As home owners throughout our nation have struggled to either retain their properties or minimize the damage in losing them, they have looked towards a patchwork of government programs for help.  These programs such as Hope for Homeowners, HAMP, and now HAFA have promised a lot but delivered very little results so far.  The one effective relief program has been the Federal Debt Foregiveness Relief Act and comparable State laws which enables homeowners to avoid taxes on the forgiven debt on their principal residence.  No such program has been created to protect investors but… relief from these taxes may be available anyway.

Debt Forgiveness Tax arises anytime a lender is not paid in full on a loan. Typically, this is measured by the lender issuing an IRS 1099 for miscellaneous income showing what was owed and what was paid. You get taxed on the difference as income unless some exemption applies. There are several.

1.  Capital Loss Offset - When you buy a property, your purchase price generally establishes your “taxable basis”, ie: what you invested. This is increased by capital improvements you make, such as a new roof, and it is decreased by your depreciation write off.  For many investors, your taxable basis may be much higher than the current market value and higher still than the amount owed on the property. For example, if you purchased for $500,000 with a $400,000 loan and the property sells or is foreclosed at a price of $250,000 (not uncommon); then you would have a debt forgiveness of $150,000 (amount of loan unpaid in the sale) but you would also have a capital loss of $250,000 (amount invested less sale price).  Accountants are generally in agreement that you can offset the debt forgiveness tax with the capital loss. In this example, the result would be elimination of the debt forgiveness tax and a carry-over remaining capital loss of $100,000 which could be applied against other investment losses. 

2.    IRS Insolvency Exclusion - In my February 19th posting, I wrote about how the Insolvency Exclusion works as detailed in IRS Publication 4681 “Cancelled Debts, Foreclosures, Repossessions, and Abandonments”. http://www.irs.gov/pub/irs-pdf/p4681.pdf.  The important point is that this Exclusion applies equally to homeowners as well as investors.  In short, you list all of your liabilities and below that list all of your assets. If your liabilities are greater than your assets, you are “Insolvent” for debt forgiveness purposes and can avoid the debt forgiveness tax. Many States, including California, have adopted the IRS Exclusion to apply to State debt forgiveness taxes as well.

3.  Bankruptcy - although this is a last resort for owners and investors alike, if a property is lost during the pendency of the Bankruptcy there will be no debt forgiveness tax applied. You cannot use BK to avoid taxes already incurred before the Bankruptcy is filed.

Before you make any decision concerning your upside-down home or investment property, be certain to get tax and legal advice from qualified professionals in your area who can look at your specific situation and advise you on how these rules apply to you.  This Article is solely intended to give you an introduction to what might be available for you but you should not rely on it to apply to your financial circumstances.

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

 has been the investor market

As many already know, the California legislature passed SB 401 on April 9th. While Gov. Schwarzenegger originally said he would not sign the Bill due to tax riders, but he signed the Bill yesterday  and it is now law.  California law will now be aligned with the Federal Mortgage Debt Forgiveness Relief Act and will give CA owner-occupant property owners debt forgiveness tax protection through 2012 and retroactively running from 2009 (2007-2008 already protected). To learn more, read today’s article by Jim Wasserman in the Sacramento Bee: http://www.sacbee.com/2010/04/13/2674065/california-wont-tax-forgiven-home.html.

There is some confusion in the Blogging world concerning debt forgiveness relief.  Some believe that the forgiveness automatically exists if the loan or loans were acquisition loans (1 to 4 unit, owner-occupied). This would be correct if the owner never refinanced and stayed owner occupant throughout. But it would not be correct if the owner later moves and rents the propertyout.  If you are in this situation, be sure to check with your accountant to determine how this will apply yo your situation.

If you have any questions concerning your rights and obligations concerning real property, foreclosure, or any related issues, please feel free to contact me at sjbeede@bpelaw.com or contact my office at 916 966-2260 for a confidential appointment by phone or in person.

Over the past year, I have posted numerous Articles which in part deal with Debt Forgiveness and the receipt of a 1099 form from a lender.  Now, as we’re seeing lawsuits being filed by some lenders to collect on unpaid debt after foreclosure, borrowers are saying “Wait… they gave me a 1099! Doesn’t that mean the debt is forgiven?” The answer is maybe.

