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/.  

For upside down property owners, 2009 was a year of frustration and hype with little if any assistance. 2010 will likely be the same. Two key factors have become clear: 1) the unwillingness of lenders to cut principal balances for existing owners; and 2) the lack political will of our government to force any such cut. Back in 2008 when Hope for Homeowners was first ballyhood across the nation, the concept was that lenders would make more money by reducing existing loan balances and keeping owners in their homes than they would make if they foreclosed and put the property back on the market as an REO. The problem was that lenders disagreed. Lenders believed they would be better off getting what they could now and getting the property in the hands of a more financially stable owner. With loan modification failure rates running over 50%, there could be some validity in that belief. When President Obama was elected in 2009, he gave us the Obama Real Estate Recovery Plan the most valuable tool of which was the proposed Chapter 13 Bankruptcy Reform which would allow Federal judges to “Cram Down” principal values if the lenders wouldn’t. Unfortunately, the Senate wouldn’t go along and so the Plan failed. Instead, the government put forth the “Home Affordable Modification Program” which to date has produced very few home saving modifications.

So what to expect in 2010?  Here are my predictions:

1)  For Existing Property Owners  - Government will continue to tinker with the HAMP program to try to get more lender cooperation. The key obstacle will remain principal reduction. As lenders continue to refuse to make cuts, pressure is building to re-introduce the Bankruptcy cram-down legislation.  Look for increased lender cooperation with HAMP to avoid the cram-down but it will likely be too-little, too-late to avoid large scale foreclosures in 2010;

2)  Foreclosures - As of the new year, there are over 400,000 homes in pre-foreclosure nationwide, over 125,000 in California alone. Without an effective modification program, more owners will realize that it is time to move on and will either walk-away or attempt a short-sale to minimize credit and tax damage.

3)   Short Sales are the Market - For 2010 and probably for several years after, Short Sales will become the primary means of transferring homes.  Lenders have managed to stabalize prices by holding back on foreclosures and listing REO’s but there is a tremendous backlog of upside-down properties that need to be dealt with. Short Sales offer both seller and lender the best solution. The big obstacle - lender demands for recourse against the seller - is changing. Even BofA has dropped their recourse demands. Short Sales will be the path to market recovery although don’t expect prices to start climbing. Right now inventories are low so there has been some upward price movement due to supply and demand. As lenders get their short sale act together, and Realtors become more effective at negotiating and packaging these deals, more properties will come onto the market. Though this will keep prices down, more properties will be sold and we’ll all get through this housing bust faster.

4)  Commercial Real Estate - the big unknown - in 2010, our attention will shift away from upside down homes (that issue is being resolved) and will turn to fears of business collapse and loss of jobs. According to commercial broker, Grubb & Ellis, we’re approaching the highest vacancy rates since the dot com bust, with office vacancy reaching almost 20%.  With banks still fearful of lending and individuals fearful of spending, this double-whammy put more and more companies out of business and with them went a loss of jobs that has continued the downward spiral.  While few expect that these conditions will create a Depression-style generation of non-spenders, clearly the debt-fueled spending of pre-2006 is over. Bob Bach, senior vice president and chief economist at Grubb & Ellis put it clearly: “Retailers and owners of retail real estate will need to adapt to a ‘new normal’ in consumer attitudes that may last for some time, including more conservatism and attention to value as households rebuild their savings.”

2010 PRESENTS NEW OPPORTUNITIES - So what should you do going into 2010?  Get good advice. We are in a changed economy that is going to be with us for a long time. If the only economy you’ve known is the “go-go” days before 2006, get educated. Our economy operates on booms and busts which generally happen every 8-10 years.  You cannot simply sit on the sidelines and wait for things to get back to where they were. They won’t…. at least not for a long time.  But this new economy is full of opportunities for those willing to work hard and be creative. The US Dept of Labor estimates that more than half of all new jobs will be in in professional and related occupations and service occupations. Learn more at their website at http://www.bls.gov/news.release/ecopro.nr0.htm. I see a rise in demand for Short Sales Specialists;  Consultants in real estate; and small boutique service companies providing cost-effective services to businesses.  Production jobs will continue to disappear.

Lastly, I remain bullish on real estate investment despite having now gone through five down-turns including two crashes.  Throughout history, real estate has been the most stable long-term investment providing both shelter and income potential. This will remain so.  The danger in all investments is expecting continued growth which, if that happened, would not make it an investment at all.  Investment is the taking of “risk” in pursuit of the “potential” of gain. The risk will never go away nor the potential. So my advice to you is don’t give up on investing but keep your day job.

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/.  

