Upside Down in Your San Diego Home? A Short Sale may be the solution. – San Diego Real Estate Connects

Upside Down in Your San Diego Home? A Short Sale may be the solution.

Are You Having Troubles Making Your Mortgage Payment?

Is The Foreclosure Date Approaching?

Is Your Home Worth Less Than You Owe?

SHORT SALE: A short sale is the sale of a home for less than the amount owed the lender(s)   When approving a short sale, the lender(s) agree(s) to settle the debt owed on the property and/or release their secured position (deed of trust) for less than the full payoff of their loan.

Credit Ramifications: Fannie Mae and Freddie Mac’s new waiting period guidelines on loans they will approve for Buyers who have either lost their homes in Foreclosure or sold their homes under a lender approved Short Sale are as follows:

  • FORECLOSURE:
    • 5 – 7  years
  • DEED-IN-LIEU OF FORECLOSURER:
    • 4 – 7   years
  • DEED-IN-LIEU WITH EXTENUATING CIRCUMSTANCES:
    • 2 – 7   years
  • SHORT SALE:
    • No late payments through the process no waiting period
    • Late payments of 2 – 4 months  2   years
    • Late payments of over 4 months  2 – 7   years

A Short Sale is usually reported on one’s credit report as “debt settled for less than the amount owed”.  Typically, this will result in a less significant impact on their credit report compared to foreclosure and/or very delinquent payments on their mortgage.  Ultimately all negative payment performance affects everyone’s credit. The more established one’s credit, and the more current their loan is at the time of the closing of their SHORT SALE, the less negative impact is likely to their credit.

Income Tax Ramifications: In most cases when one does a short sale the lender is agreeing to settle the debt for less than the amount owed.  Under GAP accounting rules and IRS regulations the lender can write off this loss against their income.  When a loss of $600.00 or more is written off, they are required to send the borrower a 1099-C (The “C” stands for “Cancellation of Debt”), for the amount that they wrote off. The IRS considers “debt relief” to be income for tax purposes. This income, in turn, must be reported by the borrower on their tax return the year that the debt relief occurred.  In the past, a borrower was required to pay both state and federal taxes on the reported debt relief amount.  Thankfully there are now some exceptions to the obligation to pay tax on the forgiven debt amount.

Federal Tax Relief: The Mortgage Forgiveness Debt Relief Act of 2007, provides Federal tax relief under certain criteria relieving borrowers of the obligation to pay taxes on the amount of “debt relief” reported on the 1099-C received from the lender. The Act provides relief for debt forgiven in tax years 2007 through 2012. It applies to debt forgiven up to $2,000,000 for a married couple and $1,000,000 for an individual tax payer or a married person filing separately.

Qualifying Criteria

Listed below are the qualifying criteria for the tax exemption.

  1. Primary Residence: The debt relief must have occurred on the taxpayer’s primary residence and the loan must have been secured by that residence.
  2. Purchase Money Loan: To qualify for the exemption, the amount forgiven must be a portion of the original purchase money loan used to purchase the residence, or in the case of refinance, the amount forgiven up to the balance of the original purchase money loan at the time of the refinance(s).
  3. Cash out refinances: Any cash out funds, (funds exceeding the payoff of the purchase money loan at the time of refinancing), utilized to substantially improve the taxpayer’s primary residence will also qualify for the exemption. Cash taken out and used for other purposes, such as paying off credit card bills, purchasing furniture etc. will not qualify.
  4. Insolvency: If one is insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable. One is insolvent when their total debts are more than the fair market value of their total assets.

California State Tax Relief: In 2007 California passed its own version of the federal Mortgage Forgiveness Debt Relief Act of 2007. It was Senate Bill 1055.  The Bill’s term expired after the 2008 tax year.  On April 12, 2010, California Senate Bill 401 was enacted into law, which generally aligns California tax treat of mortgage debt relief income with federal law.  The existing federal exemption is for indebtedness up to $2 million, where as the new California exemption is for indebtedness up to $800,000 and forgiven debt up to $500,000.

These tax breaks apply to debts forgiven from 2009 through 2012.  Californians who have already filed their 2009 tax returns my claim the exemption by filing a Form 540x amendment.

