As regular readers to my Blog should know, under California law (Civil Code Section 580b), if a lender makes a loan to enable a borrower to buy a 1-4 unit property which they live in, the lender has no recourse against the borrower. They can only take (foreclose) the property. They cannot get a judgment against the borrower if the property is not worth the amount owed on the loan. This is called an “acquisition loan”.  If the borrower later refinances this loan by getting a new loan, this protection is generally lost because the new loan was not obtained to acquire the property.  That makes sense.  But what about a loan modification?

Recently, several clients have had lenders (or collection companies) tell them that their loans became recourse because they got a loan modification.  From what I can see, this appears to be false and is no doubt said in an attempt to collect some money even when there is no recourse.

The First reason that this is false is that the loan and security (deed of trust) have not changed. It is still the acquisition loan and the same date of purchase recorded security.  Second, there is a rule in law called “substitution”.  The substitution doctrine applies when an acquisition loan is refinanced by the lender holding the original acquisition debt. The acquisition portion refinanced retains its purchase money character and the anti-deficiency protections of CCP §580(b) apply. (Union Bank v. Wendland, 1976).  Further there is legal authority that the protection extends to situations where the “beneficiary of the purchase-money loan ‘refinances’ the loan, ie: same lender, borrower, and security, but different loan amount.  From these sources, it appears fairly clear that a modification will not alone convert a non-recourse acquisition loan into a recourse loan.  As the court said in the Union Bank case, “…. the protections of the anti-deficiency statutes can not be avoided because of some clever paper shuffling on the part of the lender. To allow such is a circumvention of the anti-deficiency statutes.”

 We recently had a case in which our client had bought a home using 1st and 2nd acquisition loans. When she later sought a $6,000 education loan from the same lender, the lender replaced her 2nd loan with a Home Equity Line of Credit (HELOC) which included the original 2nd loan amount of $76,000 plus the additional $6,000. When the market later crashed and our client was losing her home, the lender claimed that the new 2nd loan was a refinance and thus they had recourse. They then sued the borrower for the entire $82,000.  Clearly the Substitution Doctrine should apply here at least to the $76,000. Unfortunately,  other financial issues have forced our client into Bankruptcy so this will not get resolved, but based upon the Union Bank holding and other cases, we are confident that our client would prevail on her claim that the $76,000 is non-recourse.

Of course, none of the above is going to stop unethical lenders and collection agencies from threatening and scaring borrowers into paying money on non-recourse debt.

If you have specific questions about your liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com or call us at (916) 966-2260 for a phone or personal appointment.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.  

On Monday, October 12, 2009, Gov. Schwarzenegger signed Assembly Bill 260 which, effective January 1, 2010, will ban negative amortization loans and preclude mortgage brokers from earning special fees on these high risk loans. According to the Bill’s author, Assemblyman Ted Lieu, the intent is to ban the practices that led to the foreclosure crisis that eventually triggered the recession which we now suffer. This will be good news for some but offers no assistance for the millions who remain at risk of losing their homes under their existing negative amortizing loan contracts. Although lenders will stop making such loans, they have been extremely resistant to cleaning up (modifying) such loans.

As those of you who have followed my Blogs know, the negative-amortization loan was a program offered by lenders to make loans to people who couldn’t qualify for normal fixed rate loans. Because they were marketed on a very low teaser start-rate, a great many gullible borrowers signed up believing the promises that they could later convert to fixed rate or “flip the home” for a profit. Both of these incentives were the unintended consequences of our Government’s desire in the late 1990s to expend home ownership and the American Dream.  The result was that millions of people got loans to buy homes they could not really otherwise afford. When the adjustments started happening and the homes couldn’t be flipped, this expansion of the American Dream quickly became a worldwide nightmare that we’re still dealing with.

The sad reality in all of this is that the lenders were very familiar with the dangers of adjustable rate loans from the problems in the 1980’s but it didn’t stop them from taking the fees up front and setting up this house of cards which had to collapse.  Hopefully this new law will stop such risky practices in the future and compel the lenders to be trustee stewards of their investors’ monies and their borrowers’ expectations.

Possibly this new law will add additional fuel to the legal arguments raised by attorneys seeking to stop foreclosures of these high-risk and now illegal loans. Since it is not retroactive, it does not have any legal effect on existing loans but certainly may influence a judge or jury in determining whether a loan was predatory.

If you have specific questions about your liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com or call us at (916) 966-2260 for a phone or personal appointment.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/. 

With the stroke of a pen, Gov. Schwarzenegger signed Senate Bill 94 and put an end to loan modifiers who charge up front fees.  As reported in the Sacramento Bee today, the action comes following massive complaints to the Dept. of Real Estate comcerning loan modifiers who took borrower’s money - up to $4,000 - and then abandoned them. While not condemning all modifiers, the new law applies to every such company that collects up-front fees. 

