The Top Seven Financial Pitfalls
Every Homeowner Facing Foreclosure Must Avoid
The foreclosure process is perplexing, even for those experienced in real estate. Real estate agents, attorneys, mortgage brokers, title companies, real estate investors and other real estate professionals all have differing views on the foreclosure process and what is the best route to take when a homeowner faces this difficult situation.
Real Estate Liquidators specializes in educating homeowners about foreclosure. We also have also bought houses all over Florida since 2007. This report is a culmination of hundreds and hundreds of situations in which we have helped real estate agents, mortgage brokers and homeowners to better understand the foreclosure process and The TOP 7 FINANCIAL PITFALLS that occur in a home foreclosure.
Each time a homeowner faces a foreclosure they are pushed up against several decisions they must make with little time to spare. This report has been written to educate homeowners in default about the biggest traps to avoid! With so much misinformation, we want to make sure you know your options, but don’t just take our word for it. At the end of this short report you will find a list of references on the Internet so that you may do your own homework.
Amid the confusion and anxiety that comes when facing foreclosure, it is not uncommon for homeowners to jump at anything that may alleviate their uncertainty. It is also not uncommon for homeowners to do absolutely nothing as they face the scary and often daunting task ahead of them.
While banks say that they offer several types of workouts, the options for homeowners really come down to three:
1) a loan modification/repayment plan;
2) short sale; and
Two of the three we group as part of the seven traps that homeowners need to avoid.
Let’s begin by addressing the first two traps to avoid.
Trap 1: Loan Modification/Repayment Plan – This is a possible solution to foreclosure if the homeowner contacts the bank early in the process. Some lenders are willing to change the terms, such as interest rate or payment amount or extension agreement (extending the amortization period for the remaining principal). The homeowner must be employed and needs to have steady income to qualify. If a homeowner is not currently employed, has filed for bankruptcy protection or does not make enough income they will not qualify for a repayment plan. In most cases the repayment plan/ loan modification is structured in such a way that the new payment for the homeowner is HIGHER than the previous payment. It is for this reason that most loan modification plans are not approved by the lender servicing the loan.
Recently, the government has promoted several new programs that encourage repayment plans and workouts. Likewise, companies that specialize in working loan modifications with the bank on behalf of the homeowner have become common. They often charge a fee to the homeowner for this service and most have a low success rate. Hundreds of stories exists of homeowners across the US paying a thousand dollar fee to such companies and receiving absolutely no value or service for the money they spent. For companies that charge up front fees, new laws have been enacted specifically to prevent “foreclosure rescue scams” that include such practices. Homeowners should be aware that only 10 percent of all loan modification requests are successful.
The most commons reasons why loan modifications and repayment plans do now work include:
1) The new payment is higher than the previous payment which the homeowner cannot afford.
2) The homeowner has filed for bankruptcy protection which eliminates their ability to qualify for repayment plans
3) The homeowner either doesn’t make enough money or is unemployed and simply will not qualify for a loan repayment plan.
Trap 2: Deed-in-Lieu – This is a voluntary foreclosure. The deed–in–lieu takes place when a homeowner in default voluntarily signs a deed giving the ownership of their property back to the lender who issued them the mortgage. Homeowners may mistakenly decide that this is the best option so that they can move on with their lives; however, this is only an illusion. Many lenders are aggressively pursuing homeowners in default to pursue the deed-in-lieu of foreclosure option. The reason the lenders pursue this option is because it saves them a tremendous amount of money. A deed-in-lieu saves expenses associated with the foreclosure because the bank does not have to pay an attorney for the fees associated with the foreclosure process.
When a deed-in-lieu is approved and executed the lender may still sue the homeowner for the losses they incurred (a deficiency judgment). In addition, the homeowner will have a foreclosure on their credit report as the deed-in-lieu will show up on their credit report as a foreclosure. In short, the deed-in-lieu is a huge financial benefit to the bank, and of no benefit to the homeowner.
Before discussing the benefits of a short sale, let’s look at some additional traps that homeowners all across the country experience.
Trap 3: Bankruptcy – Homeowner’s facing foreclosure often file Chapter 7 as a solution to the foreclosure. Many attorney’s will advise their clients that if they file for Chapter 7 that they will not need to worry about the house. While debts are erased, the bank still needs to be made whole and will need to sell the house. The lender will foreclose on the property to force the sale and repossess it. This results in double jeopardy for the homeowners, as they find that they not only have a bankruptcy on their credit history, but also a foreclosure. The damage done to their credit will eliminate their ability to get a new loan of any kind for five years for the foreclosure, with more years added for the bankruptcy.