To understand the tax ramifications that may apply to any individual situation, we recommend you review your specific tax scenario with a CPA or accountant to answer any questions you may have.  We are not tax or legal advisors and do not give tax or legal advice.
Lenders’ Deficiency Rights: Whether or not a borrower will be liable to their lender(s) for amounts that the lender may lose either on a short sale, or a foreclosure sale depends on the following factors.  (1) Whether the loan is the original purchase money first trust deed loan on the borrowers primary residence (a non-recourse loan): (2) Whether the loan secured by a second trust deed was the same or different lender than the first trust deed loan: (3) What legal remedy the lender(s) exercise to collect their loan: (4) Whether the lender(s) waive(s) their rights to collect any deficiency, on those loans (re-course loans) where they have a deficiency right, as part of their short sale approval.

  1. Purchase Money Loan: A purchase money loan is defined as the original purchase loan secured by a first deed of trust, and in some cases also by a second deed of trust on the property purchased as the personal residence of the borrower. California Civil Code of Procedure Section 580b specifically prohibits recovery of a deficiency from a borrower, who incurred the loan in order to purchase their home as their primary residence, when the property contains 1-4 units and the property was used to secure the loan(s). (Home Buyers who refinance and pay off their original purchase money loan risk losing this “anti deficiency” protection) They may however, keep their federal tax exemption as outlined above for losses incurred by the lender for all or a portion of the loss the lender takes, calculated utilizing the balance of the original purchase loan amount at the time of the refinance.
  2. Junior Lenders: Second, third, etc. trust deed loan(s) on a borrower’s primary residence, unless the proceeds were used to purchase the property, do not qualify by definition under “anti deficiency” protection of the California Civil Code of Procedure Section 580b. If the first lender completes a foreclosure sale, thus foreclosing out the security interest of all junior lien holder(s), and, provided that the loan proceeds were not used to purchase the property and/or they are not the same lender as the first, they can turn around and sue the borrower for the payoff of their loan. Many Short Sales and Foreclosures involve homes that are secured by both a first and a second trust deed loan.  For the short sale to successfully close escrow, all lenders have to approve the short sale, agree to settle the debt and /or release their security interest in the property (re-convey their deed of trust).  In the majority of cases, it is in the best interest of both lenders to approve the short sale.  The first lender is often willing to allow a small portion of the net sales proceeds to go to the second lender in order to get them to agree to the short sale.  The second lender will get nothing if the first completes a foreclosure, so with that in mind the second realizes that it is better to get a little something now.  When the second approves the short sale they sometimes want the borrower to sign an acknowledgement that they still owe the balance of the debt.   On those occasions where the first and second lender are the same, and the lender elects to go to foreclosure sale on the first trust deed, the lender is prohibited under California statute from filing suit to collect on the second loan, likewise, should the lender complete a private “power of sale” foreclosure on the second trust deed, they would be prohibited from pursuing the borrower for a deficiency under California Civil Code of Procedure 580d.
  3. Lenders have the following remedies to collect their loan upon default:
    • Private Foreclosure: Code of Civil Procedure Section 580b prohibits lenders from pursuing and obtaining judgments from unprotected borrowers, (borrowers whose loans are refinanced loans and not purchase money loans), when the lender foreclosed upon the secured property by a private “power of sale” foreclosure proceeding, pursuant to the terms of a deed of trust. This section also applies to any second (junior) lenders who foreclosed upon the secured property by the same private “power of sale” foreclosure proceedings.
    • Judicial Foreclosure: If a lender wishes to obtain a deficiency judgment against an unprotected borrower for the unpaid balance, Section 580d requires the lender to initiate a judicial foreclosure (suit for breach of contract) as set forth by statute. This is a long drawn-out process, but does allow the lender to receive a judgment for any deficiency. Junior lenders can exercise this remedy any time their loan becomes delinquent. They can also exercise this remedy even if their security interest is foreclosed out by the foreclosure sale of a senior lender. A junior lender who was the same lender as a senior lender who completed a Private Foreclosure sale is prohibited from pursuing the borrower to collect the amount of their second loan (this prohibition falls under the “One Action Rule” requiring the lender to choose one action and not multiple actions to collect their debt.
    • Approval of a short sale: The growing remedy of choice for lenders is the approval of a short sale. This allows the lender to get paid off sooner as opposed to later, keeps its costs down, and in many, many cases allows them to recover more money towards the payoff of their loan. One thing we all need to keep in mind, is that lenders, just like us, will do what is in their best interest. The greatest thing about the short sale process is that it is generally a win – win for both the lender and the borrower. As stated earlier, lenders sometimes want the borrower to acknowledge continuing liability for the unpaid balance of their loans. While never preferable to the borrower, this may, under certain circumstances, be the best long term financial strategy to deal with the obligation to pay the debt.
  4. Short Sale vs. Foreclosure:
    • Short Sale: The primary advantage to doing a short sale as opposed to letting the property go back to the bank in foreclosure is that with a short sale the borrower has the opportunity to settle the debt and have the bank agree that they are not owed any additional money. This is especially comforting when both the first loan and the second loan agree to the short sale. Should the first loan complete their foreclosure sale, the second trust deed lender, if a different lender than the first, can sue the borrower for the full amount of their loan. If the lenders agree to take the proceeds to settle their debt completely, the borrower does not have to worry about further liability to those lenders. As pointed out earlier, another advantage of a short sale is that the negative impact on one’s credit is minimized. It is viewed as the borrower doing the responsible thing in light of the circumstances.

