There’s been a lot of cheering lately for the news that on June 3rd, the California Senate passed SB 1178 that would extend deficiency judgment protection to include refinances. Under existing California law, a homeowner generally has no liability to repay the lender for any deficiency between the value of a foreclosed property and the amount owed to the lender. This “anti-deficiency” law only applies to owner-occupant loans obtained to purchase a 1-4 unit property.  SB 1178 extends this anti-deficiency protection to any refinance of the original purchase money debt.  Whether this protection will include “cash-out refinances” is questionable although I understand that the Bill’s proponent, California Association of Realtors, is seeking that result.

What has gotten lost in all the cheering is the reality that SB 1178 will not go into effect until June 11, 2011. It is intended to stop lenders from bringing deficiency lawsuits against borrowers after that date. Nothing stops lenders from bringing deficiency actions before that date where they would have such a right under current law. In most circumstances, these would be lawsuits brought by “junior” lenders whose security gets wiped out by a senior lender’s foreclosure.  A lot of these are being filed right now.

A lot could change before the final form of this measure gets through the Legislature and is signed by the Governor. Presently the Bill is in House committees and the next hearing will be late this month.  Various challenges and clarifications are being discussed and there is no certainty at this point when or if this Bill will get passed or what a final form will look like.  We’ll keep you informed as it progresses.

Meanwhile, if you are facing a lender lawsuit or if you have specific questions about your liability, short sales, foreclosure, or any legal issues, feel free to contact us at sjbeede@bpelaw.com.  We offer a $200 flat fee consultation to evaluate your liabilities and strategize a resolution. This can be done in person or by phone. If interested, please call us at 916-966-2260.

The rights and responsibilities of lenders in dealing with upside-down loans are governed by State as well as Federal law.  In all cases, lenders must act “in good faith and with fair dealing” and comply with the law. However, in at least two recent actions in California, Wells Fargo appears to indicate that they consider themselves above the law and can do whatever they choose:

1)  A Buyer and Seller entered a Short Sale Agreement to which Wells Fargo consented as long as they completed the sale by May 31st.  Everything went well and the Buyer obtained his financing by mid-May and was ready to close escrow. However, on May 11th, Wells Fargo breached their own short sale consent and foreclosed.  They admitted this was a mistake and, even though a fix was easy because they ended up with the property, they have refused. Their only suggestion was that the Buyer could attempt to buy it when Wells Fargo puts it back on the market.  It apparently doesn’t matter to Wells Fargo that the Buyer loses the money he spent pursuing the purchase; the Agent loses the sale commission they earned; and the Seller suffers greater credit damage with a foreclosure on their record. And of course, Wells Fargo’s own investors will likely lose more in an REO re-sale. The Buyer, Seller, and Agent have now filed suit against Wells Fargo to force them to rescind the foreclosure and honor the Short Sale Agreement and the title to the property has been clouded with a Notice of Pending Action (”Lis Pendens”) stopping any re-sale.  We’ll keep you informed as this progresses.

2.   In another more incredible action, Wells Fargo has actually filed a lawsuit against a Borrower without even foreclosing!  In California (and most States), a lender who makes a loan which is secured by a lien against the real estate must foreclose first before they have any right to pursue any claim against a borrower for a deficiency. This is called the “Security First Rule”. In this case, Wells Fargo made a home equity loan to a property owner which was secured with a Deed of Trust against the property. The owner subsequently defaulted on the loan. But, instead of foreclosing, Wells Fargo filed a lawsuit against the borrower, failed to identify in the suit that the loan was secured with the real estate, and instead have treated this like an unsecured personal loan. When confronted with this breach of California’s real estate laws, Wells Fargo (through their attorney) has refused to dismiss the lawsuit and comply with the law.  While this reaction demonstrates a very troubling arrogance, it is equally troubling that their attorneys would knowingly violate California law.  Sadly, in this case, the property owner cannot afford to challenge Wells Fargo’s actions in Court.

There is no question that these are tough times for lenders as well as borrowers. The lenders created a house of cards by making loans that should never have been made to borrowers who could never have afforded them if they were priced according to economic reality. It could only have worked if real estate prices continued to climb forever. But the real estate economy never works that way. Booms are always followed by busts usually every 6-10 years. The lenders knew this even if the gullible borrowers did not. 