Trap 4: Refinance – When properties were appreciating, this option made sense. Today, most homeowners owe more than their property is worth. To complete a refinance, the bank will order a new appraisal and will lend out 80 to 90 percent of that number. If the house is over-leveraged, the homeowner and the property will not qualify for a refinance option.
$300,000 total mortgage payoffs
$250,000 current value of property
$225,000 90% of the current value available for refinance
Under these circumstances the lender will only lend $225,000 so the property is $75,000 and regarded as upside down. The request for a refinanced loan will be declined.
Trap 5: Transferring the mortgage to a new owner – The homeowner may be able to find someone who can buy the property and either assume the mortgage or take the property “subject to” the existing mortgage. Unfortunately, most homeowners facing default are in homes that are upside down, meaning that the property is not worth what the bank is owed, and therefore not attractive to those who would otherwise assume the mortgage.
Please note that most loans are no longer assumable. In 1985 a law was passed that restricts the ability to assume loans and most if not all major lenders no longer allow their loans to be fully assumed by a new buyer or mortgagor.
“Subject to” transactions have been attractive to investors because they can own a property without having the mortgage in their name. Homeowners have sold their property “subject to” in the past because it prevented a foreclosure and allowed them to move into another property without their credit being harmed. Homeowners that pursue this option today need to make sure that the investor buying their house “subject to” is bringing the loan current and is making all payments on time. A “subject to” gives the right of use to the investor, but if he or she defaults on the loan, it is the Seller on the mortgage that the lender will pursue. Today, many investors have lost interest in “subject to” because so many houses are over-leveraged and are worth far less than what is owed to the bank.
Trap 6: Mentally Checking Out – Often homeowners are so overwhelmed by the process of foreclosure and what it could mean for their immediate future as well as the years down the road, they do nothing: they mentally check out. This mistake will result in at least one of the following penalties, on top of losing the house, and one’s ability to be approved for a loan for at least five years.
They are: 1) the 1099; and 2) the deficiency judgment.
1) The IRS Form 1099 – The 1099 is sent by the IRS when someone receives income but is not an employee of a company. The 1099 states that income has been earned, but that no taxes have been paid. When an individual receives a 1099 they will be responsible for paying taxes on the 1099 amount noted at the end of the tax year.
When a homeowner sells a property for less than what is owed their mortgage lender is responsible for sending them a 1099 for debt forgiveness income. In other words, the IRS has traditionally looked at any debt forgiven as income to the homeowner.
$300,000 Mortgage Balance subtracted by
$200,000 Proceeds from a Short Sale or REO sale
=$100,000 Loss to the mortgage company –Debt forgiven and thus taxable under the IRS debt forgiveness rules.
Several places exist in the tax code that allow the homeowner to legally avoid having to pay taxes on this debt forgiveness income.
The reason the 1099 is a financial trap is that some homeowners let their fear of the 1099 keep them from moving forward. The first thing to know is that it only applies to qualified principle homes, meaning owner occupied. Second, “Acquisition Indebtedness” is no longer subject to taxation.
For example, if a homeowner borrows 350k from the bank to buy a house, lives in it, and then sells it for a loss at 200k, the IRS would say that the homeowner had the benefit of a 150k gain and that he or she needed to pay taxes on this amount; however, if the money was used to buy that property and it was a principle residence, it no longer is seen as a taxable gain.
Acquisition indebtedness can also mean “to build” the property: to buy the land, pay the contractor, etc. It can also mean money for substantial improvements such as a remodel and rehab.
For most purposes, acquisition indebtedness is covered, unless you took money from a home equity loan, used part to rehab the house and the other part to take a trip to Bali, you now have a tax issue.
How much was used to improve the house? How much was used for the vacation?
The section of the Mortgage Debt Relief Act of 2007 that applies to this discussion is HR 3648. Homeowners in default need to speak to their tax advisor about how HR3648 applies to them.
For those in California or in the luxury market, there’s a twist to what was just explained: Up to a million dollars in acquisition indebtedness is covered. That’s it. Married and filed singly, it’s half a million dollars.
So, a rich divorcee buys a 2 million house at the peak of the housing market, and then ends up having the house sold as a short sale for one million, he or she will only be able to avoid paying taxes on half of the amount (500k).
What’s not included in HR 3648?
a. Non-acquisition indebtedness: If the bank forgives the cost associated with the loan in foreclosure (penalties, late fees, Foreclosure costs, attorneys fees), then the bank may issue a 1099 for that part –– it’s not wipe out by the legislation.
b. If an individual is in a Chapter 11 bankruptcy. Why? Because you get a lot of people who are self-employed that put their house up for collateral on a small business loan. The good news is that these people have another way out (The other way out is that they can still go with proving an insolvency using IRS form 982 and the related documentation to show they were insolvent. Also, a bankruptcy discharge rather than a reorganization would also eliminate the obligation to pay taxes on any debt forgiveness) . . . the bad news is that HR 3648 doesn’t apply to them.