A 1099 is simply a type of IRS form used to report income other than wages, salaries, and tips. The most common forms are:  1099-Misc to report miscellaneous income; 1099-Div to report dividend income; and the 1099-Int to report interest income.  Following foreclosure two different forms of 1099 are used: the 1099-C to report cancelled debt; and the 1099-A to report the acquisition or abandonment of a secured property. It is this last one that causes the confusion and no doubt will be the subject of litigation.

The 1099-A contains several boxes, one of which requires the lender to state whether the borrower was personally liable for the debt or not.  If there is no liability (such as in California with acquisition debt or following the lender’s Trustee Sale), then the unpaid debt amount is forgiven and debt forgiveness tax can be assessed (unless an exclusion applies). This gives the same result as the 1099-C. But… where the 1099-A states that the borrower is personally liable, then the filing of the 1099-A  might not mean debt is forgiven. Rather, it may mean that the lender has only filed the form to designate that an event has occurred and they have not as yet determined whether or not to cancel, ie: forgive, the debt. This is a very confusing result. 

You can learn more about the use of 1099-C and 1099-A on IRS Publication 4681: http://www.irs.gov/pub/irs-pdf/p4681.pdf. For any of you Accountants reading this, if you can shed more light on this, please post a Reply or e-mail me at sjbeede@bpelaw.com.

Watch this Blog for further insight as this issue gains greater clarity. We’re just starting to provide defenses for borrowers sued by wiped out junior lenders and the role of the 1099 may be an important defense argument (as well as the many other defenses that may exist).  Remember, lenders want to try to get paid but they don’t want to throw good money after bad. If there is some recourse, a settlement may be the fastest and most cost-effective result for everyone.

If you’re facing a post-foreclosure lawsuit or have any questions concerning upside-down loans or your rights and obligations concerning real property, foreclosure, or any related issues, please feel free to contact me at stevebeede@bpelaw.com or contact my office at 916 966-2260 for a confidential appointment by phone or in person.

Last week I posted comments on the Home Affordable Foreclosure Alternatives program which is taking effect on April 5th. I was not very complimentary and in fact was pessimistic as to its impacts on the economy. While those negative sentiments may still prove true, I have since then taken a closer look at the program and spoken extensively with lenders, real estate agents, and upside-down borrowers. From this, I must now admit I see a lot to like in HAFA… if the lenders will cooperate.

HAFA has two parts: First an attempted Short Sale and then, if that fails, a Deed in Lieu of Foreclosure.  Since it was designed as an add-on to the Home Affordable Modification Program (HAMP), the particpation requirements are the same: principal residence, first-lien mortgage, serious delinquency, unpaid balance under $729,750, and a mortgage payment over 31 percent of gross income.  If a borrower fails a modification or is denied a modification under HAMP, then they can enter the HAFA program and their lender must participate. 

Short Sale - There are several benefits to pursuing a Short Sale through HAFA compared with doing so outside of the Program: 1) Lenders will pre-approve what will be an acceptable sale price;  2) The Application must be considered within 30 days; 3) Up to $3,000 is provided to satisfy the liens of junior lenders (juniors must release their liens); 4) Borrowers can get $1,500 in moving assistance; 5) Real Estate Agents get commission protection; and most importantly 6) No Deficiency judgment is allowed against the borrower.  These are all very good benefits that will both speed up short sales and improve the market.  The downside is whether lenders will actually cooperate with the HAFA program. They are only compelled to consider the Short Sale Application, they are not compelled to approve it.  Nevertheless, cooperation may grow as lenders realize that it is in their own best interests to get the Short Sales done and remove upside down properties from the market faster.

Deed In Lieu - This is an important addition as well.  Currently, if a short sale fails, the property goes into foreclosure with  all of the negative consequences of credit damage, job impact, and depending upon the State, potential recourse liability.  The HAFA Deed in Lieu program eliminates this.  The 1st lender will accept a Deed transferring ownership of the property to the lender. Any junior lenders must agree to release their liens and any recourse. if this occurs, foreclosure and all of its impacts are avoided.