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/. 

As you know, a key point of President Obama’s Real Estate Recovery Plan unveiled last February was the proposal to allow Bankruptcy Court judges to reduced the principal balance on home mortgages (ie: cram-down”) to current market value.  To the cheers of upside-down homeowners and the jeers of the banking industry, the proposal was quickly brought up in the House of Representatives and was passed in mid-March with a close vote along party lines. Then it was off to the Senate where a vote was expected by Easter. It was not to be.

The banking industry found a much more receptive ear in the Senate.  The Bill’s sponsor, Sen. Richard Durbin (D-IL) fought hard for passage arguing that this was necessary to avoid a wave of future foreclosures. The banking industry countered that allowing the courts to interfere with a mortgage contract would create greater risk in the economy, deter investors, make loans harder to get, and ultimately hurt future homeowners.  The bankers bolstered their lobbying with 12,450 letters to Senators from its members and flooding their inboxed with e-mails.  In the end, pressure swayed enough moderate Democrats to join with the Republicans and defeat the Bill 51-45.  Sentator Durbin plans to continue advocating a cram-down bill in the Senate but for now it is dead. Meanwhile, the hundreds of thousands of foreclosures that have been holding off for this Bill will now likely go forward.

If you are burdened by an over-encumbered property that you no longer can afford, be sure to get competent legal advice on your rights and strategies to minimalize or possible eliminate your exposure to a financial judgment and debt forgiveness taxes.  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/

Much talk has been made recently about President Obama’s proposed “cram down” provision that would allow bankruptcy judges in Chapter 13 case reduce the principal owed on mortgage loan secured by a debtors principal residence. While the bill seems to have stalled in the Senate, another provision of the bankruptcy code may be particularly interesting to individuals finding themselves struggling to make their payments on vacation or investment properties. Under 11 USC 506, a person filing for bankruptcy under Chapter 13 can in fact “cram down” the amount owed on certain types of property to the current market value. This of course depends on the nature of the property we are dealing with.

While the provision is most commonly linked to consumer purchases, for example, an automobile, household appliances or even furniture that are bought on credit and those goods in turn secure the repayment of the credit extended, the provision also applies to mortgages other than acquisition loans on a principal residence.

Essentially the way this provision works is that the debtor can file a 506(a) motion to revalue the collateral (secured by in most cases a Deed of Trust) and seek to reduce the security to the market value at the time of the filing of the petition so as to prevent the property from being oversecured, ie, securing more debt than the value of the property. What this motion seeks to do is to bifurcate the security (split it into two parts). If the court grants the revaluation of the property, the Creditor retains a secured interests in the property only to the extent of the value of the collateral. In the situation where the value is less than the amount owed on the mortgage, that portion of the mortgage that exceeds the value of the property then becomes an unsecured debt and leaves the creditor standing in line with the rest of the unsecured creditors, seeking a pro rata share of the monthly trustee payments.

In essence the way this plays out most frequently is when a debtor purchases a second property, they can not secure financing for the entire balance of the unpaid purchase price. So the either entice a second bank to give them a smaller loan in second position (which during the housing boom, banks were entirely to eager to accommodate) or the seller would carry back a note and deed of trust in second position securing the balance of the purchase price. The debtor then finds themselves upside down on the property and struggling to make payments. So they file a Chapter 13 bankruptcy petition to reorganize their debt. At the time they file their repayment plan they also file a 506 motion to revalue the collateral. The property they bought two years ago for $400,000 which is secured by a First Deed of Trust in the amount of $340,000 and a Second Deed of Trust in the amount $60,000 is now valued at $350,000. The Court can under the bankruptcy code bifurcate the status of the Second Deed of Trust, by treating $10,000 as secured (value of the collateral = to amounts owed 340,000 on first deed of trust plus $10,000 owed on the second deed of trust) and the remaining $50,000 owed on the Second Deed of Trust then becomes unsecured.

While the provision has historically been utilized to cram down payments on personal property, most commonly automobiles, the courts are allowing qualified debtors to cram down certain mortgages. See generally In Re: Latimer, 395 B.R. 304 (Bankr.W.D.N.Y. 2008) (cram down of a second mortgage held by State Farm Bank); In re: Paschen, 296 F.3d 1203, (11^th Cir. 2002) and In Re: Eubanks, 219 B.R. 468 (6^th Cir. BAP 1998). All of these cases also involve other sections of the bankruptcy code that deal with cram down provisions currently contained in the code. But that is a whole different article.

If you think that a Section 506 Motion will benefit you in coping with your upside down investment or second home properties, seek the advice of competent bankruptcy counsel as soon as possible to determine if you - and your property - qualify for this treatment.

