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/. 

While little has been done at the State or Federal level to provide assistance to upside down homeowners, efforts have been made to give greater protection to tenants in foreclosed properties. 

As a general rule, a foreclosure wipes out all leases and other rental agreements leaving the tenant in a month-to-month situation. For tenants on a lease, this can be a great shock when a Notice to Quit is posted on the front door.  Typically, state law requires the new owner to give the tenant 30 Days to vacate and if they don’t do so an eviction action can be started.  In July, 2008, California has adopted Code of Civil Procedure Section 1161(b) granting all residential tenants or sub-tenants a 60 days written notice to vacate after foreclosure.

In addition, in May, 2009, President Obama signed the “Protecting Tenants at Foreclosure Act of 2009″. The Act establishes a ninety (90) day notice to vacate period and grants additional rights to tenants in foreclosed properties. The central purpose is to provide innocent tenants, whose landlords have lost properties to foreclosure, with additional time within which to secure alternative housing arrangements.

EVEN MORE SIGNIFICANT is a portion of the Act which provides that, in the case of foreclosure on any federally-related mortgage loan or on any residential real property in which a recipient of public housing assistance resides, the immediate successor in interest assumes such interest subject to: (1) the lease between the prior owner and the tenant, and (2) the housing assistance payments contract between the prior owner and the public housing agency for the occupied unit.  Definition of a “federally-related mortgage loan” include any loan that a) is made by a lender that is either regulated by or whose deposits or accounts are insured by any agency of the Federal Government; b)  is made in whole or in part, or is insured, guaranteed, supplemented, or assisted in any way by the Federal Government; or c) is intended to be sold by the originating lender to the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation (or its successors).  This is a very broad spectrum of loans.  A ”housing assistance payments contract” means such Programs as Section 8. 

A thorough statement as to the purpose, import and impact of the Act can be found in a recent Federal Register Notice from the Department of Housing and Urban Development (”HUD”) and in a summary of Senate Bill 896. [Source www.thomas.gov].

The Act is extremely broad and vague and has given rise to more questions than answers, it is abundantly clear that the rights of persons or entities purchasing tenant occupied properties purchased through foreclosure after May 20, 2009, will be significantly impacted.

  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/.

A lot of mis-information appears to be circulating on the web concerning how the debt forgiveness tax relief is applied. “Debt Forgiveness” occurs anytime you don’t have to pay back a debt that you owe someone. In today’s world, that most commonly occurs through a foreclosure or a short sale when a lender or lenders are not paid in full. Unless the lender is pursuing a judgment for the deficiency (which is rare), our IRS Code states that the amount not paid, ie: forgiven, is taxable income to the borrower.  In December, 2007, the Federal government passed the Mortgage Forgiveness Debt Relief Act which provided that if you incur debt forgiveness between 2007 and 2012 on your principal residence there will be no tax. Some States have adopted similar provisions to deal with state taxes.  What has become confusing is what is meant by “principal residence”.

Several writers on the web have stated that the test for Principal Residence is that you lived in the property for 2 of the last 5 years. If this were true, then the forgiveness might be available even if the property is now rented out.  So, this is significant.  The “2 out of 5 years” rule is the test for capital gains tax exclusion and is used to determine whether you would have to pay capital gains tax when the property was sold or foreclosed. But this is a different question from debt forgiveness. Capital gains measures the difference between what you paid for the property (taxable basis) and what it sold for (short sale or foreclosure sale). So, if someone has owned their property a long time and refinanced well above their taxable basis, then the “sale” price could result in a capital gain tax to which the 2 out of 5 year rule would apply.  Ambiguities in explanations of the Mortgage Forgiveness Debt Relief Act have led some to conclude that the determination is made by using the capital gains rule on personal residence.  I do not believe that this is accurate. More importantly, this mis-information could leave debtors exposed to debt forgiveness tax.

When it comes to tax questions, it is valuable to examine what the IRS has to say on the issue because if they disagree with what you claim, you’re in for a nasty and costly fight. Luckily, the IRS appears to have answered this question.

IRS Publication 4681 “Cancelled Debts, Foreclosures, Repossessions, and Abandonment” is available for download at http://www.irs.gov/pub/irs-pdf/p4681.pdf. In this Report, the IRS explains how this is treated. At Chapter 1 “Cancelled Debts”, Page 7, the IRS defines what constitutes “Qualified Principal Residence Indebtedness” which is the criteria to avoid the debt. It clearly defines this as “the home where you ordinarily live most of the time. You can have only one principal residence at any one time”. There is nothing whatsoever that provides for a 2 of 5 year definition.

Based upon this, it seems conclusive to me that the IRS will only grant debt forgiveness on the home where you ordinarily live at the time that the debt forgiveness occurs.  Of course, reasonable people could reach different conclusions.  If you are facing a debt forgiveness event, be certain to get competent legal and tax advice.

The question keeps coming up:  What is the deficiency liability of an individual involved in a short sale?