This reality doesn’t excuse borrowers from defaulting even if it was foreseeable. The laws on breach of contract are clear… don’t pay and you’ll be foreclosed. But the borrowers distress certainly doesn’t give the lenders such as Wells Fargo any legal right to disregard the law simply because they think the borrower can’t afford to stop them.  It is exactly this arrogance that has caused Americans to attack Wall Street for its greed and lack of concern for the damage caused to its investors.  In the lending industry, Countrywide paved the way for the economy’s collapse by promoting subprime loans.  Wells Fargo in contrast acted responsibly and maintained their reputation for sound lending. Now however, Wells Fargo’s apparent lack of concern for the law may undermine not only its reputation and further damage its borrowers, but may also promote a broader distrust of the lending industry at a time when trust and credibility are needed most. 

We’ll keep you posted as these and other similar cases move forward. Meanwhile, if you’ve been challenged with a wrongful foreclosure or if you have specific questions about your liability, short sales, foreclosure, or any legal issues, feel free to contact us at sjbeede@bpelaw.com.  We offer a $200 flat fee consultation to evaluate your liabilities and strategize a resolution. This can be done in person or by phone. If interested, please call us at 916-966-2260.

As my readers are aware, we’ve been grappling for many months over whether “Personal Residence” means 1) where you live at the time the property is sold or foreclosed; or 2) where you lived for 2 of the past 5 years. Obviously we’d all like the 2nd definition to apply since that would give debt forgiveness tax relief to the many property owners who have rented out their homes or moved. 

I have argued that the 1st definition controls based upon the following statements in the IRS Publication 4681 concerning Cancellation of Debt. In that document, the IRS defines Qualified Personal Residence Indebtedness as: “any mortgage you took out to buy, build, or substantially improve your main home. It also must be secured by your main home. Qualified principal residence indebtedness also includes any debt secured by your main home that you used to refinance a mortgage you took out to buy, build, or substantially improve your main home, but only up to the amount of the old mortgage principal just before the refinancing.”  The IRS then goes on to define “Main Home” as: “the home where you ordinarily live most of the time. You can have only one main home at any one time.”   Given this definition, I do not see how one could identify their Main Home as being anything other than where they live now.  This supports the argument that you must live there to get the debt forgiveness tax relief.    But, that may not be as clear as it sounds.

In a 2007 Publication on the tax impacts of foreclosure, the California Franchise Tax Board defines the taxpayer’s principal residence as “where they have lived for at least two of the past five years”. However, at that point, the FTB was talking about the possible capital gains liability from a foreclosure and for that purpose, the 2 of 5 year Rule does apply.

All of the commentarors on this issue look to U.S. Code Section 121 - Exclusion of Gain from Sale of Principal Residence - which provides: “Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more”.  So, does this only concern Capital Gains Tax or does it include Debt Forgiveness Tax? 

We get some clarity from the language of the actual law: “The Mortgage Forgiveness Debt Relief Act of 2007″ which states at Section 2.5: “principal residence’ has the same meaning as when used in section 121″. ie: the capital gains definition does apply. This was reaffirmed in 2008 when Congress passed the “Emergency Economic Stabilization Act of 2008″ which created the TARP bailout program for banks and extended the operative term of the Debt Relief Act to December 31, 2012. The joint committee report for the EESA states that the meaning of personal residence for purposes of the QPRI exclusion is the same as in Section 121.

So, what should we conclude from all this?  It does appear that the intent of Congress in passing these laws is that a foreclosure is considered to be a “sale” and the definition of “Principal Residence” shall be the 2 of 5 year Rule set forth in U.S. Code Sec. 121, not the Main Home definition that the IRS appears to be using.  It also means that there may remain an ambiguity in the law that has yet to be defined conclusively. Arguably, the IRS could disallow an exclusion from Debt Forgiveness Tax when the debtor was not living in the home at the time of sale.  Will they do so?  We don’t know yet.  What we do know is that if you need the 2 of 5 year definition to apply to you, be sure to get competent advice from an accountant or CPA that you trust and who knows these issues.

If you have specific questions about your liability, short sales, foreclosure, or any legal issues, feel free to contact me at sjbeede@bpelaw.com.  We offer a $200 flat fee consultation to evaluate your liabilities and strategize a resolution. This can be done in person or by phone. If interested, please call us at 916-966-2260. Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: /http://www.stevebeede.com/copingwithanupsidedownmortgage