Q&A: Here’s a question that a Wisconsin credit union recently asked The League’s Legal Affairs team, along with our answer. Do you have a compliance question? Contact The League’s Compliance Hotline at (608) 640-4050 or email.
Q. We have a member who owes 3 years of back taxes. Can we add it to their mortgage loan with the credit union?
A. When delinquent property tax questions come up, we usually tell credit unions that they have three options:
- They can remind the borrower/homeowner to pay. This may be effective if a missed payment was simply an oversight.
- They can consider foreclosure, since the mortgage documents require the borrowers to keep up on their tax payments, and failing to do so constitutes a default (even if the borrower is current on their mortgage loan payments to the credit union).
- If the credit union chooses to pay the back taxes, it can make what is known as a “protective advance” for that purpose. This means advancing funds to protect the credit union’s interests in the mortgaged property (and thus preventing the county from starting a tax foreclosure that could wipe out the credit union’s mortgage and leave it with a large, unsecured loan.)
Check your mortgage documents
Your mortgage documents should give the credit union the right to make a protective advance to pay delinquent property taxes, but you must check the documents to be sure. For example, The League’s Consumer Mortgage form (WCUL #82020) gives the credit union the right to pay delinquent taxes, and the sums it pays are secured by its existing mortgage:
6. Authority of Credit Union to Perform for Mortgagor. If Mortgagor fails to perform any duty imposed upon Mortgagor by this Mortgage or the Obligations, Credit Union may, after providing to Mortgagor the notice of and reasonable opportunity to cure non-performance that are required by law, perform or cause to be performed any of such duties, including but not limited to signing Mortgagor’s name or paying any amount so required. All amounts paid by Credit Union for performance of such duties shall be secured by this Mortgage, shall be payable by Mortgagor upon demand, and shall bear interest at the rate stated in the Note from the date the Credit Union performs the duty until the date Mortgagor repays the Credit Union. In the event Mortgagor fails to insure the Property as required by the Note or this Mortgage, Credit Union may, at its option, purchase such insurance only in the amount that protects Credit Union’ s interest in the Property and not Mortgagor’ s equity in the Property, and Mortgagor will be bound to pay Credit Union as provided above in this section.
When it comes to making protective advances, we generally tell credit unions to pay particular attention to two things:
- Before the credit union can make the payment, The League’s Consumer Mortgage form (WCUL #82020) requires it to give the borrower written notice of their non-performance under the mortgage and give them a chance to “cure” the default.
- Nothing in our mortgage form lets the credit union automatically add to the loan balance the amounts that it advances. Our form says: “All amounts paid by Credit Union for performance of such duties shall be secured by this Mortgage, shall be payable by Mortgagor upon demand, and shall bear interest at the rate stated in the Note from the date the Credit Union performs the duty until the date Mortgagor repays the Credit Union.”
If you use mortgage forms from another vendor, check for similar language in those forms and contact your vendor for guidance.
Arranging repayment of the protective advance
How does the credit union arrange for the borrower to repay the protective advance, if it cannot automatically add it to the loan balance? If you use our mortgage form, then the credit union needs to notify the mortgagors of the advance, demand payment, and charge interest at the note rate if they need to stretch the payments out over time. If the credit union and the borrowers want to add the amount of your protective advance to the balance, you will need to modify the note – the loan agreement – to do so. (That is because the note itself does not really address advances; the relevant language is in the mortgage. And remember, the homeowners who sign the mortgage are not always the same people who are the borrowers on the note.) Modifying the note requires a modification agreement. The League does not have standard forms for modifications, and so a credit union would be wise to have an attorney draft a modification agreement, to be sure it covers all the issues that may need to be addressed.
The credit union could, instead, notify the debtors of the advance and give them a deadline for repayment. If the borrowers fail to pay the advance, then the credit union can foreclose. There is no legal requirement that limits how long that repayment period could be. It is up to the credit union as to what repayment period it is willing to allow the borrower, which could be more (or less) than 12 months.
Pros and cons
It is a risk-based decision for management to make as to whether they want to advance new money to pay off unpaid property taxes.
- On one hand, the member, who has already failed to pay their property taxes, will be faced with the added expense of repaying the protective advance and may not have the resources to make the payments. Credit unions are often (and justifiably) reluctant to make protective advances, since they may never collect on the tax payments they have advanced for the member.
- On the other hand, if the taxes are not paid, then the county could conduct a tax foreclosure and wipe out the credit union’s mortgage. A protective advance protects the credit union’s lien on the property as collateral for its loan.
Consider requiring escrow
If the loan does not have an escrow, you might consider conditioning the granting of an advance to pay the delinquent taxes on the establishment of an escrow account to pay future property taxes.
The escrow rules get very complex. Suffice it to say that the credit union might be able to require escrow for taxes going forward, but likely could not pay the delinquent taxes, add those to the loan balance, and then require escrow to repay that sum to the credit union.
Setting up an escrow is a good way to protect against tax delinquencies in the first place.
Other types of future advances
This Courier focuses on protective advances. There are two other types of advances that credit unions can make on existing loans:
- Obligatory advances are those that the credit union commits to in advance. Examples include the advances committed to under a HELOC agreement or a construction loan agreement. With those loan programs, the credit union must make the advances if the conditions in the agreement are met.
- Optional advances are those which the credit union does not have to make. One example could be if the credit union approves a $10,000 home improvement loan when the member’s original $80,000 mortgage has a $40,000 balance. The $10,000 loan is underwritten at the time of the request.
The priority rules are different for each type of advance. The League’s ii Release No. B048 has details on making protective advances.