There are 5 things you can do when you realize you can no longer make your mortgage payments:
- Nothing
- Deed in Lieu (Hand the Title, and keys, back to bank)
- Short Sale
- Bankruptcy
- Loan Modification
All of these options will adversely affect your credit. However, some options ARE better than others.
For example, the on the severity scale of how bad your credit will take a hit, on a scale of 1 to 10, an outright foreclosure or bankruptcy is like an 11. The Deed in Lieu is probably the dumbest thing to do because the bank will let you stay in the home rent free for a while anyhow while you work this all out.
A Loan Modification is the best route to take, but you have to know what you’re doing. There are only a handful of legitimate Loan Modification companies out there that know how to handle this for you (for a fee) but are well worth the money. Making your monthly payment smaller could allow you to keep your home and sometimes the bank will reduce the AMOUNT owed (principal balance).
A short sale is the best route to take, usually, if you…A) Can’t get a loan modification, B) The loan modification doesn’t help anyhow because you can’t afford even the new amount, C) The home you’re living in is your principal residence (i.e. it’s not an investment property), and D) you can work out discharge of indebtedness with the IRS.
We get the term “short sale” from the fact that the bank is taking less from the proceeds from the sale of your home than the current loan amount owed. Ergo, the bank comes up “short.” In other words, the bank takes the hit in the pocket and you take the hit to your credit. When you short sale, the amount “forgiven” you by then bank for the difference owed and the final purchase price is actually considered a “gift” by the government, and the government will tax your income accordingly.
Example: You bought your home in 2006 for $750,000. The home is now worth $600,000 and you’ve lost your job. Your wife (or husband) can’t handle the payments with their income alone. You try to call the bank and work out a loan modification but the bank says “no” even though the person on the phone is not authorized to tell you “no.” So you call an expert who can negotiate with the bank for you. THAT doesn’t even work so now you must short sale your home. You find a real estate agent who lists the home you once bought at $750,000 for $575,000. The agent tells you that you need to get together a “packet.” The packet consists of two years taxes, 2 months bank statements, a hardship letter to the bank explaining why you can’t make your payments, and any other documentation of income. The agent gets several offers and eventually (after several weeks) submits the highest and best offer (we’ll say $600,000 for the sake of this discussion) to the bank with the “packet.” The packet with the offer reaches the bank’s loss mitigation department where it sits on a desk with several other offers and packets on several different properties. If there are 2 or more lenders on your home, the packet and offer have to be sent to those banks as well. When there is a Second on the property, it gets sticky because the First Lien Holder always wants to screw the Second Lien Holder and the Second wants to get something out of the deal. The negotiations between the 1st, 2nd (and sometimes) 3rd Lien Holders will often delay this process even longer. Let’s say the bank settles on the $600,000…and you owe $700,000 since you originally put down $50,000 when you bought the place. Now, you are taxed on that $100,000 as if you made that money since it is considered a gift by the IRS.
The good news is that there was a bill passed by Congress to relieve you of that “gift” taxation as long as you live in the property as primary residence and can prove insolvency (that your bills are more than your income). You would then apply for this using IRS form 982 called “Reduction of Tax Attributes Due to Discharge of Indebtedness.” You apply when you file your income taxes. The word on the streets is that the IRS is so back-logged that they are not going after people for the difference on their home’s short sale, but I wouldn’t trust in that information but consult a CPA or lawyer to see how you’ll be affected.
Need help selling or buying a home in Orange County?
Contact me, Nic Petrossi with Prudential at (714) 272-3646 or email me at npetrossi@yahoo.com
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NIC PETROSSI, Orange County Real Estate Advice 