Will all of the benefits of HAFA work? We’ll all have to wait and see how the Lenders respond.

If you have any questions concerning your rights and obligations concerning real property, foreclosure, or any related issues, please feel free to contact me at sjbeede@bpelaw.com or contact my office at 916 966-2260 for a confidential appointment by phone or in person.

As readers of my Blog know, there has been very, very little help provided by any government programs that theoretically are to help troubled homeowners keep their homes.  Even less help has been provided by the lenders.  The original Hope For Homeowners program failed to get lender cooperation. This was followed last year with the Home Affordable Mortgage Program (”HAMP”) which also has failed to deliver any substantial help to upside down borrowers.  And now, effective April 5th, the government will open their newest program, the Home Affordable Foreclosure Alternatives Program (”HAFA”).  Significantly, this Program is being introduced as a part of the HAMP program but it has nothing to do with helping people keep their homes. Rather, it is designed to assist lenders in getting the existing owners out through a short sale or deed in lieu of foreclosure. 

The sad reality of HAFA is that it effectively gives the lenders what they wanted… a politically correct reason to deny modifications (which they don’t want to do) and a faster way of getting the existing owners out (which they do want to do). So, for upside-down owners, there’s no help in HAFA.  But for our economy, the results may be even worse.

Today’s real estate market, especially in California, is operating on an artificial economy.  The lenders are holding back putting all of their foreclosed properties on the market. This keeps the supply down and keeps prices up.  The lenders could put more properties on the market but that increase in supply would cause prices to fall since demand by buyers is not growing. The result of this is that the lenders have been slowing down the foreclosure process so they don’t get more properties that they’ll just hold back.  But since all of these must eventually get sold, this means that it will be many years before our real estate economy is not driven by the lender’s inventory of foreclosed homes. And, thanks to HAFA, it may now get much worse.

Under the rules of HAFA, all lenders that participate in the HAMP program must participate in HAFA. This means that if a lender denies a homeowner a modification under HAMP or the modification fails or is not accepted, the lender must offer the homeowner a short sale or a deed in lieu of foreclosure and our government (we the taxpayers) will pay the lenders and borrowers to participate.  This will speed up the change of ownership.  But what will be the effect on the already over-supplied real estate economy?

According to the lending industry information service, Mortgage News Daily, as of the end of 2009, only 4.3% of all HAMP modifications resulted in permanent loan modifications. Over a million trial modifications are in process. Unless the permanent modification numbers increase dramatically, we could be facing an additional 950,000 short sales and foreclosures coming on the market.  This would be a disaster as these get added to the already over-supply driving down the values of property. Existing buyers, investors, and lenders would be scared away from an unstable market and the problems in the economy would become even worse.

Is there any solution?  Well if the objective is to help people keep their homes through loan modification, then there needs to be a way to compel lenders to reduce principal amounts owed. If lenders continue to refuse, then Congress should pass the Chapter 13 Bankruptcy Reform which the Senate shut down last year. Alternatively, compel lenders (particularly BofA) to waive deficiency recourse so that everyone can move on.

Sadly, there remained no Hope for Homeowners in that program and Making Home Affordable has not made homes more affordable. HAFA gives up on the hope of helping owners stay and instead will only help owners go. Unfortunately, this may hurt us all.

If you have any questions concerning your rights and obligations concerning real property, foreclosure, or any related issues, please feel free to contact me at sjbeede@bpelaw.com or contact my office at 916 966-2260 for a confidential appointment by phone or in person.

California law requires that property owners must return the tenant’s security within three weeks from the time the tenant vacates and document any deductions. When ownership is transferred to another, the former owner is required to either transfer the deposits to the new owner or return them to the tenant.  But what happens when the property is foreclosed and the former owner that collected the security deposits is gone or even bankrupt?

