Short-sale debt collection draws ire – Why are banks getting tax break while also pursuing discharged debt?

Homebuyers may be attracted to the big bargains that foreclosures and preforeclosures can offer. But distressed properties can involve tricky, lengthy transactions, and there’s a lot to think about before jumping in.

In fact, some home shoppers have shunned short sales altogether, preferring a more reliable process to a reduction in price. Getting all parties to agree to a short-sale price can be problematic, and lenders have been known to change their minds when more bidders surface.

Given the difficulty and uncertainty of negotiating a short-sale transaction, you would think lenders would bend over backward to make things easier for the consumer once the deal is finally done.

But it appears some lenders are seeking an additional pound of flesh long after the frustrated, exhausted and often financially drained seller has moved on.

Short sales occur when owners, often in distress, sell their homes for less than the amount they owe their lenders. The lender may then write off the remainder of the debt and receive tax benefits.

Some lenders, however, will also assign or sell the remaining debt obligation to third-party debt collectors, often for pennies on the dollar. The third-party debt collector can then use the legal system to continue to pursue the former homeowner for the balance owed.

This has become such an issue that legislators in Olympia, Wash., have taken action. Senate Bill 6337, proposed by David Frockt, D-Seattle, would protect short-sale sellers from being pursued by lenders or their assignees for the difference between the sale price and remaining loan balance.

“The banks will basically have to make a choice,” Frockt said, “to either write off the amount and take the tax benefit, or pursue the owner — but they cannot do both.”

When a lender agrees to a short sale, it can either retain the ability to collect from the short-sale seller the amount of mortgage debt owed by the seller that is not satisfied by the purchase price, or it can discharge all or a portion of the unsatisfied debt amount.

If a lender discharges debt, it reports this discharge of debt to the Internal Revenue Service on a 1099-C Cancellation of Debt Form. The issuance of the 1099-C allows the lender to take a tax deduction for the loss represented by the amount of debt discharged, and this same amount of debt discharged becomes taxable income to the short-sale seller.

After the taxpayers bailed out the mortgage industry, many borrowers are still unable to get a loan modification to stay in their homes. Now the industry has a sketchy-to-lousy national reputation, and more stringent qualifying standards are not helping their case.

In light of all this, how can some lenders knowingly seek both a tax deduction for the mortgage debt not paid while also seeking to collect that same mortgage debt?

“Yes, we have heard of this happening,” said Deborah Bortner, director of consumer services for the Washington state Department of Financial Institutions.

“I hear it mostly from attorneys or others who assist those in obtaining a short sale. I understand that the documentation provided by the institutions doesn’t always make it clear whether they will pursue a short sale or not. The consumer only finds out later when contacted by someone trying to collect the deficiency.”

In some instances, mortgage debt collection rights have been referred to third-party debt collection companies, even though short-sale sellers have paid income tax on the amount of this discharged debt.

“This is another step to help the short-sale process that is keeping many homeowners from the tragedy of foreclosure,” said Faye Nelson, president of the Washington Association of Realtors. “Nearly 40 percent of the inventory in the Puget Sound region right now is short sales. State legislators recognize that protecting this process is critical to homeownership and the housing market.”

By Tom Kelly, Wednesday, March 7, 2012.

Inman News®Tom Kelly’s new e-book, “Bargains Beyond the Border: Get Past the Blood and Drugs: Mexico’s Lower Cost of Living Can Avert a Tearful Retirement,” is available online at Apple’s iBookstore, Amazon.com, Sony’s Reader Store, Barnes & Noble, Kobo, Diesel eBook Store, and Google Editions.

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4 predictions about 2012 real estate market

With 2012 nearly upon us, many of us will be spending this week reviewing the events of 2011 and setting resolutions, goals or visions for what we’d like to accomplish next year.

It will come as no surprise that the most common New Year’s resolutions fall into the categories of getting organized and getting fit — physically and financially.

Financial fitness includes getting your real estate business in order. But you can’t set up your real estate plans for the year in a vacuum. They must be done in context of what’s going on in the market. Here are four predictions about what that market context will look like in the coming year:

1. Even more foreclosures

While I’d like to claim crystal-ball credit for this one, it doesn’t take heightened powers of prediction to foresee an uptick in the rate of home repossessions in 2012. Last fall’s robo-signing debacle and the ongoing legal fallout from it created a massive backlog in the foreclosure pipeline, meaning that banks are taking many months, even years, to actually foreclose on mortgages in default.

Earlier this year, the New York Times reported that the additional hurdles New York state courts are requiring banks to leap in the wake of the robo-signing revelations, like additional settlement meetings with the homeowner to see if a modification can be brokered, have created a backlog of foreclosures that it would take 62 years to clear, at the current rate of foreclosure.

