Dear Chris Giddings,
My property has dropped in value and I may owe more that its worth. How can I refinance. What if anything, will my lender do to help? The payments are increasing and I don’t think I will be able to keep them going much longer.
Lately, I keep hearing the term ‘Short Sale’ what does it mean?
Sincerely,
Overwhelmed.
Dear Overwhelmed,
It sounds like if you could afford it, you would keep the house.
The first thing to do is to contact your lender. Ask for the loss mitigation dept also known as the work out dept.
Depending on the type of loan you have i.e. conventional, VA or FHA will depend on the number of options open to you. VA and FHA have a myriad of choices available to homeowners struggling with payments. Ranging from loan modifications, grant money, catching up back payments, to loan deferment and forbearance
Should you have a conventional loan then options become limited. But, not in all cases, much of the time will depend on the lender you are dealing with, also the case officer assigned to help. Not all of them are friendly, and sometimes it seems like they are darn right rude. However, in such a situation ask to get reassigned a new case worker. Be firm but polite.
If you have two loans against the property, it is more likely the loan in second place will be flexible in making alternative arrangements. So, that being said. The first place to start your communication with is the second deed holder. Also second deeds of trust or mortgages are more likely to have a higher interest rate than the first loans, reason being it’s a higher risk loan so calls for a higher interest rate .
Step back and put yourself in the lenders shoes. They lent money, the property has lost value, if you don’t pay, and the property will eventually get foreclosed on. At a foreclosure sale it’s very possible in a declining market the second will get wiped out completely. They get nothing, nada, zip. Think they want to deal? You would think so for sure wouldn’t you? Not always, amazingly enough, the departments and financial decisions are made by clerks making $15 per hour. Do they really care if the bank looses money? Not if they are still getting a pay check. So it’s important to relate to the clerk on an emotional level, be polite being firm and have your realtor provide you with comparable sales, and current list of homes available for sale. This you can supply to the lender. Lot of work so far huh . Now you’re starting to see why so many homeowners throw their hands up in the air and walk away. They can’t get past the frustration level. It is so important to be persistent. After all it’s your very lively hood. If the first person you speak to says no then call back the next day and speak to someone else. If they say then call back the next day, well you get the idea, you just keep going until you either wear them down, or find someone who is sympathetic to your cause.
However, if you just don’t have the patience or the time, a number of non profit agencies have been established to speak on your behalf. The best one I know of is H.O.P.E for homeowners a non profit agency based out of Chicago. They will actually do all the work for you for free!
HOPE is actually supported by financial grants from guess who, the lenders! But that’s a whole different subject!
So what is a short sale?
Simple terms, the bank accepts less money than it is owed. Why would they do this? Something can be better than nothing. As foreclosures rise, and they are, and the banks now own properties, they are now classified as REO (Real Estate Owned) this is now a property on the banks books as a non performing asset. Interestingly enough the banks have, for many years been attempting to break into the real estate market. This, with fierce opposition from the National Association of Realtors. I’m not sure this is exactly what they had in mind (or did they?). Anyway conspiracy theories to one side, the Bank/ lender now owns a piece of real estate that its investors have put up the money on. Here’s where it gets interesting (well to the real estate geeks it gets interesting), when the Bank has a non performing asset on its books it is not uncommon accounting practice (Tier1 Tier2 ) to put to one side a minimum 3 times the value of the property in reserves and in many cases much more than that. Meaning if the bank has a $250,000 dollar property on its books which it has to dispose of it also has 3 times more or $750,000 tied up in reserves which it is not lending out. Bearing in mind the $750,000 the bank is paying interest on in one form or another to its investors (the investors can also be made up from the average Joes saving accounts CD’s etc). This is pretty simplistic terms but you get the picture. It’s a house of cards.
If you decide to sell and go for the short sale, it’s imperative you find a real estate agent who has experience with the process. It helps if the property is given market exposure at fair market value. For a Reason that is known only to those who choose to make rules in order to have your short sale considered the loan has to be behind a payment or two is better! Incredible isn’t it. The bank actually says no don’t pay us, keep the monthly payment to yourself get behind a couple of months and then we will talk to you! Studies have proved on the average it costs a lender approx $40,000 to foreclose on a property.
Let’s do some basic math and see what makes sense. The property for example is valued at $350,000 however when it was purchased it was Valued at $400,000. Chances are when it was purchased two loans were initiated. One for 80% or $320,000 and the other for the remaining 20% $80,000 totaling $400,000 this is a great example of 100% financing.
For conversation purposes, and so we don’t have to break out our amortization calculators, we will say both loans are interest only meaning none of the loan has been paid down or in realtor/lender lingo no principle reduction has occurred. So the loan balances are still the same as the day the property was purchased. (Yes lots of people did this type of loan on the advice from the smiling vultures, woops I mean lenders)
You list the property with an agent, and receive an offer of $350,000 the agent is charging a 6% brokerage fee and the normal closing costs covering title insurance transfer tax escrow fees etc amount to 2% of the sales price. That’s 6% + 2% of $350,000 which calculates in dollars to $28,000
We used the example above saying the property had loans on it for $400k
Not everyone is staying with me at this point and of you fall in the category its ok just nod wisely and raise an eyebrow. Things will work themselves out.