Under California Civil Code Section 1950.5, a successor owner is jointly liable with the former owner to retun the deposits once the tenant vacates. The idea is that the innocent tenant’s right to the deposit should be protected and that any disputes over this are between the current and prior owner, not then tenant.  There is an ambiguity being argued by lenders that this obligation is extinguished by the foreclosure just as is the rental agreement itself.  This may be held to be true where the post-foreclosure owner treats the rental agreement as extinguished. In that case, the tenant similarly has no obligation to pay the rent and so the situation may become a wash.  But the result is reasonably different where the new owner treats the rental agreement as continuing and actually collects rent.  There, most likely, the law will protect the tenant.

Despite the above-stated ambiguity, all perties acquiring property through a foreclosure must anticipate that they will likely be liable for the tenat’s security deposit that was collected by the former owner. Further, they should make sure that they have a new rentail agreement signed by the tenant if the rental is to continue.

If you have any questions concerning your rights and obligations concerning real property, foreclosure, or any related issues, please feel free to contact me at sjbeede@bpelaw.com or contact my office at 916 966-2260 for a confidential appointment by phone or in person.

Short Sales are a difficult process at best and they are made worse by numerous uncertainties, most particularly in the case of lenders demanding further payment from the Sellers. Faced with such demands, some sellers may find it is more financially prudent to simply walk-away and let the property go to foreclosure.  However, such action may expose a seller to damage claims from the Buyer or agents.

A short sale involves four separate contractual agreements:

1.   THE LOAN(s) - A loan is a contract between the borrower and the lender made up of a promissory note (the promises to pay the loan back) and a security agreement (pledging the property as security for repayment). Depending upon the laws of the particular state, the lender may be able to get a money judgment against the borrower if the loan does not get paid in full. A short sale arises when the Seller owes more on the loan than the selling price of the property. Generally, the seller/borrower is seeking to get the lender to release any liability claims on the shortage.

2.  THE LISTING AGREEMENT - this is a contract between the seller and a real estate broker. The seller hires the broker to locate a buyer and sell the property. If successful, the seller pays a commission to the broker. In a short sale, success is also contingent upon the lender agreeing to the short sale but the conditions of that consent are often not spelled out.

3. PURCHASE AND SALE AGREEMENT - this is a contract between the seller and a buyer setting forth all of the obligations of both parties. A short-sale form of this contract adds a contingency for the lender to consent to the sale. Again, typically the terms of that consent are not spelled out.

4. CONSENT AGREEMENT - this is a contract between the seller and the lender stating the conditions under which the lender will agree to the short sale. Since the short sale changes the obligations under the loans, consent by the lender and seller to these changes is necesary for the short sale to close. The most important issue for both seller and lender is whether the lender will have recourse against the seller for any loan amount not paid in the short sale. This contract is where this issue is decided.

 Every contract comes with what is called an “implied promise” that all parties to the contract will act in “good faith” and with “fair dealing” in carrying out their obligations. Thus, at a basic level, the borrower must pay the loan; the broker must find the buyer; the buyer must be ready to buy; and the seller must be ready to sell.  What happens however if the lender demands recourse or more payment against the seller?  Can the buyer force the seller to sell?  Alternatively, can the buyer and agents collect money damages and commissions from the seller if the seller refuses to sell?  The best answer is…look to the contracts.  Does the seller have any good faith basis upon which to refuse to sell if the lender demands recourse?

As readers of my Blogs know from prior articles, the right of a lender to get recourse against a borrower if they’re not paid in full depends upon the language of the loan documents, how and when the loan was made, and the application of real estate law in the State. Rarely does a loan document ever expressly state that it is “non-recourse”. Instead, nearly all loans are written as being “recourse” even though the lender’s actual rights to recourse will be governed by the above factors. This is where the conflict with short sales arises. A lender has no obligation to take a penny less than they are owed in order to enable a seller to sell their property yet that is what the seller typically wants. This conflict is resolved - or not - in the Consent Agreement. If resolved, the sale goes through. If not, the sale dies and the property likely goes to foreclosure. So the key question, is when must the seller consent or, alternatively, when can the seller walk-away from the short sale without liability?  The legal answer should be found in determining if the seller acted with “good faith and fair dealing”.