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 Upside Down property owners seek to sell their property and avoid foreclosure through a “Short-Sale”. It’s called this because the amount a Buyer is willing to pay is “short” of enough money to pay off the existing debt. If the sale is to close, the shortage has to be dealt with to get the lender(s) to release their lien on the title.  The whole issue is about who should take the hit on covering the shortage. Typically the Seller/borrower submits a “Hardship Package” to the lender to convince them that the Seller cannot afford to pay the difference. The lender could accept the hardship and agree to eat the difference but more and more, they’re trying to preserve a right to collect the difference from the borrower later.

A year ago, lenders often submitted a “Promissory Note” into the short sale escrow demanding that the borrower agree to repay the difference at a later time. However, in many states (such as California), the lender might be barred from seeking a deficiency if they foreclosed so most borrowers refused to sign. Short sale success rates were running 4-12%.  About 6 months ago, lenders started dropping the Promissory Note demand and instead began putting language in their short sale consent documents stating that they were merely releasing their lien and “reserving their rights” to go after the borrower for any deficiency. Again, depending upon the laws of the particular State, such a reservation may have been unenforceable and meaningless.

Recently, lenders have begun using a consent form that goes beyond the reservation of rights and actually has the borrower sign a document confirming that only the lien is released and that the deficiency will be collectable against the borrower.  This is much closer to the original Promissory Note and may equal an enforceable re-affirmation of the debt. Understandably Seller/borrowers are refusing to sign.  The result is a stand-off. Does the lender really want to foreclose? Agents and Buyers are caught in the middle. 

How should a short sale seller/borrower respond to such a situation?  First, get advice on what recourse the lender realistically has against the borrower if it goes to foreclosure. If there is none, then the borrower has much more leverage in getting the recourse provision dropped. If the lender has recourse or if their are junior lenders that would get recourse from a senior lender’s foreclosure, then the short sale is an excellent forum to negotiate a resolution of all liability.  Remember, just because the lender says they want it all, does not mean they won’t settle for less. 10% of the shortage is not an unusual settlement amount.  If you need help with this analysis, we have a $200 flat fee consultation program that can be done in person or by phone that goes through the analysis and leads to a strategy for the borrower and their real estate broker to use in the negotiation. Call us at 916-966-2260 for more information. 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/

In February, President Obama’s Homeowners Affordability and Stability Plan proposed altering the Bankruptcy Rules to allow Chapter 13 Judges to reduce (”cram-down”) the amount of debt owed as part of a repayment plan. By March 5th, the House of Representatives passed a Bill giving Ch 13BK Judges the authority to modify loans to “affordable” levels by lengthening terms, cutting interest rates and reducing mortgage balances of bankrupt homeowners. It also would permanently increase the FDIC’s coverage of bank deposits to $250,000. The measure passed the House 234-191 and went to the Senate (SB 61) where passage was expected by Easter.

Easter has now come and gone and passage is no closer. Lobbying from the banking industry has met a receptive audience in the Senate and the Bill’s sponsor, Richard Durbin, has backed off from his early strong support. Current negotiations propose limiting such authority to “subprime” loans but even that may go nowhere since Durbin has been unable to gather enough support to pass any such bill. Senator Charles Schumer suggested last week that he might seek to “tack-on” this bill to someother pending legislation to try to get a faster vote. However, many think that even if this watered down bill got through the Senate, the House would then reject it.

As it stands now, action is not likely to occur until after Memorial Day. Public comment remains split between consumer advocates who want relief now and those who say the correction must sun its course to fix the economy. Strong voices are being heard on both sides but not strong enough to put Bankruptcy cram down relief into law.

Stay tuned for further information. 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/

There’s been a lot of activity recently promoting loan modifications while challenging those business that assist owners in obtaining modifications. Here’s the latest.

Mortgage Foreclosure Rescue Scams - While lenders are deciding how to respond to Pres. Obama’s real estate rescue proposals and the Senate procrastinates on Ch 13 BK “cram-down” authority, Fed and state regulators have gone on the attack against loan modification companies that prey on troubled owners by taking money up front but then deliver no results. While certainly there are good and effective modification counsellors out there, separating the real from the scams is extremely difficult. Watch out for these signs: 1) Big Money Up Front - the promises may be only to get your money. Look for pay upon success programs and check references; 2) Bailouts - don’t sign your title over to anyone that promises they’ll cure your default and then sell the property back to you. If it sounds too good to be true, it likely is;  3) Stop Foreclosure ads - many ads promise they’ll stop foreclosure by finding defects in your loan documents.  While an imminent foreclosure may be stopped, it may really be nothing more than a costly delay. Get a second legal opinion if these ads tempt you.   For more information, check out: http://www.fraudguides.com/mortgage-foreclosure-rescue-scam.asp

