as" (DBA) with your local county courthouse." But that' kind of a silly statement isn"t it? It' like saying that you don"t need to register a car wash company name if you wash your own car on your driveway. True, but why would anyone need a "company" name to wash their own car or work on their own property. For whose consumption is the company name? On page 151 of Building Wealth, Whitney admits the company name is "for loan purposes." And what, pray tell, might that be? Could it mean anything other than deceiving lenders? I cannot think of another legitimate "loan purpose" reason to give a sole proprietorship that works only on your own properties a name other than your own name. Deep in the book At Harvard Business School, they taught us that, when it comes to annual reports, "The numbers giveth and the footnotes taketh away." When it comes to get-rich-quick books, the front of the book giveth and the later pages often taketh away. Whitney does acknowledge the regulation against borrowing the amount of "contractor' profit" when you use do-it-yourself labor, but not until you get to page 125 of Building Wealth. It' an "Oh, by the way" like the "Youmustbeeighteenyearsoldtoentervoidwhereprohibited" you hear at the end of radio contest ads. He does not say, but I will, that the same principle applies to all types of improvement loans. In other words, the reasons why HUD adopted that regulation apply to all improvement loans and non-Title I lenders should adopt the same rule for the same reason. Many have. Profit and overhead Whitney states, correctly, that general contractors include profit and overhead in their bids. Then he rationalizes that he is entitled to call himself a general contractor and include profit and overhead in work he does on his own properties. Tilt! There are several things wrong with that. 1. Title I regulations only allow do-it-yourself borrowers to borrow the cost of the materials. The purpose of that law is to prevent borrowers from using Title I loans as a sort of self-created job funded by the taxpayers. Whitney seems to think that if an outside contractor is entitled to profit and overhead for working on his home, why shouldn"t he be on the exact same job? Although there is some logic to that position, it simply is against the law. HUD figures there is too much conflict of interest for a borrower to be allowed to pad his own cost estimate with profit and overhead. With a true outside contractor, you have an arms-length transaction and presumably the bid was the lowest from among several and competition between the contractors bidding drove the price down to fair market value. When borrowers create their own bids, there is nothing to restrain them from exaggerating or inflating the cost of the improvement. You might think the lender would be responsible for scrutinizing the estimates for overly high figures. No. One banker I interviewed about this said, "We aren"t estimators." His bank refuses to do Title I loans direct with property owners because of fear of inflated cost estimates. They only work through contractors whom they have checked out. 2. When you improve your own property, your profit and overhead are paid by the increase in building value as a result of the improvement, or at least that' the plan. You get paid when you sell. 3. Why would anyone borrow their profit and overhead? The purpose of borrowing is to acquire money you need to pay for something. Borrowing is undesirable. It costs money"”namely, interest. You do need to borrow money for materials, if you do not have enough in your bank account, so you can pay Home Depot or ACE or whomever. But why would you need to borrow money to pay yourself? Are you going to sue yourself for nonpayment if you don"t? 4. If you do not wish to wait until you sell the property to get the profit and overhead embedded in the property value as a result of your improvements, refinance. That is, ask a bank to lend you a second mortgage or new first mortgage. They will appraise the property. If it is, indeed, worth more by the amount of your materials, profit, and overhead, they will agree to make the loan. In fact, most improvements only increase the value by a fraction of their cost. True, refinancing costs more than a Title I property improvement loan, but tough. Title I was not created to make life easy for real estate investors. You are not entitled to defraud a Title I lender, and thereby, the federal government, because you want to save the cost of an appraisal"”or avoid its hard truth coming out. "˜Proposal and contract" form What is the purpose of the "proposal and contract" form when you are doing the work yourself? Who is proposing what to whom? You are proposing to yourself. That' dumb if it' disclosed; a waste of time and money if it' not. Almost certainly, the fact that you and the "contracting company" are one in the same is not disclosed. The purpose of the "proposal" is to make it look like an outside contractor is doing the proposing. Same is true of the contract. What"re you gonna do? Sign a contract with yourself? "Proposal and contract" forms are just that. They contain contract language to bind the contractor to do certain work and the property owner to pay for the work. Why would anyone need a contract to force themselves to do work on their own property or to pay themselves for having done it? I can think of no other purpose of the company name and "proposal and contract" form than to mislead the lending institution into thinking the estimate is from an arms-length, unrelated, third party and that the third party will be doing the work. In 1984, Whitney wrote a book called Offers & Contracts Basics Rehabs Realities Overcoming the Hurdles and Pitfalls of Real Estate Investing. It was published by real estate guru Mark Haroldsen' National Institute of Financial Planning. It purports to contain actual documents from various deals Whitney did. Pages 13-15 are a stationery store "Proposal and Contract." At the top, it says "Southwest Management and Development" and lists an address in Cape Coral, FL. A search of the Florida Secretary of State' Web site finds no registration of the fictitious name Southwest Management and Development. The only fictitious name Whitney ever registered was, oddly, the first initials and last names of three persons, one of which was Whitney, one was a partner, and the third was another person. That fictitious name registration was filed 9/30/91 and expired 12/31/96. Someone has stamped "GENERAL CONTRACTOR" on either side of the name and address. The address is 2520 S.E. 8th Place. I do not know what that address is or how Whitney was connected to it. The date on the proposal was 3/4/83. I would appreciate someone in the Cape Coral area telling me the nature of the structure at that address and also the nature of Whitney' connection to it. The first line says "proposal submitted to" Whitney and his partner at 1630 Woodford Street in Fort Myers. The "architect" is listed as "RW." To claim to be an architect, you must be licensed with the state. Generally, you also must have a college degree in order to claim to be an architect. After listing three pages of improvements to be done, the proposal says Southwest proposes to do this work for $17,775. There is a signature, which appears to be an illegible version of Whitney' signature. The "Acceptance of Proposal" is signed by Whitney' partner. So we appear to have a proposal from Whitney, doing business as Southwest Management and Development, prepared by an architect with the initials "RW" and submitted to himself and his partner. Whitney' partner signed acceptance on behalf of himself and Whitney. Page 16 of the book has a one-page "Proposal and Contract" from Southwest to Whitney and his partner for furniture for the same building. It is dated one day later for some reason, and generously offers to add dozens of furniture items for no additional charge. Not surprisingly, Whitney and his partner signed "acceptance." Page 24 of Offers & Contracts has a 5/11/83 purchase agreement that lists Whitney and his partner as having the address 2520 S. E. 8th Place, the same address as Southwest. A Reg Z notice on page 26 shows Whitney and his partner living at 4944 Normandy Court, Cape Coral on 6/30/83. Page 28 lists a contract for sale of real estate in which the company name has now become "Southwest, Management, Development, and Realty, Inc." Florida Secretary of State records indicate that corporation was filed 8/12/83 and "involuntarily dissolved" on 11/4/88. Page 40 of Offers & Contracts says Southwest is "A division of R & D Companies of Florida." No such fictitious name is found in the Florida Secretary of State records. Marking up costs As 24 CFR '§201.20(b)(1) says, Title I loan proceeds may be used only for the purposes disclosed in the loan application. Since Whitney presumably is not disclosing to the lender that there is a profit-and-overhead amount in each line item of his estimate, he may not use the loan proceeds for those purposes. The same would generally be true of any non-Title-I improvement loan as well on the grounds of contract law and prohibitions against lying to a lender or concealing material facts.