For example, in California if a borrower gets a loan to purchase a 1 to 4 unit property that they live in, this is called a “purchase money loan” and the lender has no recourse against the borrower if the loan is not paid in full, regardless of what the loan documents may say.  In contrast, if that same borrower later refinances the property, the new loans are not purchase money and therefore the lender would generally have recourse.  Unfortunately in most short sales, this distinction is not considered in drafting the Listing Agreement or Purchase and Sale Agreement. And so, the parties are blindly proceeding expecting the lender to give up recourse and only then considering the impact if the lender refuses.  This could make the seller and possibly the seller’s broker liable for damages if the seller refuses to accept a short sale with recourse.

Since the seller/borrower should know up front when the lender has recourse rights in their loan, the seller really does not have a right to be surprised by a recourse demand in the short sale agreement. Therefore, ”good faith and fair dealing” reasonably would require them to complete the short sale with recourse (if it couldn’t be negotiated down).  Refusing to do so could make them liable for financial damages to the buyer and the buyer maybe even be able to force the sale.  In such situations, it is reasonable that the seller’s broker and agents could similarly be liable for the buyer’s damages (and the commission of the buyer’s broker) for putting the property on the market with the implied representation that if the lender accepts the short sale buyer, the seller will close the sale.

In contrast, where there is no recourse in the loan (such as in the purchase money loan referenced above), the seller could reasonably claim that they were acting in good faith and fair dealing in rejecting a short sale consent agreement that gives the lender more recourse in the short sale than they would have in foreclosure. Is the seller right in this claim?  Well, on the one hand, it was not unreasonable for the seller to expect that the lender would not increase the seller’s liability merely because it is a short sale. On the other hand, in a voluntary transaction such as a short sale, the lender is not bound by what it could do if it foreclosed.

So, my conclusion is: “Yes”, the Seller can be liable to the Buyer in walking away from a short sale.  More importantly, since the seller’s broker is providing the Listing Agreement and advising the seller on the contents of the Purchase and Sale Agreement, the brokers - both seller’s and buyer’s - owe a fiduciary duty to their clients to provide for this type of contingency.  At the simplest level, the Listing Agreement and Purchase and Sale Agreement should reference the conditions under which the seller will be bound to accept the lender’s Consent Agreement.  If the Seller is to be able to walk away if the lender demands recourse, the Seller’s broker should make sure that that contingency exists in the Purchase and Sale Agreement.  Similarly, the buyer’s broker should make an early evaluation of the recourse on the seller’s loans and so advise the buyer of the walk-away risks before the buyer invests a lot of time and money.

Short sales are hard enough for everyone and are stressed with the uncertainty of the lender’s response to the seller’s short sale request.  It is within the diligence ability of all of the parties to have a better understanding of how the seller will likely respond if the lender demands recourse before the Purchase and Sale Agreement is made.  If the parties took this step, a lot of anguish, frustration, and legal liability could reasonably be avoided.

If you have specific questions about your liability, short sales, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com or 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/.

The content of this Article is for general information purposes only and is not to be relied upon as legal advice. Be sure to consult a knowledgeable real estate attorney in your State for advice on your particular situation.

As borrowers continue to grapple with upside-down loans and short sales and foreclosures continue to climb, the risk of debt forgiveness tax becomes more important, especially for investors who do not have the personal residence exclusion from Federal taxes on forgiven debt.  “Debt Forgiveness” occurs when the lender doesn’t get paid all that they are owed and they are not going to pursue you for any unpaid balance.  Although the risk of a judgment on the unpaid balance goes away, you can be taxed on the amount of forgiven debt as if it were income you had earned,. This is often called “Phantom Income” because you never really saw it but you are still affected by it.  As I discussed in prior Blogs, the Federal government has relief from this tax on personal residences through 2012. California has no relief.  Luckily, both have an “insolvency Exclusion” that may apply and which can enable a debtor to otherwise avoid being driven into Bankruptcy. Since Bankruptcy has far greater potential negative consequences than a short sale or even a foreclosure, the possibility of avoiding these taxes without filing Bankruptcy is important. Here’s how the Insolvency exclusion works.

