DO I HAVE TO PAY TAX ON MY FORGIVEN DEBT NOW THAT THE MORTGAGE FORGIVENESS DEBT RELIEF ACT HAS EXPIRED?

The big question from many short sale sellers in 2014 is:  “Will I have to pay income tax on my forgiven debt now that the IRS mortgage forgiveness act is expired?”

Here’s some background:  Unless there is an exemption, the Internal Revenue Service has historically treated forgiven debt as taxable income.  That means that people with forgiven debt (such as from a mortgage, credit card, or installment loan) would pay tax as if the forgiven amount were ordinary income.  To give homeowners some relief, President George W. Bush signed the Mortgage Forgiveness Debt Relief Act (MFDRA) of 2007 into law, allowing short sale sellers of their principal residence to pay no income tax as long as they submitted IRS Form 982 with their federal tax return.  The original MFDRA was good until December 31, 2009.  President Barack Obama then extended it until December 31, 2012.  Then the MFDRA was extended one more year as part of the fiscal cliff deal.  It expired on December 31, 2013.  There are currently two bills in the House of Representatives and one bill in the Senate calling for it to be extended, but as of the date of this article none of the bills are scheduled for a vote.  And as of the end of 2013, Zillow.com reported that about 10.8 million U.S. homeowners have negative equity.

So, what can a person do to avoid being hit with higher taxes after a short sale? 

Thankfully, there is another way to avoid tax on debt forgiveness that applies to many short sale sellers.  Forgiven debts do not need to be counted as taxable income if the debt was canceled in a bankruptcy case, or if the person is insolvent, or if the forgiven debt was intended as a gift.  Certain business or farm property may also qualify.

The most relevant option for short sale sellers is the insolvency exception.  It applies not just to principal residences but in some cases to those with forgiven debt from investment properties and vacation homes.

To be considered insolvent, the person’s liabilities must exceed the fair market value of their assets.  The IRS code states, “A taxpayer is insolvent when his or her total liabilities exceed his or her total assets.  The forgiven debt may be excluded as income under the ‘insolvency’ exclusion.  Normally a taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is insolvent.  The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real property business indebtedness.  If you believe you qualify for any of these exceptions, see the instructions for Form 982.” 

If the seller’s debts and liabilities exceed their assets by more than the amount of debt forgiven, then they do not have to pay income tax on the forgiven amount.  Below is an example:

Susanna’s home is worth $200,000, but her mortgage debt is $300,000.  When the house is sold for $200,000, Susanna’s lender receives $175,000 and they forgive the remaining $125,000. 

$200,000         Sale price.

– $25,000         Real estate commission and closing costs.

$175,000         Amount Susanna’s bank receives on the $300,000 balance.

$125,000         Amount of debt the bank forgives.  This is sent via a 1099-C to Susanna.

At first, Susanna panics because she fears that her income will increase by $125,000, thereby pushing her into a 33% tax bracket and increasing her tax bill by over $41,000.  However, Susanna’s accountant performs some calculations to see if she qualifies for the insolvency exemption:

$225,000         Assets ($200,000 house plus $10,000 in savings and a $15,000 car)

– $350,000       Liabilities ($300,000 mortgage plus $50,000 in credit card debt)

$125,000         Insolvency amount

Susanna’s accountant states that the insolvency of $125,000 and the 1099-C of $125,000 are a wash.  They cancel each other out.  Therefore, Susanna does not owe any tax on the canceled debt.

Let’s imagine that Susanna had an insolvency amount of $100,000 instead of $125,000.  Then she would have to pay income tax on the remaining $25,000 of forgiven debt. 

This article is not intended as tax advice.  We suggest you consult with your tax advisor prior to your short sale and then after the sale.  Your tax advisor can examine your particular situation and guide you appropriately. 

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Five things buyers need to know when purchasing a short sale.

  1. Neither the seller nor the lender is likely to make repairs to the property.

    Many short sale properties have deferred maintenance, as the seller may stop paying for maintenance as money becomes tight. By the time the sale occurs, many short sale sellers are either unable or unwilling to pay for repairs. They realize that every dollar they spend on the property is a dollar they will not receive back. If a buyer wants to purchase a short sale and the property requires repairs before the buyer’s bank will lend any money, the buyer should find a way to make the repairs themselves or find a different property to buy. There is a risk to the buyer repairing a house before they purchase it or obtain a short sale approval to purchase it. If the buyer improves the house and the short sale fails or the buyer opts to walk away, then the buyer will have wasted their time and money on a house they will not own. Furthermore, few contractors will work on a property and wait to be paid at closing.