Earlier this year, State and Federal crackdowns on loan modifiers limited such services to real estate licensees and mandated DRE approved contracts for any up-front fees. However, many simply ignored the restrictions. More significantly, the earlier law excluded attorneys. As a result, law firms quickly filled the gap by collecting up-front fees and then partnering with loan modifiers to do the actual work. The new law puts an end to this.

While protecting the victims of these scams, the intent of the law is to stop abuse of borrowers in trouble. Legitimate loan modifiers can still operate but they cannot get paid until they have performed all of the services promised in their contract with the borrower.  This does not require that payment only be made if the modification is successful.  Borrowers must pay the loan modification firm for the services they provided, even if the firm cannot get the loan modified. 

Furthermore, the modification firms must tell potential clients that they may be able to get the same services for free from government-approved nonprofit mortgage counsellors. You can find these by Googling under such names as “nonprofit mortgage counsellors” or “debt management consultants”. I would expect that with this latest crackdown, getting access to this free help will become much more competitive so don’t wait. Act now and be persistent.

The new law will expire on January 1, 2013 which coincidentally is the expiration date for the Federal Debt Forgiveness Relief Act.  Apparently the concensus in Washington D.C. and in California is that this real estate mess will be cleared up by the end of 2012 so loan modification protection will no longer be an issue.  We’ll hope that they are right.

If you have specific questions about your liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com or call us at (916) 966-2260 for a phone or personal appointment.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/. 

One of the advantages of counselling hundreds of upside-down property owners is that I get confronted with situations that may call for solutions outside of what we would normally expect. This is one of them.

A client bought their home for $500,000. Today’s value is at best $300,000 and they owe $340,000.  Because of the economic downturn, they can no longer afford the home and are facing possible foreclosure or a short sale. Generally, we advise owners to stay living in the home as their principal residence to take advantage of the Debt Forgiveness Tax Relief.  However, under our current tax law, an owner cannot take a capital loss on their personal residence. So, my clients would lose the benefit of writing off the more than $200,000 investment they have lost.  In meeting with them, I realized that the amount of taxes they would save on Debt Forgiveness Tax Relief would be approx. 33% on the $40,000 of debt forgiveness, or $13,000. In contrast, the tax savings available by writing off their $200,000 capital loss would be $66,000 but to get this, they would have to turn their personal residence into an investment property.  Since I’m not an accountant, I advised them to check with their tax advisor or a CPA to determine if they could do this and, if so, how it would be done.  But that launched my own investigation which appears to confirm my suggestion.

One internet contributor, www.realestatecolorado.net, identified the key issue as how long one must have the property as an investment (”rental”) to get investment property treatment. They state: “although there is no defined “holding period” to be considered “held for investment,” many tax/legal advisors believe 1-2 years is sufficient barring any factors which contradict an investment intent.”  So, the key is to be intentionally holding the property as investment.  Another resource, The Center for Financial, Legal and Tax Planning, Inc., at www.taxplanning.com/takingacapitallossonyourhouse.html, provides an excellent explanation of the process and similarly concludes: “To cement the property as being a rental, renting the premises for two years should be sufficient to peg the property as a rental.”   So again, it is demonstrating investment intent over time.  The Center also notes: “As well as renting the property, the taxpayer should be cognizant of the little details that the IRS looks to in order to prevent the taxpayer from taking a capital loss.  Such items as having your name on the utility bills, using a regular personal residence mortgage and applying a homestead exemption for local taxes, must be changed in order to cripple an IRS argument that the property is actually a primary residence as opposed to being a rental property.”

Now back to the main question: Can a couple facing foreclosure on their personal residence rent the property out, give up the debt forgiveness tax relief, and get the capital gain write-off?  The answer appears to be “Yes” if they can be convincing that the change was done for investment intent.  It is unclear how the two year intent benchmark is measured, whether that is calendar years or tax return years.  Thus, my clients facing a 2010 foreclosure could theoretically rent their home now and show it as a rental on their 2009 tax return. Then, when the home is foreclosed (or sold short) in 2010, it would appear again as a rental on the 2010 tax return.  Two years showing as a rental on tax returns may be sufficient.  Would the IRS deny investment intent if the property loan is unpaid and foreclosure is forseeable? It is possible.

Certainly, the benefits of making the change could be worth it if successful.. plus you’d get the rental income during the interim.  But don’t take my word as advice to you on what to do . If this appears to be an approach that could benefit you, contact your CPA or tax advisor and get their advice and guidance for your particular situation and rely upon their recommendations. They would have to defend you against an IRS challenge. It certainly is worth checking out further.

If you have specific questions about your liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com or call us at (916) 966-2260 for a phone or personal appointment.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.