In the current real estate market, short sales are becoming more prevalent as defaulting borrowers attempt to avoid a foreclosure on their property. The risk is whether a borrower after completing a short sale and receiving approval from the lender(s) would then become liable for any deficiency arising out of the difference between the principal amount owed on the mortgage(s) secured by the property and the amount the sale price agreed to during the short sale.

The short answer (in California at least) is that given the current statutory framework and case law available on this issue it is unclear whether there is any liability. California has three interconnected laws that govern lender recourse:  1) the Security First Rule; 2) the Single Action Rule; and 3) the Acquisition Loan Rule. These all limit the ability of a lender to go after a borrower for a deficiency following a foreclosure.  The language of each statute itself is broad enough that arguable they will preclude deficiency liability after a short sale (ie: the lender cannot simply waive the Security First Rule by releasing their security and then suing on the remaining debt).

Lenders have been scrambling to find a way around these Rules and create some recourse against borrowers following a voluntary short sale.  A short sale is a contract between the lender(s), seller/borrower, and buyer. In the contract, the lender is essentially agreeing to compromise their position in order to avoid a foreclosure. The lender is getting something of value in return for their agreement to the short sale. Likewise, the seller/borrower is getting something by way of release from deficiency debt. If the lender were to attempt to pursue a deficiency, against the borrower/seller then the contract likely fails for lack of consideration. Essentially, the borrower/seller in that situation got nothing of value for their participation in the short sale contract.  Whether less credit damage is consideration enough is very questionable.

Taking this to the last step in the analysis, brings us to the theory of accord and satisfaction. Which is a term of art that simply states that when one settles their rights for value and receives that value, then they have compromised their claim and can not pursue it any longer. By agreeing to contract for the short sale, the lender(s) is essentially stating that they are willing to take less in the short sale process to avoid the foreclosure process. Thereby precluding the lender from asserting additional claims for deficiency after the settlement process.

What has been happening with frequency lately, is that some lenders (such as BofA) are requiring borrowers/sellers to sign a document stating that the borrower will remain liable for the deficiency as a condition to the lender consenting to the short sale. The lender(s) are trying to contract around the anti-deficiency statutes prohibitions. While it is permissible for parties to contract around statutory obligations there is not any known reported case law on this particular issue where there is no real benefit to the seller/borrower… especially when it the contract increases the lender’s benefits. Certainly, it seems that by requiring the borrower/seller to sign such a document, there is a lack of consideration as discussed above. Thereby possibly nullifying the documents effect. However, there is no case law on this topic.

The bottom-line reality is if you are confronted with one of these documents, you should seek legal counsel regarding the terms of the particular agreement before executing the document, as you very well could be contracting away anti-deficiency protection and more than likely exposing yourself to costly litigation.

As readers of my Blog are aware, the Federal Government passed a law in December, 2007 allowing debtors to avoid the tax on debt forgiveness which typically occurs through a foreclosure or short sale. Debt forgiveness is considered taxable income by the IRS even though the debtor never had the actual income. The federal Debt Forgiveness Relief Act enables most people who lose their homes between 2007 through-going budget c 2012 to avoid the tax.  Most states including California followed suit although California’s relief expired in December, 2008.

In January 2009, Assemblyman Roger Niello introduced AB 111 to extend California’s law to match the Feds. Unfortunately, in late May the Assembly voted down his Bill… most likely in response to the ongoing Budget crisis. No new Bill appears to be in the works to replace this.  “AB 111 was based on fairness and common sense. The tax revenues from mortgage foreclosures are windfall gains to the state at the expense of California’s most desperate families. The tax revenue exempted by AB 111 would not have been realized if California weren’t at the very epicenter of the mortgage crisis,” said Assemblyman Niello.

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/

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 has been written since President Obama proposed giving Chapter 13 Bankrupcty Judges the power to “cram-down” home loans to current market value. Leglislation to do this passed the House of Representatives in March and is now stalled in the Senate.  The general impression in the marketplace has been that, other than for consumer debt such as boats and cars, cram-down was not available.  That might not be true.

Yesterday we wrote about how a little known legal filing under Bankruptcy Code 11 USC Section 506(a) may result in a cram-down of investment property valuation. This “506(a) Motion” as it has come to be called is used as part of a Chapter 13 Repayment Plan to do the consumer debt cram-down but most recently has found favor in reducing certain loans, particularly junior deeds of trust on investment property. See yesterday’s article for more.

An additional Code Section governing Chapter 13 Bankruptcies appears to also open the door for personal residence cram-downs when the loan must be paid off in a short time, such as a 5 year balloon loan. Under 11 USC Section 1322(c)(2), when the last payment of a loan’s original payment schedule for a loan secured only by the debtor’s principle residence is due before the date on which the final payment of the Ch 13 Plan is due, the Plan may provide for modification of the amount the lender claims is owed.  While this will not apply to everyone, anyone with a short term (ie: 5 years or less) payoff date on their loan needs to know about this.

If you or anyone you know is facing loss of their investment property or personal residence, make sure that they are getting competent and comprehensive legal advice that enables them to know where they stand and to formulate strategies to minimalize their risks and hopefully keep their property.

If you think that these cram-down Motions will benefit you in coping with your upside down properties, seek the advice of competent legal 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/