  1. If the buyer waits until after the short sale approval is granted to ask for a repair concession or lower price, it is far less likely to be approved.

    Some buyers wish to wait until after a written short sale approval is granted before they conduct their home inspection. In a regular transaction, the inspection period may be an opportunity for the buyer to request a credit or price reduction for repairs. Buyers should realize that if the seller’s lender has already approved a short sale, then it is highly unlikely that the lender will allow a price reduction or repair credit. If a buyer believes that a repair credit or price reduction may be needed, they should conduct their home inspection right after the signing of the real estate contract. It is much easier to amend the price or terms of the transaction before the seller’s lender makes a final decision. In most short sale transactions, it is better for the buyer to conduct their home inspection right away instead of waiting for a short sale approval.

  1. It may take months to receive a response from the seller’s bank. Short sales happen gradually, then suddenly.

    A buyer who must move into a home within 60 days of submitting an offer should seriously consider making an offer on a property that is not a short sale. The closing date is hard to predict early in a short sale negotiation process. Furthermore, there is a risk that a short sale may not be approved, and the buyer may not learn of this until weeks have passed. Anyone who wishes to buy a short sale should be patient and not under pressure to move in soon.

  1. If the buyer is under contract with the seller, take steps to ensure that the seller is committed to the transaction.

    The policy on how to mark a short sale listing in the Multiple Listing Service (Pending, Available with Contingency, or Available, among others) is subject to the office’s Broker of Record and perhaps the local Association of REALTORS®. Once a seller signs an offer from a buyer, some listing agents mark the listing as being under contract with no more showings as a sign that the seller is committed to that buyer. Other listing agents continue to market the property, soliciting offers that may be superior to the one that the seller already signed. If the listing agent continues to advertise the property, that could jeopardize the initial buyer’s position, as there is a distinct possibility that the listing agent and seller may seek to terminate the contract in favor of a better offer. If the buyer has already paid for inspections, an appraisal, an interest rate lock, and other costs associated with the purchase of real estate, the buyer may forfeit those costs if their contract is terminated. In some states, the policy is to have the property remain active or available in the MLS even though the seller is under contract with a buyer. Regardless, the buyer and their agent should convey their high level of commitment to the seller and elicit a high level of commitment in return.

  1. Be prepared to pay a little more at closing, as last-minute payoffs creep up that the seller and their bank may not pay.

    As the final fees and costs are tallied on the Settlement Statement, there is a possibility that someone will have to pay more than expected. A water bill that is higher than planned, a late fee added to a delinquent lien, or a property tax credit that is smaller than anticipated could increase the seller’s costs. However, the seller may not have the funds to pay the extra cost, and the bank may be unwilling to take less to cover the shortfall. That may mean the buyer has to pay a little more just to ensure that the transaction occurs. The buyer should be prepared to absorb several hundred dollars in additional costs just in case.

 

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How some opportunists may induce the seller and agent to commit mortgage fraud.

When a short sale is listed, some sellers and agents are besieged by unorthodox requests from seemingly helpful real estate investors or other short sale opportunists.  Of course many buyers look for a good deal, and it is the bank’s prerogative to allow a property to be sold for less than fair market value.  However, some of these investors or opportunists may entangle the agent and seller in what amounts to mortgage fraud.

One fraudulent situation is the double-close-and-flip transaction.  That occurs when an investor places the property under contract at a low price and offers to negotiate that offer with the bank.  Meanwhile, the investor tells the listing agent to continue marketing the property so they can procure a much higher offer.  The investor tells the bank that the low offer is the only one, while concealing the much higher offer from the bank.  The investor’s intention is to engineer the transaction so they can collect the difference between the low offer and the higher offer while keeping the bank unaware.  The listing agent, who has a fiduciary duty to the seller, ends up procuring a higher offer for the investor’s benefit and not the seller’s benefit.  Furthermore, the short sale fraud department within many banks may sue all the parties if they discover that a double-close-and-flip transaction occurred.