It’s pretty clear that in 2012 and beyond, the banks will work through those backlogs. The inevitable result will be an increase in foreclosures.

2. REOs and short sales will become the new normal

If you even know anyone who has house-hunted in the past couple of years, you’ve likely heard tales of the high-drama high jinks — super-long escrows, first-time buyers being bested by investors’ cash offers, banks resistant to negotiating for repairs — that take place in the course of a distressed property sale.

In the coming year, distressed home sales will continue to represent an increasing share of homes on the market. So, buyers will shift from considering whether to buy a short sale to understanding that they must be educated and prepared to do a deal with a seller, a bank (to buy an REO) or a hybrid of the two (to buy a short sale) to access the full selection of homes on the market.

This, in turn, will empower buyers to make smart decisions about what to offer and what to expect on any listing they like, as well as to set smart priorities and make realistic comparisons between listings based on their own personal priorities around timing, certainty and seller flexibility.

3.  So-called ‘smart cities‘ will do well 

This year, a number of housing markets saw double- or even triple-dips in home values. In others, pricing stayed relatively flat. However, in areas where technology powers the economy, home values prospered along with the industry. Silicon Valley real estate, for instance, saw fierce competition among buyers as the young employees of companies that went public like used their newly stocked bank accounts to buy their first homes.

I recently talked with Jed Kolko, chief economist for real estate search site Trulia, and his 2012 forecast was that so-called “smart cities” will continue to have hot real estate markets next year. But Kolko defined smart cities much more broadly than the California tech hubs. Other tech centers like Austin, Texas, and the Massachusetts suburbs of Cambridge, Newton and Framingham all made Kolko’s list, as did Rochester, N.Y. (a town known for its highly educated, highly skilled work force).

4. Consumers will get ‘hopeless’

I mean hopeless in the best of all possible ways. For years, buyers and sellers have been waiting for that singular event to occur that would cause a quick market recovery. But 2012 will mark the fifth or sixth year of the real estate recession, depending on who you talk to. I predict that those consumers who have not already done so will drop unrealistic hopes for a fast return to the heady real estate fortunes of the subprime era.  Instead, people will make their real estate plans based on:

  • today’s low home prices, rather than the fantasy of what could happen if the market miraculously came back;
  • assumptions of very low, or no, appreciation in home values for years to come; and
  • very conservative estimates of their own finances and how they will grow.

As a result, buyers won’t break their necks to hurry and buy before prices uptick; rather, they’ll save and plan to buy when it makes the most sense for their finances. Homeowners will do the same; they will either refi, remodel and be content where they are for the long haul, or decide their homes no longer fit their lifestyles and their finances, divest of them and move on. But the good news is, people will make these decisions based on what is or is not sustainable for their lives and their finances, and not based on inflated hopes about what the market will or will not do.

By Tara-Nicholle Nelson, Tuesday, December 27, 2011.

Inman News®

Tara-Nicholle Nelson is author of “The Savvy Woman’s Homebuying Handbook” and “Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions.” Tara is also the Consumer Ambassador and Educator for real estate listings search site Trulia.com. Ask her a real estate question online or visit her website, www.rethinkrealestate.com.

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Pros and cons of paying mortgage during short sale

Q: We just got multiple offers on my “vacation” house listed as a short sale. And so far, we have begged and borrowed to keep our mortgage current so our credit scores will be less bruised. But now that our house is in contract, do I continue to pay the mortgage? Our debt exceeds our income due to job and benefit loss.

Here’s my bigger concern: Since we are current, I don’t want the bank to reject the offers just because we have been current, although our financial papers will prove that our debt exceeds our income. –Cindy

A: There are a number of schools of thought and approaches to deciding whether to continue making your mortgage payments while you’re selling your home on a short sale, and your ultimate decision will require you to weigh a number of factors and see where your personal calculus of your own values and interests comes out:

Legal: Legally speaking, you have an obligation to pay your mortgage and property taxes as long as you own your home. While you might very well make the decision not to for a number of reasons (see below), it’s important to keep the legal contract you made to pay especially your mortgage in mind, as some lenders make efforts to reserve the right to come after you later for the deficiency (i.e., the difference between the sale price of your home and your mortgage balance). For this reason, it’s not a bad idea to have a local real estate attorney involved in your short-sale transaction, to help you negotiate a complete release of liability for the mortgage.

