WASHINGTON - A California appellate court last week overturned a lower court and ruled that mortgage loans financed by tax-exempt bonds need not be forgiven if they are sold by the trustee before the bonds are redeemed.
Several lawyers said the unanimous decision by the First Appellate District of the California Court of Appeal last Thursday calls into question the many forgiveness riders that have been written into the notes and deeds of trust in mortgage revenue bond financings.
One effect of the ruling, they said, is that the mortgage yields in these financings will have to be recalculated because they typically have been reduced to take into account the forgiveness riders that were supposed to allow some mortgages to be forgiven upon redemption.
Such riders have been included in these financings because of concern that some mortgages are always outstanding when the bonds are paid off in 30 years. Payments on the mortgages could cause the bond issuer to exceed a one and one-eighth spread it was allowed to earn between the yields of the mortgages and the bonds. Doing so would make the bonds taxable.
The court's ruling means that a Foster City, Calif., couple will have to continue making mortgage payments on the condominium they purchased in 1986. The couple had purchased the condo with financing from a $20.6 million tax-exempt bond issue that had been sold in 1985 by the Foster City Community Development Agency. The loan was originated by Coast Funding Corp., a small family-owned mortgage banking company.
But the trustee for the bond issue decided to redeem it after the Foster City agency could originate only four loans because of a drop in interest rates. Before the bonds were redeemed the trustee sold the loans to Coast Funding Corp. Coast tried to obtain refinancing for the borrowers, but Michael and Bonnie Benov claimed their mortgage should be forgiven under the forgiveness clause. They sued Coast in 1989 and a San Mateo Superior Court ruled for them in 1991.