For example, the investor may go under contract with the seller at a sale price of $100,000.  The investor tells the listing agent that they will receive six percent commission, which is $6,000.  The investor tells the seller’s lender that $100,000 is the only offer received.  The investor may even have the seller sign the deed over to them, or the investor might file an option on the public records.  The deed and the option each give the investor incredible control over the transaction, and it is hard to push the investor out of the deal later.  So, while the investor is negotiating a $100,000 sale with the mortgage lender, the investor tells the listing agent to keep marketing the property.  The agent procures an offer for $135,000.  The investor instructs the buyer to give them $35,000 and says the buyer can take over their contract to buy the property for $100,000.  Or the investor convinces the buyer to give them the $135,000, and the investor uses $100,000 of that money to buy the house and even pays the agent another commission on the $135,000 sale.  Then the investor signs a deed immediately thereafter, transferring ownership to the end buyer while pocketing the difference.  The fraud occurs in the misrepresentation to the bank, who may later claim that they were defrauded of out tens of thousands of dollars.  That is the equivalent of walking into a bank branch and robbing the teller of tens of thousands of dollars.  The agent and seller may be found to be complicit in the fraud, even if they were somewhat naïve to the investor’s intentions.

Another potentially fraudulent situation involves the investor placing an option on the property or inducing the seller to turn over the deed without paying off the mortgage.  The investor creates a cloud on the title and then demands a payment from the ultimate buyer to release their option or transfer the deed.

The third type of fraudulent transaction involves a non-arms-length transaction or collusion in which the buyer allows the seller to remain in the property.  Some sellers convince a family member, often with a different last name, to buy the house at a discount.  Then the family member either rents or sells the house back to the former borrower.  The bank is defrauded out of thousands of dollars.

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Can the bank foreclose in the middle of winter?

A mortgage lender can foreclose at any time of year if they have properly followed the state’s foreclosure procedure.  A borrower in default receives notice of the foreclosure sale well in advance.  Furthermore, even after the house has been foreclosed, the occupants have some time to move out. 

In recent years, major banks have elected not to foreclose on people in December since it is close to the holidays.  It can create bad press for a lender to foreclose on a family right around the holidays.  Some lenders will delay December foreclosures until January.

Some states have laws about eviction of families with young children in the midst of winter.  Some state laws extend the time period for a family to move out during the winter months.

 

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Should I shut off my utilities if I vacate the house?

As the owner, you are still responsible for what happens on and to the premises.

In wintertime, the owner is responsible for preventing damage from frozen pipes.  If the owner is unable or unwilling to pay for heat, then the house should be winterized.  If the owner is unable to pay for the cost of winterization, they should notify their mortgage lender immediately.  In many cases the mortgage lender will pay to winterize a house and add the cost to the principal balance. 

If the owner shuts off the utilities, it can cause problems when the buyer conducts their home inspection.  Many real estate contracts state that the seller will have the utilities on for inspections.  If the buyer has to activate the utilities, they may be reluctant to make an offer in the first place, or they may simply make a lower offer than what they originally intended. 

Also, if the electricity is shut off, that can wreak havoc with showings, particularly showings in the evening.  If the house is dark, buyers are likely to be less interested in the home.  Keeping the electricity on makes showings run much more smoothly.

When the buyer conducts their pre-settlement walk-through inspection of the house, they will feel more comfortable if the utilities are on.  If the electricity and water are on, that could prevent any last-minute doubts or late-stage negotiation.  If financially feasible, it is wise to keep the utilities on.  At the very least, keeping the electricity and the water on can aid in the smooth sale of the property.

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Why can’t I sell my short sale to my family or business associates?

Most banks these days insist upon an arms-length transaction.  That is a transaction in which the buyer and seller act independently and have no relationship to each other.  They are not related, nor are they business associates.  The concept of an arm’s length transaction is to ensure that the parties are acting in their own self-interest and are not subject to any pressure from the other party.


If a woman sells a house to her brother, she may sell the house at a discount.  If the owner of a business sells his commercial property to an employee, he may sell at a discount or perhaps provide favorable financing.


If two strangers are involved in the sale of a house, it is more likely that the sale price and terms will be close to fair market value.  The assumption is that both parties are well informed, well represented, and not under any major duress.  The notion is that the seller seeks the highest possible price and the buyer seeks the lowest possible price, and they meet near fair market value.