As set forth in full on IRS Publication 4681 “Cancelled Debts, Foreclosures, Repossessions, and Abandonments” http://www.irs.gov/pub/irs-pdf/p4681.pdf, Insolvency is determined by first listing the fair market value of all of your liabilities immediately before the debt forgiveness event (short sale or foreclosure). Next you list the fair market value of all of your assets at the same point in time.  Next, you subtract your assets from your liabilities. If the result is zero or less, ie: your liabilities exceed your assets, then you are insolvent.  Page 6 of Publication 4681 has the actual worksheet you can use to make this calculation.  Once the insolvency is determined, you report this on your tax return through the use of IRS Form 982 http://www.irs.gov/pub/irs-pdf/f982.pdf. 

California appears to draw it’s insolvency determination from the IRS Form 982. California’s taxing agency is the Franchise Tax Board (”FTB”). As stated in the FTB Tax News dated February, 2010 http://www.ftb.ca.gov/professionals/taxnews/2010/February/Article_8.shtml “if the loan is recourse indebtedness and the debtor incurs cancellation of indebtedness income (CODI), IRC Section 108 provides certain exceptions in recognition of that income. One of the exceptions applies where the taxpayer was insolvent (total liabilities exceed total assets) when the CODI was realized. The exclusion only applies up to the amount of insolvency, i.e., to the extent the liabilities exceed the FMV of the assets”. However, California law does not conform to all of the provisions currently available in IRC Section 108.

The key is this:  If you are an upside-down borrower facing a debt forgiveness tax as a result of a short sale or foreclosure, you may be liable for debt forgiveness tax and may queslify for the insolvency exclusion. Be certain to get tax advice from a qualified professional who can look at your specific situation and advise you on how these rules apply to you.  This Article is solely intended to give you an introduction to what might be available for you but you should not rely on it to apply to your financial circumstances.

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

Many people are confused as to what happens if the property in which they live has been foreclosed. Most fear that a Sheriff will come knocking on the door to suddenly kick them out. In California (an likely most other states) that cannot legally occur.  A foreclosure simply creates a change in the ownership of the property. The rights of the occupants in the property are determined by what their status was before the foreclosure and now, Federal and California has made these rights even clearer.  This creates more protection for tenants and a possible trap for unaware foreclosure buyers.

Here are the current rules:

1. FORMER OWNER IS OCCUPANT - If the former owner remains as an occupant of the property after a foreclosure, the new owner must give that person only a 3 DAY NOTICE TO QUIT. The theory is that the former owner knew the foreclosure was coming so they should have made arrangements to move.

2. OCCUPANT IS RELATED TO FORMER OWNER - If the occupant is related to the former owner, ie: child, parent, or spouse, and the former owner is not an occupant, then the new owner must give the occupants a 60 DAY NOTICE TO QUIT. In theory related parties should be aware of what is going on. Even so, this change gives these parties more time than they had before.

3.  UNRELATED OCCUPANTS ON PERIODIC TENANCY - If the occupant is not a former owner or related to the former owner and is on a periodic tenancy such as month-to-month (not a Lease), then the new owner must give the occupants a 90 DAY NOTICE TO QUIT. The thought here is that periodic tenants are innocent victims who may be surprised by the foreclosure and will need more time to find a new place to live.

4.  UNRELATED OCCUPANTS ON LEASES -  If the occupant is not a former owner or related to the former owner and is on a fixed-term Lease (such as 6 months, one year, etc.), then the new owner cannot terminate the occupant’s tenancy UNTIL THE END OF THE LEASE TERM unless the new owner intends to occupy the property themseves in which time the new owner must give the occupants a 90 DAY NOTICE TO QUIT. The thought here is that while Lease tenants are innocent victims who may be surprised by the foreclosure, they contracted for a specific term and had no right to expect a longer tenancy. However, as set forth below, they may have to actually pay rent to get the benefit. Despite this however, since the foreclosure extinguished the Lease, the new owner can treat this resulting tenancy as a periodic month-to-month tenancy if they intend to move-in.