Finally, if the lender does file a 1099 the homeowner, regardless of the size of the debt forgiven, simply needs to prove his or her insolvency during the time of the foreclosure.
Additional help in the tax code for a homeowner experiencing debt forgiveness income is IRS Publication 523 and Internal Revenue Code form 982 section 121. Again, please consult your tax adviser regarding debt forgiveness income.
Another point to keep in mind is this: If a homeowner allows a property to go to foreclosure and the lender repossesses it then the lender will turn around and sell the property as a bank owned house. Each month that the lender is not paid will force the payoff balance to increase. Once the lender sells the property, the loss the lender experiences will be greater and greater each month this continues. If the property is then sold the potential deficiency judgment will be higher. In this instance it would be much less damaging if the homeowner had sold the property using a short sale.
2) Deficiency judgments are just that: judgments. They are an albatross around the neck of the debtor/homeowner and can only be removed by paying it off, negotiating it down and then paying it off or by bankruptcy. Furthermore, deficiency judgments usually earn interest until paid. In Florida right now that rate is 11% a year ––better than the bank by far!
If a homeowner is saddled with a deficiency judgment, guess what? They won’t be able to buy anything using credit. New house? Forget it. New car? Forget it.
Another point of consider, if the house goes into foreclosure and is taken back by the bank to be listed as an REO, the meter keeps running on the costs incurred by the bank until the REO dept. sells the house. This can make the deficiency huge.
Trap 7: Buy and Bail – This is a tactic used by many homeowners who suddenly find themselves struggling to make payments on a property that is worth considerably less than what is owed. Owners will try to buy another property before the possible foreclosure on their current residence destroys their ability to get a loan for several years. Unfortunately, when lenders see that an applicant has a large mortgage on another residence they are suspicious and will not do the loan until they know that the first property has sold. Moreover, owners that walk are missing the one chance they have to achieve the best outcome possible for their situation.
1) Avoid working with anyone who charges an upfront fee, or for that matter, a fee of any kind.
2) If using a real estate agent to sell your property, make sure that they have a successful track record of working with other individuals facing similar circumstances. Ask about the success in selling property that is over-leveraged. Ask them how their marketing plan separates them from others in their industry.
The Short Sale
If the homeowner is unable to structure a workout, repayment plan or a forbearance agreement with the foreclosing lender, then a short sale is the next best option.
What is a short sale? A short sale takes place any time a property is sold for less than the mortgage balances and the foreclosing lender allows the transfer to take place even though they do not receive their full payoff balance.
The Benefits of a Short Sale
1) Be aware that Fannie Mae recently established a 2-year elapsed time period for re-establishing credit for homeowners who sell their homes through a short sale. Two years may seem like a long time to wait before they can begin to be able to get a new loan, but compare this to what happens if the homeowner is foreclosed upon. According to the Fannie Mae guidelines, effective 11-1-2013, a homeowner who has filed a foreclosure against them will be “ineligible” for a loan for five years.
Did you see that? FIVE YEARS!
Two years or five years…? That’s something definitely worth considering.
2) Another benefit involves circumventing a possible deficiency judgment. When a house is sold at auction, the chances of the foreclosing lender filing a deficiency judgment increases dramatically. Real Estate Liquidators is in the business of buying properties, but often the negotiation process used to achieve a short sale with the bank gives the homeowner his or her only shot at avoiding a deficiency judgment.
In most cases we are able to negotiate an approval as a settlement in full from the lender. This means the homeowner will not have to worry about a potential deficiency judgement.
3) We do not charge a fee for our service. Never ever work with a “foreclosure consultant” who charges an upfront fee for processing a workout plan, repayment plan, forbearance agreement or short sale.
4) When selling a property using a short sale the homeowner will not have a “foreclosure” on their credit report. If a homeowner elects to do a deed-in-lieu or just let the property go to foreclosure they will significantly damage their credit. A short sale will save them from this damaging report to the credit bureaus.
5) Selling a property using a short sale will often remove the heavy financial burden of the foreclosure. This will also help the homeowner avoid having to file a Chapter 7 bankruptcy which will also help save their credit from further damage.
Again, as professional home buyers we offer homeowners a way out. In buying houses in foreclosure, homeowners may avoid the long term harm of a deficiency judgment, a bankruptcy, a 1099, any processing fees, and the inability to be approved for a loan for years to come.
Truly selling the property is the best option when a homeowner is in default and has no equity.
Do Not Let Your Property Go To Foreclosure . . .
That Just May Be The Worst Possible Decision You Could Make.