In a short sale, the mortgage lender insists upon an arms-length transaction to prevent collusion or fraud.  There are instances where someone facing foreclosure will ask a family member with a different last name to purchase the house.  The lender would forgive the remaining debt, which could be tens of thousands of dollars.  The family member who buys the house might then rent or sell it back to the previous owner.  That person would have the benefit of continuing to live in the house, but for less money.  Furthermore, the lender would bear the brunt of the loss.  In addition, the lender assumes that the offer price from the family member might be far below fair market value, further deepening the lender’s loss and unjustly enriching the owner. 


Most lenders today require that the buyer, seller, and real estate agents sign an affidavit in which they swear that it is an arms-length transaction.  Some banks have short sale fraud departments, and they investigate suspicious transactions a few months after they are consummated.  If a bank discovers evidence of a non-arms-length transaction when the parties all signed an affidavit to the contrary, the lender can press criminal charges and sue for civil damages.  The buyer, seller, real estate agents, and even the title agent or attorney can be sued for committing a fraud.  Lenders are losing tens of millions of dollars in fraudulent short sales, and they are serious about finding evidence of illicit activity.

 

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Is it harder to do a Short Sale if I have more than one mortgage loan?

In many cases, it can involve more work to successfully negotiate a short sale if there are multiple lienholders.  However, not all short sales involving multiple lienholders are difficult.


There are multiple factors to a short sale.  Some lenders are more challenging to negotiate with than others.  It may be much harder to negotiate a short sale with just one lienholder if that lender is disorganized, unreasonable, bureaucratic, or overwhelmed.  If there are multiple cooperative lienholders, a short sale may be easier to pull off than if there is one, difficult lienholder. 


There are other critical factors that affect a short sale.  One is the seller’s willingness to cooperate.  Lenders often ask for updated paperwork.  A seller who is organized and responsive makes it more likely to obtain a short sale approval than a seller who is slow to submit paperwork.  Another factor is the strength of the contract between the buyer and the seller.  If a buyer offers a reasonable price and is flexible, that increases the likelihood of the short sale being successful. 


The lender’s policies factor into the potential for success.  If the lender permits a seller assist, that increases the size of the pool of potential buyers.  If the lender’s staff is not overwhelmed, they can respond more quickly to the parties.  As a matter of policy, some secondary lienholders will give in if the first mortgage approves a short sale, so the focus has to be placed on the negotiation with the first mortgage.  Some federal short sale programs mandate what the second mortgage can receive, which could make a short sale more likely to be approved by all parties. 


The bottom line is that having more than one mortgage does not necessarily make the short sale less likely to be approved.  The other factors play a huge role in the outcome.

 

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What are the Stages of a Short Sale?

While many short sales are different, there are three basic stages to each short sale.  They are the Document Collection Phase, the Negotiation Phase, and the Closing Phase.

Document Collection Phase. 

In this stage, the lender or servicer evaluates whether to consider a borrower for a short sale.  The lender requests a litany of documents, which typically include the last two federal tax returns, the last two months’ bank statements, the last two pay stubs, a financial worksheet detailing monthly income and expenses, a copy of the listing contract showing that the property is for sale, a preliminary HUD-1 Settlement Statement showing the projected amount of money the lender will receive, and a real estate contract with a buyer. 

This is often the longest stage of a short sale.  If the borrower does not submit documents in a timely fashion, then the lender will want all new documents.  For example, the lender wants the last two pay stubs.  If the borrower submits the pay stubs from February, but waits until April to submit their most recent tax return, then the lender will expect to see the April pay stubs even though the February pay stubs were submitted.  Some borrowers have expressed consternation when the lender repeatedly asks for documents that were submitted earlier.  Our advice is to keep giving the lender the documents they request.  Remember that the lender will not advance the file out of the Document Collection Phase until they are satisfied that they have a complete, up-to-date package.  


Negotiation Phase.

In this stage, the lender assigns a negotiator.  The lender’s negotiator may ask for additional documents from the borrower or their representative, who could be a real estate agent, a third party short sale negotiator, or an attorney.  If there is a mortgage insurance policy in place, the bank negotiator will communicate with the mortgage insurer to see how much the insurer will pay the lender and if there are any restrictions on how much of a loss can be incurred.  The lender’s negotiator will liaison with the borrower and their representative.  The bank negotiator will likely order an appraisal or Broker’s Price Opinion (BPO) to ascertain the current value of the property. 