The moral/ethical perspective: Morally and ethically, some homeowners view themselves as having an obligation in line with their legal commitment to pay all these items. Others look at the various factors beyond their control that have forced them to short-sale their home, like the decline in property values and the weak employment market, and have made a decision that their personal moral imperative weighs in favor of protecting their family finances and children’s education funds. In that vein, some make the conscious decision to stop paying once they’re in a short-sale situation or on a clear path to foreclosure.

Financial/business: Once you know 100 percent that you’ll be divesting of your home in some way, shape or form, continued investments in the property can seem to easily fall into the “throwing good money after bad” bucket, looking at the situation from a strictly business and financial perspective. There is also a strong sentiment among many real estate professionals that if you keep your mortgage current, while applying for a short sale or loan modification of any sort, you decrease the chances that your lender will approve of the sale.

The theory goes that if you are current on your payments, you can’t possibly have the level of hardship you must claim (and the lender must believe you have) for them to agree to waive the deficiency amount and release you from the mortgage.

I’ve seen very mixed feelings on this in the real estate industry; on this point specifically, you should definitely talk with your listing agent and your local attorney, and take their advice into account — they might have worked with this bank in the past and be able to shed light on how staying current or falling behind may affect the success prospects of your short sale application.

Credit/ability to buy again: Right now, you are probably fixated on getting out from under this onerous debt, as virtually every homeowner in your situation is as a matter of course. But I’ve worked with a number of folks through this entire experience of going upside down, losing a home through a foreclosure or short sale and financial recovery, and I know that before too terribly long, you could very well be looking to buy a home again. Just be aware that most lenders will impose a two- to three-year waiting period after you have a short sale, if you were in default on your mortgage at the time the short sale closed (sometimes the waiting period is as long as seven years, depending on what type of loan you’re trying to use to buy your new home).

However, if you do not default on your loan and are able to get your lender to green-light your short sale, you can qualify for an FHA mortgage immediately. I don’t know your personal situation, and it’s been my experience that the majority of homeowners who have a financial hardship severe enough to even attempt a short sale need a couple of years to get back on their feet, but if you think you’ll want to buy another home anytime sooner than two years from now, you’ll need to stay current on this mortgage.

Just as there are many factors your bank will weigh in determining whether to allow your short sale to close, and on what terms, you have a lot of considerations to weigh in deciding whether to continue making your mortgage payments while you await their decision. I can’t urge you strongly enough to include your real estate agent and an attorney in your decision-making process.

By Tara-Nicholle Nelson, Monday, November 28, 2011.

Inman News™

Tara-Nicholle Nelson is author of “The Savvy Woman’s Homebuying Handbook” and “Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions.” Tara is also the Consumer Ambassador and Educator for real estate listings search site Trulia.com. Ask her a real estate question online or visit her website, www.rethinkrealestate.com

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4 steps to buy again after foreclosure

Homeowners facing foreclosure seem to be desperate to buy again.

Frequently, I receive letters from someone who hasn’t yet lost their home to foreclosure but anticipates they soon will, and wants to be able to get back into the market, quick-like.

Many claim their haste is because they don’t want to miss out on today’s bargain housing prices or interest rates. Yet neither seems poised to rise significantly any time soon.

In the same breath, many of these folks say they’re ready to pay top dollar for their next home, and pay an additional premium if they are forced to rely on lease-to-own, seller financing, or a hard-money mortgage.

Others claim they don’t want to miss out on the opportunity to build equity in a home instead of paying rent, or cite the tax advantages of homeownership as the piece they particularly want to retain.

My advice is almost always this: Slow down! Most legitimate loan programs now impose a three-year-plus waiting period after a borrower loses a home to foreclosure, even if they would otherwise qualify for a mortgage based on their credit score, income and assets.

Here are my four suggestions for how you can wisely use that waiting period to recover from a foreclosure — these steps also do double duty in terms of setting you up for success and sustainability the next time you buy a home.

1. Feel the pain.

Many folks who write to me are still in the early stages of grief at the loss of their home: anger and denial. They are angry at the bank, and in denial about the loss of their home and its advantages, from status to tax write-offs.

What I know is that getting through this grief is an essential first step to truly moving forward. Inherent in grief is an acknowledgement that something is dead and over. The acceptance of that finality is what allows you to move forward and learn the lessons that such experiences can teach.

As long as you’re stuck in the emotional protestations of how unfair it was that you lost your home, or spinning in a place of outrage about the Wall Street bailouts, you’re probably not making emotional progress to the point where you can begin to learn from your experience.