Much of the new requirements arise under President Obama’s “Protecting Tenants at Foreclosure Act of 2009’’ which was contained in the ‘‘Helping Families Save Their Homes Act of 2009’’, which was signed into law by the President on May 20, 2009. California amended its laws effective January 1, 2010 in compliance. While any new law becomes a fertile ground for disputes, this one presents an interesting issue concerning tenants on leases seeking to stay the duration of the lease. The Act defines a “bone fide lease” as being a lease which requires the receipt of rent that is not substantially less than fair market rent for the property. But does this mean that the rent must be paid? That remains unclear. If so, this would seem punitive considering that a tenant without a lease would get a 90 day notice with no obligation to pay. But is it really fair to the new owner to let someone live their longer than 90 days without paying? Perhaps the intent was only to establish that the lease was real…not to provide an ability for the new owner to collect the rent. But with no payment, who would ever want to bid at a foreclosure sale? Of course, it It will be up to the court’s to decide who’s interpretation is correct.

If you have specific questions about your loans, 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. We offer a $200 flat fee attorney consultation to enable you to evaluate your judgment and tax risks and to plan a strategy to minimize or even avoid them. Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage.

Every upside-down property owner is aware of the risk of a lender seeking a deficiency judgment for any amount of the loan that remains unpaid after short sale or foreclosure. Depending upon the laws of the state where the property is located, they may or may have any such right.  This issue of “recourse” is the first thing that I, as a real estate attorney, look at when advising borrowers and is the #1 reason that short sales fail (learn more in previous blogs).  But lately the question has been arising about whether a Mortgage Insurance Company has recourse if they pay-off a deficiency.

Private Mortgage Insurance (generally called PMI) is typically required by a lender anytime you borrow more than 80% of the purchase value of the property being acquired. In essence, you buy an insurance policy to protect the lender from the increased risk of loss with a higher loan-to-value ratio.  So you pay and the lender is the beneficiary. Here’s where it gets tricky.  An insurance policy is a contract between you and the insurance company for the benefit of a beneficiary. Like any agreement, the rights of the parties are governed by the terms of the contract and the laws of the State.  You pay for the policy in order to get the benefit of the lender giving you the loan… not for the benefit of avoiding a deficiency if there is a default (although this may be a reasonable belief if it is even considered at the time of the loan).  Thus, the policy may protect the lender from a deficiency and protect you from the lender’s claims but the policy may also provide that you must reimburse the insurer for any such payouts.  This is similar to your auto insurance which may pay a damaged third party for injuries suffered in an accident which you caused. The policy pays the injured party and you may have to reimburse the insurer for all or a part of what they pay out.  Again, the language of the insurance contract governs the rights of the parties.

But in the upside-down homeowner situation there are additional confusing issues. First, there must be an actual deficiency between the amount owed and the amount the lender receives.  If the lender has no recourse, they’ll generally give you a 1099 from which you may be liable for debt forgiveness tax.  But, if the debt has been forgiven, how can the PMI insurer claim recourse?  Second, since the insurer is communicating with the lender and not you, how can they hold you liable for a claim of which you had no knowledge and no input?  Third, since the only real purpose of the PMI is to insure injury resulting from a default by the borrower, then - unlike the auto accident - it is the default that is being insured, not obtaining the loan and therefore there should not be any recourse right for the insurer.

As of this point is time, we are not aware of any cases in which insurance companies have actually filed lawsuits against borrowers seeking PMI recourse. Such cases may be going on at the local Court level and have not reached the visibility (and legal authority) that only arises from an appeal after a Judgment to a Court of Appeals.  Given that a breach of contract claim such as failing to reimburse an insurer must be brought within a certain period of time after the breach occurs (such as 4 years in California), we may wait a long time before there is any certainty how Courts will treat such claims.  Further, if and when those cases are brought, there may be a great difference in rulings by different courts. It is the appeals process that starts to bring uniformity to decisions.

So the short answer to whether a Mortgage Insurer can get a Deficiency Judgment is “maybe”.  However, as set forth above, if any such suits are brought there many defenses that borrowers can argue to protect themselves. Even more effective may be the reluctance of judges and juries to further punish upside-down borrowers especially when the lenders (that arguably created this problem) get made whole.

If you have specific questions about your loans, 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.  We offer a $200 flat fee attorney consultation to enable you to evaluate your judgment and tax risks and to plan a strategy to minimize or even avoid them.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.