If the bank’s requirements have been met, the negotiator will send the short sale package to the decision-maker, who is referred to as “the investor.”  The investor is a person with approval authority working for the true lender of the money.  The investor may take days or even a few weeks to make a decision.  That decision will be either be a short sale approval, a counteroffer, or a rejection.  The decision is relayed to the bank negotiator, who then informs the seller or their representative. 

The short sale approval may include terms or conditions that the seller cannot accept.  For example, the buyer might state in the real estate contract that they need a $10,000 credit from the seller for buyer closing costs.  The lender may approve the sale price but only allow $3,000 in seller assist for the buyer.  If that is the case, then the buyer has to determine if they wish to buy the property and come out of pocket with $7,000 more than they had hoped.  It is plausible that a short sale approval could include conditions that the seller or buyer cannot accept.

If there is a counteroffer, the lender will impose a deadline for a response.  In some cases, the deadline may be less than 24 hours.  In many cases, the deadline might be two or three days away.  In some cases, the lender will dictate that the counteroffer is a take-it-or-leave-it amount.  In other cases, the lender will be open to a counteroffer from the buyer or seller.  In most short sale counteroffers from the lender, the bank calls for a higher sale price.  It is important for the seller and buyer to respond to the lender within their time frame, or the bank could close the file. 

Once the seller is satisfied with the terms of the short sale approval letter, the short sale advances to the Closing Phase.


Closing Phase.

The final stage of the short sale is usually the shortest one.  The buyer and seller must make the necessary arrangements for the sale of the property.  They must comply with the terms and conditions of the short sale approval letter.  If the lender states that the settlement must happen within 30 days, then that is a strict rule.  A buyer should not be lackadaisical and believe that they can simply request an extension for more time. 

The title agent or attorney must ensure that the closing costs and fees on the final HUD-1 Settlement Statement match the approved settlement expenses in the short sale approval letter.  The lender only approves certain closing costs, and if there is a discrepancy the lender can unwind the entire sale.  We have seen a couple of instances where the lender wired the money back to the title agent because the final HUD-1 Settlement Statement had unapproved closing costs. 

Since the lender may have strict rules on which closing costs are approved, in numerous short sales there are still expenses that must be paid at settlement but will not be allowed to be paid out of the proceeds of the sale.  For example, assume that a house is located in a development where the Home Owner’s Association (HOA) has a transfer fee of $750 that traditionally is paid by the seller of a property.  The lender might not approve payment of the $750 fee.  However, the fee still has to be paid at settlement.  Therefore, the buyer might expect the seller to pay for all or at least some of it.  If the seller does not have sufficient funds to pay that amount, then someone else will have to contribute.  That could be the buyer, and it could include contributions from the real estate agents, attorneys, and title agent. 

In the below example, the seller’s mortgage lender approves the sale price of $245,000, the 6% agent commission, the 1% transfer tax, $4,550 in closing costs, and a minimum net proceeds of $223,300.  However, just three days before the settlement the title agency discovers that the HOA requires a transfer fee of $750.00.  While the parties hope that the lender will generously absorb the additional $750 in closing costs, the lender adamantly refuses to permit some of their proceeds to be used to pay the HOA fee.  Therefore, the parties look to the seller to pay the $750, as that is a fee typically paid by the seller in a traditional, non-distressed transaction. 

Below are the numbers:


        $ 245,000                    Sale price

       $   14,700                    6% real estate agent commission

       $     2,450                    1% realty transfer tax (each state is different)

       $     4,550                    Approved closing costs and pro-rated property taxes

       $        750                    HOA transfer fee not approved by lender

       $ 223,300                    Mortgage payoff, as the lender takes a $56,700 loss

         $      (750)                    Amount that the seller or other parties must pay


If the seller has the $750 and is willing to pay that amount at settlement, then no one else in the transaction has to contribute money.  However, in some cases the seller is so short on money that they state that they are unable to pay anything.  Then a last-minute negotiation occurs between the buyer, listing agent, and buyer’s agent.  In some cases, the buyer may pay some or all of the fee as a buyer’s assist to the seller’s closing costs.  Or perhaps the agents will each take a little less in commission. 