      President Obama provides incentives for Short Sales

    • President Obama provides incentives for Short Sales: Taking effect April 5, 2010 there was a new administration program, Affordable Foreclosure Alternatives Program (HAFA), designed to encourage both lenders and borrowers to take advantage of the short sale process. To bring the various parties to the table—the homeowner, the lender servicing the loan, the investor who owns the loan, and the bank who owns the second mortgage on the property—the government intends to spread its cash around. Under the new program The Borrower receives $3000 in “relocation assistance”, the servicing bank will get $1,500 for services to cover administrative and processing costs and up to $2000 match for investors allowing a total of up to $6,000 in sale proceeds to be distributed to junior lien holders. For the first time this government sponsored program gives money to the distressed homeowners themselves. A meaningful incentive to homeowners to consider and cooperate with the Short Sale Process.
    • Cost to the Borrower/Seller: A short sale does not cost the borrower/Seller anything—the lender in determining the amount they are willing to take from the net proceeds of the sale, calculates their net proceeds after the payment of all closing costs, escrow fees, commissions, etc. They may also include in that calculation any outstanding property taxes.
    • Foreclosure: There are, under certain specific circumstances, advantages to allowing the lender to conduct a foreclosure sale. Those advantages have to do with private foreclosures as opposed to judicial foreclosures. As discussed earlier, when a lender conducts a private foreclosure and forecloses under the “power of sale” foreclosure proceedings as specified in the deed of trust securing the loan, Section 580b of the Code of Civil Procedure prohibits the lender from collecting any deficiency they may have. This can be an advantage when a second lender exercises this foreclosure remedy or when a non-purchase money (refinance, recourse loan) first lender exercises this remedy. However should a first lender foreclose under the private sale proceeding, junior lenders still have the right to sue the borrower for the amounts owed even though their security interest was foreclosed out by the first lender. Under a judicial foreclosure action the lenders have a right to receive a judgment against the borrower for the deficiency they may have after the property is ordered sold. As pointed out earlier, the impact on a borrower’s credit, when either a private foreclosure, or judicial foreclosure action is initiated and completed is more severe than when the property is sold through a negotiated and approved short sale.
  5. Timeframes: The time frames for the various remedy options are:
    • Short Sales: The short sale process usually takes about 4 months. It can take longer depending on how accurate and complete the borrower’s required documentation is when received by the lender and/or how long it takes to generate an offer(s) on the property. It can also depend how backlogged the lender is with prior requests. One can live in the property during the entire process or one can move out whenever one wishes.
    • Private Foreclosure: The absolute minimum time period as required by statue is approximately 111 days from the date the Notice of Default is filed. While the lender can file a notice of default upon loan delinquency, usually the lenders do not file until their payment is 90 days delinquent. That could give a borrower approximately 180 to 210 days after defaulting on the loan. When a borrower is attempting a short sale, the lenders have a history of postponing their actual foreclosure sale if they believe a short sale closing is eminent.
    • Judicial Foreclosure: While giving the lender an opportunity of receiving a judgment against a borrower for the amount of their deficiency, this process is much more cumbersome and time consuming than the short sale and private foreclosure remedy. The process requires the lender to file a law suit to collect the debt, requires a sale of the home by the Sheriff’s office, and requires the lender to prove up the amount of the deficiency. The amount allowable is the difference between what the value of the property was at the time of the Sheriff’s sale and the payoff of their loan at the time of the sale. This remedy also provides the Borrower with the right of redemption to redeem the property for the amount they owe, within a 90 day period immediate following the Sheriff’s sale of the property. Under most cases this remedy takes approximately 12-15 months from the date the suit is filed.

Choosing the right remedy for you is a complicated process.  We recommend that you consult, with a knowledgeable CPA or tax advisor, and or a knowledgeable attorney, as we are not tax advisors or attorneys, and do not dispense tax or legal advice.  Should you wish, call my office and I can refer you to several.