Mortgage underwater? Do your homework
Originally appeared in Bay Area News Group publications on Sept. 10, 2010
If you are making payments on a house that is worth substantially less than your loan, you may have thought about how to get out from under this burden. Financial, legal, tax and credit ramifications are all important in deciding which route to take.
You might have approached your bank for a loan modification only to discover that this seemed to be a shell game that took a lot of your time and effort, but did not result in a new, more affordable loan.
Maybe you have considered a short sale, a deed in lieu, walking away without making any further payments or even bankruptcy. Although these and other ways to remove the negative cash flow may have the attraction of eliminating your monthly mortgage payment, property taxes and insurance, they also can seriously harm your credit and could require you to come up with a pile of cash you never anticipated and do not have.
Do not ask for or accept advice from anyone other than a real estate attorney who specializes in this arena and a CPA who can explain the possible legal and tax consequences of any action you take. Even with the best of intentions, friends, family, co-workers and real estate agents can, unknowingly, lead you down the wrong path.
Sadly, untold numbers of property owners in this position do not make the effort to fully understand their alternatives and the potentially detrimental repercussions of each. This can lead to years of further frustration and regret.
Most homeowners have either no idea or only a foggy notion of the serious and costly implications of the various options available for extricating themselves from a home worth less than its loans. Remember that what looks like a promising avenue to you may be disadvantageous for the lender and vice versa.
Deed in lieu of foreclosure
This is a process whereby the homeowner gives the bank the house deed to avoid or stop the foreclosure process. Some issues here are that the lender may not always be willing to accept a deed in lieu, the borrower is not entitled to excess proceeds, if any, and junior lienholders (second, third loan, etc.) may challenge the process.
A deed in lieu saves the lender the costs of foreclosure, plus holding/maintenance, and the buyer averts having a foreclosure on his/her credit report.
In a short sale transaction, the lender agrees that the property securing the loan can be sold for less than the loan amount. In some cases, the proceeds will be accepted as full payment of the loan. In other scenarios, the buyer could end up with a “deficiency judgement.” Similar to a deed in lieu, the lender saves time and costs and the borrower avoids foreclosure on his/her credit record.
Per the California Association of Realtors (C.A.R.), “A deficiency judgement…is obtained by the lender in court against the borrower for the difference between the unpaid balance of the secured debt and the amount produced by sale or the fair market value of the security, whichever is greater, in a judicial foreclosure.” The short version is this – if you don’t pay the lender the full balance of the loan, you may be personally responsible for the difference. This could apply to a first loan or a junior one.
Many folks assume that, if they work something out with the bank, they can walk away and not be further concerned. This often is not true. As an example, loans that have been refinanced can be subject to a deficiency judgement. The state of California is working on legislation to deal with this problem. Even if that passes, you will still need professional, expert advice.
Also, as part of short sale paperwork, it is common for the bank to have the borrower sign a statement such as, “(Name of lender) reserves the right to proceed for a deficiency judgement for any deficiency balance remaining on the loan.” Worse, some lenders turn these loans over to collection agencies who then proceed to hound already stressed former homeowners who thought their ordeal was over.
Aside from possibly owing money to one or more lenders, you may also owe taxes on the transaction. Only a tax expert can give you adequate counsel on this subject.
Impact on your credit
A lower credit score can cause you problems with getting any kind of new loans, e.g., credit card, not just another mortgage in the future. The Federal National Mortgage Association (FNMA) has one set of guidelines, the Fair Isaac Company (FICO) has another. An impaired credit history may also make it more difficult to rent and could even affect your ability to get a new job.
If you do not repay the entire amount owed on your loan(s), it is highly likely that any option you choose will result in something negative. This is why it is essential for you to consult an attorney and tax advisor before making any decisions.
In the meantime, C.A.R. has Q&A’s regarding all these topics and more. Ask a Realtor to email them to you. There should be no cost for that.
Be particularly wary of self-styled “loan modification consultants.” You may end up paying someone to make your situation much worse.