It is common in short sales for the final numbers to be slightly off from the approved costs mentioned in the short sale approval letter from the lender, which was probably issued a few weeks prior to the settlement.  We encourage the seller to save up at least $1,000 just to plan for last-minute expenses.  Also, the buyer, agents, and any other participants in the short sale should be open to the possibility that there might be some last-minute contributions required to make the sale happen. 

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What asking price should we choose when listing our short sale property for sale?

A short sale listing should be listed for sale at fair market value or slightly below.  The price can be lowered every three to four weeks if there is not enough interest from buyers.

It is futile to list a property too high.  Some agents and sellers list the property at a ridiculously high price that would theoretically pay off the entire mortgage balance and all other closing costs.  Buyers will not accidentally pay too much for a property.  They typically will not even look at a property that is listed well above market value.  Listing at too high a price is a waste of time.

Some agents and sellers think that the mortgage lender dictates the list price.  In certain short sale programs, like the HAFA program or the FHA Preforeclosure Sale program, the mortgage lender does determine the list price.  Some cooperative short sale programs also entail the lender choosing the list price.  In traditional short sales, which comprise the majority of all short sales, the seller determines the asking price after consulting with their agent.

Some agents list short sales well below fair market value, hoping to attract a multitude of buyers.  Some agents may simply use the short sale listing to attract buyers who they will divert to other listings.  The challenge with listing a property too low is that the seller’s lender may be unlikely to approve a sale price substantially below fair market value.  The lender will send an agent to the property to conduct a Broker’s Price Opinion (BPO), or the lender might even hire an appraiser.  If the lender’s valuation is much higher than the sale price in the Agreement of Sale, then the sale will probably not be approved at the low price.

On a national scale, according to Zillow.com in 2012, the average short sale sells for 20 percent below fair market value.  The average foreclosed home sells for 40 percent below fair market value.  Nevertheless, the ultimate market value of a short sale is dependent upon local market conditions and the condition of the property.  If the house is in a desirable neighborhood and it is in good shape, then the property will likely sell close to fair market value.

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What Government Programs are Available?

Home Affordable Modification Program

The Home Affordable Modification Program (HAMP) is a federal program designed to help homeowners avoid foreclosure by modifying loans to an affordable and sustainable amount.  The program provides loan modification guidelines for the mortgage industry to use.

Borrower eligibility is based on meeting the following criteria:

  1. The property can be owner-occupied or it can be a rental.
  2. The borrower is delinquent or faces an imminent risk of default.  If the property is not owner-occupied, then the borrower must be delinquent.
  3. The mortgage was originated on or before January 1, 2009.
  4. The unpaid principal balance must be less than $729,751 for one-unit properties.
    1. If a 2-unit property, the unpaid balance must be less than $934,201.
    2. If a 3-unit property, the unpaid balance must be less than $1,129,251.
    3. If a 4-unit property, the unpaid balance must be less than $1,403,401.
  5. The property must not be condemned.
  6. The borrower must show sufficient income to support a modified payment.

If the lender or servicer determines that a borrower is eligible for a HAMP modification, they can take a series of steps to adjust the monthly mortgage payment to 31% of the borrower’s total pretax monthly income.  The steps are:

  1. First, reduce the interest rate to as low as 2%.
  2. Next, if necessary, extend the loan term to 40 years.
  3. Finally, if necessary, defer (forbear) a portion of the principal until the loan is paid off and waive interest on the deferred amount.

Borrowers whose debt ratio is already below 31% may still qualify.  A borrower who previously defaulted on their HAMP trial period plan could still qualify again for the program.

Lenders and servicers may elect to forgive some principal at their discretion to achieve the target monthly mortgage payment.  The HAMP program provides incentives to lenders, servicers, and investors who cooperate.

Home Affordable Foreclosure Alternatives

In 2009, the Treasury Department, working in conjunction with the Department of Housing and Urban Development (HUD), introduced the Home Affordable Foreclosure Alternatives (HAFA) program to provide additional options for borrowers who are unable to keep their homes through the HAMP program.  HAFA took effect on April 5, 2010 and eligibility ends on December 31, 2013.  For people who are accepted into the program in December 2013, they must sell their property by September 30, 2014.

The HAFA program offers incentives to borrowers, lenders, servicers, and investors who utilize a short sale or deed-in-lieu to avoid foreclosure.  HAFA streamlines the short sale and deed-in-lieu process across participating banks by using standardized paperwork and establishing minimum performance deadlines.