So lets’ go back a bit, the property has an offer for $350,000 it will cost $28,000 in costs to sell, leaving us with a net of $322,000.
Not quite enough to pay of the first lender and leaving nothing on the table for the second lender. Remembering the bank said please don’t make a payment for a couple of months and then we will entertain accepting less. But if you’re current on you payments they won’t talk to you.
How do we approach this you may be wondering?
Before we can answer that we have to take into account the following;
Are you ready for another equation? I thought not, well, the bank is performing them all the time. The bank knows if the property goes to foreclosure sale, the only way it might get purchased is by a cash only investor. Cash only Investors purchase properties at the foreclosure sale (trustee sale if you want to get the lingo correct) using a profit margin of a minimum of 17% under market value. Meaning the investor will only pay $350,000 minus 17% (approx $59,500 less than $350,000 or 290,500)
The Bank understands it is owed on the first loan at least $320,000 so the minimum opening bid at the foreclosure auction will be just that, at least $320,000 and we haven’t tacked on back payments and foreclosure fees.
Based on this, the first loan also knows it is in a loosing position. The first loan knows that if it forecloses the property it will have to evict the former homeowner, fix the property if needed, hire a realtor, account for marketing time, find a buyer, wait for the buyer to obtain a loan, and pay the commissions and the closing costs, all the time reporting into its investors who it borrowed the money from in the first place plus if you remember , putting 3 times the value of the property to one side in $$’s as a reserve to stay in compliance with FDIC.
The Second loan holder knows all this as well. (Sometimes the second loan and the first loan are the same company). The second loan holder knows the first loan is going to loose. But also understands its position as a second loan is going to be the biggest looser.
Chances are the second loan holder who In this example Is owed $80,000 will discount its loan up to 90% of its face value meaning it will settle for approx $7,000!
If we remember the offer we had was netting (after closing costs) an amount of $322,000
But the second demanded a settlement of $7000, and we said the first loan had a payoff balance of $320,000.
Here goes a big math equation. $320,000 + $7000 = $327,000
It’s at this point the first loan holder is asked to reduce its payoff amount by the difference of $2,000.
Will it do this, maybe, but more likely it will approach the real estate agents and attempt to have them reduce the brokerage fees and cover the banks loss.
Depending on the experience and understanding of the transaction the realtor will make a decision based on logic rather than emotion.
Tax Consequences;
So all is well, the bank has accepted less the new borrower is buying a new property, the realtors have experienced a commissiondectimity and the book closes.
Not exactly, Now an old relative is about to show up uninvited. And its not even thanksgiving! Yep here he is, good old Uncle Sam, the I.R.S
When I say uninvited that’s incorrect, it would be better stated he was summoned by an action of the good old first and second trust deed holders.
So what’s going on, and why Uncle Sam is here and why he is smiling at me you ask? And well you should, Uncle Sam is ready to collect unpaid taxes. What unpaid Taxes? Hang on here for this one, the loan makers have the right under irc code to send you a 1099c for the deficiency it suffered through the course of accepting less. Meaning next January if your annual income was say $50,000 another $72,000 (the loss the second lien holder incurred) plus $2000 (from the first lien holder) will be added to you income for the year taking you to $124,000 in earned income increasing your tax bracket substantially!
The Bank does this to decrease its loss and show its shareholders it hasn’t suffered as much in the way as loss.
Now, if you had made improvements to the property it may be possible to offset some of this newly acquired income you didn’t actually spend.
Had you during the course of owning the property had a simple first loan and then later obtained a second loan and spent it on paying of credit cards or a cruise to the Caribbean it is very probable you will be paying additional taxes. However had you secured all loans to purchase the property and not withdrawn any equity there is a possibility you may not get hit with such a large tax basis. You are strongly advised to check with a C.P.A. And as my continual quest for information contact me for updates on this
So why not just let this go to foreclosure and avoid the tax consequences. Seems like a logical thought. Apart from further damaging the credit score what else can they do to you right?
In Nevada, and many other States, here’s what happens if you do nothing and allow the property to foreclose. The bank has a right to proceed in obtaining a Deficiency Judgment for the loss it sustained against you and all parties who signed on the loan, this includes Co signers co-borrowers, ex spouses, mum dad, friends, anyone who signed with you on the loan.
Yep, if you're looking for an example of kicking someone when they are down look no further.
However, we haven¿t touched on bankruptcy yet. Both Before and After.
If you would like an in depth analysis of your particular circumstances contact me today I hope this article has been at least somewhat helpful, But every case is different and stands on its own merits. Once again, feel free to call me -1-800 -375-4618 or email with any questions,You might get suprised you how quick of a response you receive.
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