California Foreclosure Law Changes - As reported by Morrison & Foerster, The California Foreclosure Prevention Act (the “Act”) was enacted by the state Legislature, and signed by Governor Arnold Schwarzenegger on February 20, 2009. The Act, which amends the California Civil Code as it relates to residential mortgage loans, uses a “carrot and stick” approach to advance its stated goal of allowing “additional time for borrowers to work out loan modifications while providing an exemption for mortgage loan servicers that have implemented a “comprehensive loan modification” program. The “stick” is a mandatory 90-day moratorium on home foreclosures applicable to certain first lien mortgages.  New Civil Code Section 2923.52 will add 90 days to the existing 3-month statutory waiting period between the recording of the notice of default and the giving of the notice of sale.  Loans that are covered by the new legislation must meet four conditions: (1) the loan must have been recorded during the January 1, 2003–January 1, 2008 (inclusive) period, and must be secured by residential real property; (2) the loan must be a first mortgage or deed of trust; (3) the borrower must have occupied the property as his/her principal residence at the time the loan became delinquent; and (4) a notice of default must have been recorded against the property.  The “carrot” is an applied-for exception to the 90-day moratorium at new Civil Code Section 2923.53.  To qualify for the exemption as having a “comprehensive loan modification” program”, the program must have four key features.  First, it must be intended to keep borrowers in their homes when the anticipated recovery under the loan modification “exceeds” the anticipated recovery through foreclosure on a “net present value basis.”  Second, the program “targets” a housing-related debt-to-gross-income ratio of 38% or less on an aggregate basis (i.e., based on all of the servicer’s loans under the program; this ratio need not be achieved for each individual loan).  Third, the program includes “some combination” of the following:  (a) reducing the interest rate for at least five years; (b) extending the amortization period up to 40 years from the original date; (c) deferral of some unpaid principal until loan maturity; (d) reducing the principal; (e) compliance with a federally mandated loan modification program (note – the federal program must be mandated, not optional); and (f) “other factors” that the commissioner determines are appropriate.  Fourth, the program seeks to achieve “long-term sustainability” (which is not a defined term) for the borrower.  For the target 38% ratio, the borrower’s housing-related debts include loan principal, interest, property taxes, certain housing-related insurance, and homeowner association fees.  For more information, check out: http://www.mofo.com/news/updates/files/15309.html.

NEED INFORMATION NOW? Download Steve’s audio-seminar and e-book on Coping With Upside Down Loans: http://www.stevebeede.com/copingwithanupsidedownmortgage/ 

NEED LEGAL HELP NOW? If you have questions or concerns about your legal rights and obligations concerning upside down loans or any other real estate or small business questions, feel free to contact Steve Beede at sjbeede@bpelaw.com.

Most people are aware of the risk of lenders coming after them for a deficiency judgment after a foreclosure and they know how this may be avoided.  But few people understand or appreciate the tax liability that also can occur with any unpaid loan. But there also are times that this is avoidable.

Under our Federal Tax Law, anytime you owe money to someone else and then don’t have to pay it, “debt forgiveness” occurs (unless the lender gifts the debt to you which is not likely). The IRS says if you owed it, you must have had the money to pay it. So, if you got to keep that money, it must be income that they can tax you on.  That’s right, even if you never had this “phantom income”, it is taxable if the lender doesn’t get paid in full whether due to foreclosure, deed in lieu, or even a short-sale.  Although generally the foregiveness is shown by the lender giving you a 1099 tax form, the tax code doesn’t require this.  So, if your home short-sells for $100,000 less than you owed, you now have $100,000 of taxable income….maybe.

In December, 2007, the Federal Government passed The Mortgage Forgiveness Debt Relief Act of 2007 which generally excludes debt forgiveness from taxation if  it occurs on your principal residence from 2007 through 2013 (there are some restrictions).   Many states have adopted similar laws providing the same relief for state taxes. However, California’s similar law ended 12/31/08. We’re awaiting a bill to extend it but with CA’s budget mess, this may not happen soon if at all.

So, they key point is that the Relief only applies on the home you actually live-in. If you rent out your home or leave it vacant and go live somewhere else. Your debt forgiveness relief may be lost and you may be looking at a high income tax bill from the IRS and your state.

If you need further assistance or have legal or real estate questions, feel free to e-mail me at sjbeede@bpelaw.com