HAFA alternatives are available to all HAMP-eligible borrowers who:

  1. Do not qualify for a Trial Period Plan.
  2. Do not successfully complete a Trial Period Plan.
  3. Miss at least two consecutive payments during a HAMP modification.
  4. Request a short sale or deed-in-lieu of foreclosure.

The eligibility criteria for HAFA include:

  1. The borrower has a documented financial hardship.
  2. The borrower has not purchased a house in the previous 12 months.
  3. The first mortgage balance is less than $729,751.
  4. The mortgage was originated on or before January 1, 2009.
  5. In the past 10 years, the borrower cannot have been convicted of theft, felony larceny, money laundering, fraud, or tax evasion in a real estate transaction.
  6. The loan is serviced by a participating servicer or lender.  The list of participating servicers and lenders can be viewed at http://www.makinghomeaffordable.gov/programs/lower-payments/Pages/hamp.aspx.

 

In a short sale under the HAFA program, the borrower is permitted to list and sell the property.  Generally, if the borrower makes a good faith effort to sell the property but fails to sell it, the lender may consider a deed-in-lieu of foreclosure if there are no other liens.

If the borrower qualifies for the HAFA program, the servicer may not demand a cash contribution or promissory note from the borrower.  Furthermore, the servicer will not be allowed to pursue a deficiency judgment against the borrower.  The proceeds of the sale of the property represent full and final satisfaction of the note.

Under HAFA, the servicer uses the financial and hardship information already collected when considering a loan modification under HAMP.  The borrower can receive pre-approved short sale terms before listing the property for sale.  The servicer can state the minimum acceptable net proceeds or the minimum acceptable sales price.  That pre-approval provides the listing agent with valuable information that can make a listing more effective in generating a solid offer.

A HAFA-approved homeowner will receive $3,000 for relocation assistance.  However, if a tenant is residing in the property at the time of the sale, then the tenant will receive the $3,000 instead of the homeowner.  This payment is made at settlement or upon post-settlement move-out by the occupant.  The servicer is given $1,500 to cover processing costs.  The investor (lender) is given up to $5,000.  Secondary lienholders can receive up to $8,500 in short sale proceeds, on a one-for-three matching basis.

Once a HAFA short sale pre-approval is granted, the listing agent has 120 days to procure a buyer.  The listing period could be extended up to 12 months.  The real estate commission will be six percent, as long as the listing contract states that the commission is at least six percent.

Lenders must make a decision regarding a borrower’s HAFA eligibility within 30 days of receipt of a completed application.  Some sellers can have what is known as a “pre-determined hardship.”  Those sellers must be 90+ days delinquent and have a FICO score less than 620.  Those who do not have a pre-determined hardship could still qualify for HAFA but will need to explain their hardship in an affidavit.  HAFA sales must be an arms-length transaction, and the parties will be expected to sign an affidavit.

Effective June 1, 2012, if a HAFA-approved borrower sells their house via the HAFA program and they were current on their mortgage at the time of the sale, then the lender must report the loan as paid in full to the credit bureaus.  In theory, a person who is current on their mortgage could sell their house via a HAFA short sale one day and qualify for a mortgage loan the next day.

The HAFA program guidelines vary slightly between Fannie Mae, Freddie Mac, FHA, and lenders of non-government backed loans.

HAFA short sales contain a deed restriction.  A buyer of a HAFA short sale cannot sell the property until after 30 days have transpired from the date of the purchase.  If the property is sold within 31 to 90 days after the purchase, the sale price cannot 120 percent of the HAFA short sale price.

The majority of short sales are traditional, non-HAFA short sales.  However, the HAFA program provides great benefits for sellers.  Participating lenders typically will consider a borrower for HAFA first, before considering a traditional short sale.  A borrower may request a HAFA packet from their lender.

FHA Preforeclosure Sale Program

FHA provides mortgage insurance on loans made by FHA-approved lenders.  FHA is the largest mortgage insurer in the world.  FHA became part of the Department of Housing and Urban Development (HUD) in 1965.

Below are the criteria for participation in the HUD Preforeclosure Sale (PFS) Program:

–       The home must be owner-occupied, with exceptions made for death, divorce, forced job relocation, or unemployment.

–       Investment properties or strategic defaults do not qualify for the PFS Program.

–       The property must be listed with a licensed real estate agent who is not related to the borrower.

