America's going to war and many of our reservists and active enlisted now have a new financial friend -- the Soldiers' and Sailors' Civil Relief Act of 1940Soldiers' and Sailors' Civil Relief Act. If you've been listening to the news lately, you've heard the highlights of this Act, which was last amended in 1991 during Desert Storm.

The legislation actually has its roots in the post-Civil War era when Congress passed a total moratorium on civil actions brought against Union soldiers and sailors, according to Air Force Maj. Amy Griese, assistant director for legal policy for the Department of Defense. The present statute was passed in 1940.

Low Interest Rates

First of all, let's look at the mortgages. Much news coverage has discussed how activated military personnel received rate cuts on their loans (whether for consumer or mortgage debt). Keep in mind, though, that these cuts are only for debt incurred before the solder/sailor was activated.

Debt relief, however, is not automatic. As the Coast Guard explains:

1. Petty Officer X, USCGR, a successful businesswoman in civilian life, buys a car with a 12% loan while in an inactive status. She is then recalled to active duty, voluntarily or as part of an involuntary recall. Her military pay is less than her civilian earnings. She may use the SSCRA to reduce the interest rate on the loan to 6%. Petty Officer X should send a letter to the lender asking for the 6% interest rate under the Soldiers and Sailors Civil Relief Act, 50 U.S.C. App. 526. The letter should include the account number for the loan, the date she received the loan, the date she entered active duty, and that her active duty status has affected her ability to repay the loan. She should also include a copy of her orders to active duty, and a copy of a leave and earning statement (LES). If the lender refuses to reduce the interest rate, Petty Officer X should contact a legal assistance attorney.

2. Petty Officer Y, USCG, has been on active duty for five years. He buys a brand new pick-up truck with no money down and a 14% loan. After two months, he decides he can't afford the payments. He's out of luck, and SSCRA provides no protection on the interest rate.

3. Ensign Z successfully completed Officer Candidate School and received his commission. He was a high school teacher before he went to OCS. His pay as an ensign is less than he was paid as a teacher. When he reported for active duty, he had an outstanding balance of $4000 on his VISA card. He can also receive protection under the SSCRA, and should write a letter to the bank that issued the credit card to ask for a reduced interest rate (see example 1 above for more details). However, the credit card company is required to give the 6% interest rate only on his pre-active duty balance, and may charge its regular interest rate on any purchases he made after he reported for active duty.

Lender Limits

Under the Relief Act, not only are financial institutions required to reduce your interest rate to 6 percent, but they must re-amortize the monthly payments. The National Association of Federal Credit Unions, describes the rules members must follow when implementing the Act.

"In those situations where the credit union must reduce a member's interest rate to 6 percent, the courts have interpreted this to require that the credit union also decrease the member's monthly payment amount in accordance with the lowered interest rate. Credit unions may not elect, instead, to keep the payment amount the same and shorten the maturity of the loan as this would not provide the monetary relief envisioned by the act."

The interest reduction can result in substantial savings for enlisted personnel. On a 30-year loan for $150,000 at 7.5 percent, the savings would be about $150 per month.

Just because a member of the armed forces has been called up to active duty doesn't mean he or she automatically gets the reduction in credit interest rate. NAFCU advises its members that "if a credit union believes that the member's ability to repay the debt has not been materially affected by his or her active duty military service, it may petition the court for relief."

If a financial institution merely denies the benefit without due process, it could be subject to additional penalties from a court. Fortunately for military personnel, while the issue is before the court, the credit union must reduce the interest rate until relief (for the lender) is granted.

Once a borrower ends military service, the lender may raise the interest rate back to its original contractual level; however, the borrower may apply to the court for an extension of time to repay any arrearages. The maximum time for which an extension may be granted depends on whether the loan is secured or unsecured. Lenders are also limited on when they can foreclose on a property acting as security for a loan subject to the Act. The lender must obtain a court order before repossession is allowed. Without the court order prior to taking action could result in a fine and possibly incarceration.

Real Estate Investors Be Aware

This Act provides much needed protection to our fighting men and women while they are in the midst of hostilities and protecting us here at home. Nevertheless, I can see where the Act could adversely affect some small real estate investors who have extended owner-financing to a buyer.

Most loans include a due-on-sale clause, which means if you sell your house, you must pay off the loan secured by that property. However, some loans, Veterans Affairs loans in particular, allow the owner to wrap a loan around the VA mortgage. What this means is the owner of a house that appreciated in value can sell the house for the appreciated price and accept mortgage payments from the new owner while at the same time make payments on the original note.

For instance, Mr. Smith bought his house using a VA loan for $150,000 at 7 percent and sold it years later for $175,000. Instead of paying off the VA loan he decided to hold a note for $165,000 at 8 percent for the new owner. He is receiving payments on the $165,000 ($1,210 per month) and making payments on the $150,000 ($998). Obviously, he has created a $212 positive cash-flow with this arrangement.

If his borrower is in the reserves and is called to active duty, the interest rate must drop to 6 percent if the borrower invokes his rights under the Soldiers and Sailors Civil Relief Act. This drops his monthly payment to the owner financier to just $989, resulting in a profit margin of only $9. In essence, it may not be financially feasible for the investor-lender to continue this relationship and may be forced to sell the note at a discount.

Steps To Take

It will take some legwork on the part of soldiers and sailors to protect their credit while on active duty, but following these steps can help them avoid costly credit mistakes:

• Look at the in-depth material posted at Military.com. This site is an excellent resource.

• Get deferments or agreements in writing before you leave for duty.

• Get a copy of all three credit reports and review payment history before and after being activated.

• Have a spouse or trusted family member receive all bills and communications with creditors.

• Set up a temporary power of attorney with a trusted family member to control your accounts while gone.

For more articles by M. Anthony Carr, please press here.

Published: September 28, 2001

Use of this article without permission is a violation of federal copyright laws.

Mr. Carr has covered real estate since 1989. He is the author of Real Estate Investing Made Simple. Got a personal real estate issue? Post your questions and comments at Anthony’s blog: commonsenserealestate.blogspot.com.