2. Metabolize the loss.

Henry Cloud, bestselling author of “Necessary Endings: The Employees, Businesses, and Relationships That All of Us Have to Give Up in Order to Move Forward” (Harper Business, 2011), recommends that we treat our painful past experiences as our bodies do food, metabolizing them by taking away the lessons we can distill from them that will fuel our future decisions, and leaving behind the pain and other toxic wastes from the experience.

Individuals and couples should take time out to acknowledge what has happened, and distill and discuss mistakes that were made and insights you’ve gained so that you can avoid repeating them in the future. It’s a meaningful method for progressing past grief and repositioning yourself to make smarter decisions about your money and your mortgage for the rest of your life.

3. Avoid rebound home purchases.

There’s a whole lot of what I call tuition — the price we pay to learn life lessons — involved in the loss a home to foreclosure. If rush in too quickly to the next home purchase, chances are good we’ll miss the lesson and get nothing for the tuition. This is evident in the gymnastics many foreclosed homeowners are considering going through in order to buy a home at all costs. These may mirror their willingness a few years ago to take on an unsustainable mortgage, which is what got some portion of them into foreclosure in the first place.

Trying to replace our losses on the rebound, be it after a breakup or after a foreclosure, is how people end up repeating their mistakes. Making new, unsustainable mortgage commitments and chronically overspending or over borrowing is no different from your friend who keeps repeating the same old dysfunctional relationship patterns, year after year.

4. Heal your finances.

My advice to foreclosed homeowners is to devote some real time to working on their finances, without worrying about buying another home. Get your debt paid down or off. Change your spending habits and your overall relationship with money. Get your taxes current and paid. Save some money. Create the habit of paying every bill on time every time. Eliminate unnecessary monthly expenses. Work the programs in “365 Days to Organized Finances or Financial Recovery,” or some similar book, or both. Focus for awhile on your career development.

By Tara-Nicholle Nelson, Tuesday, November 29, 2011.

Inman News™

Tara-Nicholle Nelson is author of “The Savvy Woman’s Homebuying Handbook” and “Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions.” Tara is also the Consumer Ambassador and Educator for real estate listings search site Trulia.com. Ask her a real estate question online or visit her website, www.rethinkrealestate.com

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3 reasons the real estate crisis will worsen

Foreclosures are old news. Down real estate values? Been there, done that, right? Well, we might all have gotten tired of hearing bad news about the real estate market, but the facts show that in many areas, foreclosure rates will rise before they decline, and a number of other indicators point to things getting worse before they get better.

Reality check: A down market is not all bad news. Weak home values translate into opportunity for buyers — especially when the government keeps rates as low as they presently are to encourage homebuying. Many of the mortgages being foreclosed were toxic and could stand to be purged.

Today’s low prices and record-low interest rates also portend well for the future stability of the housing market in that new homeowners are much less likely to face the problems this last generation of homeowners did (i.e., spiking mortgage payments and plummeting home values).

In any event, the real estate market is likely to stay down or continue to decline, in terms of home values and sales activity, and increased foreclosures, before it improves, for the following reasons:

1. The massive foreclosure backlog. The New York Times recently reported that it would take lenders 62 years — years! — to repossess the 213,000 New York state homes currently in some stage of foreclosures. New Jersey homes? Forty-nine years. Illinois and Massachusetts? A decade.

While the foreclosure pipeline moves more quickly in states where homes can be foreclosed without a court’s involvement, like California (three years), Nevada and Colorado (two years each), the fact remains that there is a massive backlog of homes in mortgage default that will take years to work through.

And the trend is for these foreclosures to take more, not less, time than before — after the robo-signing scandal and related self-imposed freezes, courts and law enforcement have imposed more verification requirements, settlement conferences and more detailed audits of foreclosure files before they will allow repossession to take place.

Despite the fact that the rate of new foreclosure filings has slowed (some say this has more to do with banks being slower to file than any real change in the default rate of homeowners), the rate of foreclosures will increase and/or stay elevated for years to come.

2. Too-tight lending guidelines. How tight is too tight? Lending guidelines are too tight when they screen out creditworthy borrowers, which many industry insiders say today’s loan standards do.

Sixteen percent of Realtors reported a contract failure in July, which usually indicates that a borrower who was probably preapproved (i.e., had a good job and credit history) had her loan declined because she failed to pass tough underwriting standards, the property didn’t pass the lenders’ muster, or there was an appraisal problem.

Ron Phipps, president of the National Association of Realtors, described this number as “unacceptably high,” explaining that with “both mortgage credit and home appraisals, there’s been a parallel pendulum swing from very loose standards, which led to the housing boom, to unnecessarily restrictive practices as an overreaction to the housing correction.”

Loans originated in 2009 have a default rate right around 1 percent, compared with the 22-27 percent default rate on 2007 loans and the 3 percent default rate on 2003 vintage loans.

These numbers, taken along with the contract-failure numbers, suggest that today’s lending guidelines are a knee-jerk overcorrection that is prohibiting many worthy would-be buyers from becoming owners and limiting the much-needed absorption of the excess inventory of homes on the market.

3. Job market woes and transitions. The national unemployment rate of 9.1 percent is just barely better than the average 2010 rate of 9.6 percent — and job growth totally flat-lined from July to August of this year, the latest available figures.

And those numbers are, many feel, misleadingly optimistic, as many long-term unemployed have stopped being counted, and are underemployed in part-time jobs or working freelance gigs because they have no other option.

Clearly, none of these people will be buying homes anytime soon (most thriving freelancers will need to file two years of tax returns as self-employed before they can qualify to buy); and even some employed would-be buyers are hesitant to enter the market as long as jobs are scarce because they view their own positions as insecure. Job market health is a prerequisite to housing market health.

By Tara-Nicholle Nelson, Monday, September 19, 2011.   Inman News™

Tara-Nicholle Nelson is author of “The Savvy Woman’s Homebuying Handbook” and “Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions.” Tara is also the Consumer Ambassador and Educator for real estate listings search site Trulia.com. Ask her a real estate question online or visit her website, www.rethinkrealestate.com

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Acquiring 1031 Exchange Property through Short Sales, Auctions and Foreclosures

Distressed sales continue to account for a significant portion of the sales volume in many markets.  Investors with access to cash are acquiring properties in short sales, auctions and foreclosures, and in some cases they are selling properties in a 1031 exchange and using their exchange funds to acquire these distressed properties. 

Investors who sell property in an exchange and use the funds to acquire property that is being sold by a lender in a short sale, auction or foreclosure need to keep in mind the 1031 exchange rules that may complicate the process. 

Timing

In a short sale, the bid package must be approved by the lender that owns the property, and in some cases this approval may take longer than expected.  Lenders appear to be approving packages more quickly, but an investor needs to pay attention to the timing.  In a 1031 exchange, the investor must identify replacement property within 45 days and close within 180 days after the close of the property being sold (relinquished property).   

Constructive Receipt

In order for a sale followed by a purchase to be considered an exchange for tax purposes, the investor cannot have control of the funds from the sale.  The qualified intermediary must hold the funds and the regulations say that the funds should only be delivered to the seller of the replacement property after the investor assigns to the intermediary his rights under the purchase contract.  If the funds are sent (as a deposit or as the purchase price) to the seller before the investor assigns his rights under a signed purchase agreement to the intermediary, there is a possibility that the 1031 exchange could be disqualified. 

Because of this rule, it can be difficult to acquire foreclosure or auction property in an exchange.  In a foreclosure, there is no contract to assign.  In an auction, there may not be a contract, but even when there is a contract, the seller often requires the successful bidder to make a deposit before the contract is signed.  In that case, investors will sometimes use their own funds to make the deposit rather than risk causing their exchange to be disqualified. 

In a short sale, some lenders will also require a deposit before the lender will sign the purchase agreement.  In order to avoid the constructive receipt issue, many investors will use their own funds to make the deposit and get reimbursed later from their exchange funds. 

Cooperation

In a 1031 exchange, the investor must assign its rights to the qualified intermediary under the purchase and sale agreement, and all of the parties to the transaction must be notified of this assignment.  Typically, in a replacement property closing, the seller signs a document acknowledging notice of this assignment; however, in some cases a lender selling property in a short sale may refuse to sign this acknowledgement.  One solution that some investors use is to ask the escrow agent or closing agent to state in writing that they sent the notice of assignment to the lender.  This gives the investor evidence that they have complied with this requirement in case they are audited. 

Another typical practice in an exchange is to show the qualified intermediary as the seller or buyer on the settlement statement.  Sometimes lenders who are selling property in a short sale won’t allow escrow to list the intermediary on the statement.  Although this is not ideal for the investor, most tax advisors feel that it should not adversely affect the exchange as long as the exchange documents are signed before the closing of the relinquished property and the investor does not touch any of the exchange funds. 

Reverse Exchanges

It also may be difficult to do a reverse exchange when the qualified intermediary is taking title to property that is being sold in a short sale because the lender may not allow the intermediary to go on title.  This possibility should be explored before planning a reverse exchange with property being sold in a short sale.

All of these details should be thoroughly investigated and resolved before attempting to combine a 1031 exchange with a short sale, foreclosure or auction. 

from The Exchange Update Newsletter by First American Exchange Company

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