–       The short sale must be an arms-length transaction, whereby the buyer cannot be a relative or business associate of the seller.

–       The borrower must be at least 31 days behind on their mortgage payment when they sell the property.

–       The property is to be listed on the market for at least four months, with the potential to keep it on the market for an additional 12 months.

–       Real estate commission cannot exceed six percent of the sale price.

–       The borrower must submit documentation proving the inability to continue making payments.

–       The buyer will be allowed a seller closing cost assist up to one percent if the buyer is obtaining an FHA insured purchase money mortgage.  If the buyer needs more, a variance has to approved by HUD.

–       HUD will allocate up to $1,500 toward secondary liens.

–       HUD will not pay for:

o   Title insurance

o   A home warranty

o   Repair reimbursements

o   Discount points for non-FHA financing.

–       A relocation incentive up to $1,000 will be paid to the seller if the sale occurs within three months from the date of application.  Thereafter, the incentive is reduced to $750.

–       The lender must order an FHA appraisal, which will contain the “As-Is” Fair Market Value (FMV).  The appraisal is valid for 120 days.  The appraisal must be provided to the borrower or real estate agent upon request.

 

If the property is approved for the PFS Program, an Approval to Participate (ATP) is issued.  The date of the form becomes the starting date of the PFS participation.  The ATP is a short sale pre-approval.  It will state the date by which a signed sales contract must be obtained and the minimum acceptable sale price.  The ATP is valid for four months and can be automatically extended for two months if there is an accepted Agreement of Sale with a buyer.  The lender has to delay the foreclosure proceeding during that period.

Once the ATP is issued, one can predict the acceptable sale price if it is below the amount stated in the ATP.  HUD adheres to the following Tiered Net Sales Proceeds guidelines:

–       For the first 30 days of marketing, lenders may only approve offers that will result in a minimum net sales proceeds of 88 percent of the As-Is appraised value.

–       For the next 30 days of marketing, lenders may only approve offers that will result in a minimum net sales proceeds of 86 percent of the As-Is appraised value.

–       For the duration of the PFS marketing period, lenders may only approve offers that will result in minimum net sales proceeds of 84 percent of the As-Is value.

 

For example, let’s say that FHA issues an ATP with a pre-approved sale price of $100,000, which would have been the As-Is appraisal value.  The minimum acceptable net proceeds for an offer accepted in month 1 of the marketing period would be $88,000.  That does not mean the sale price can be $88,000.  That means that after real estate commission, attorney fee, real estate transfer tax, and closing costs are paid, then FHA must receive at least $88,000.  So, assuming that commission, taxes, and closing costs add up to $9,000, the sale price could be $97,000.  If an Agreement of Sale were signed in month 3 of the marketing period, then the minimum acceptable net proceeds would be $84,000.  Therefore, a buyer could purchase the property for a little less money than earlier in the marketing period.

 

Sometimes the As-Is appraisal value is well above what buyers are willing to offer.  FHA has the following appraisal dispute guidelines (which are not published publicly by HUD but we learned from experience):

–       FHA must be provided with three to four comparable sales that sold in the six-month period prior to the date that the appraisal was completed.

–       The comparables must be full, Agent Detail Multiple Listing Service (MLS) sheets showing the sold date, sold price, and property description.

–       Sales used in the original appraisal cannot be submitted as dispute comparables.

–       The comparables must be submitted via email, not via fax or regular mail.

–       The seller needs to be advised that the dispute decision is final.

–       If the approval is granted to order a second appraisal, the As-Is FMV is final, even if it is higher or unchanged.

 

There is a serious flaw in the FHA appraisal dispute process.  They do not take into account a declining market or a deteriorating house.  FHA demands the dispute comparables be ones that sold in the six-month period prior to their appraisal.  However, if the property has been on the market for multiple months, those comparables are too old and no longer indicative of the market condition.  Furthermore, the house could be losing value due to deferred maintenance, and FHA does not properly account for property deterioration.  Therefore, it is critical for the seller or listing agent to liaison with the appraiser ahead of time so the appraiser is made aware of the market conditions.

Fannie Mae and Freddie Mac

Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) make loans and loan guarantees.  Both are regulated by the Federal Housing Finance Agency (FHFA), which acts as a conservatorship.  Fannie Mae and Freddie Mac both permit short sales.

On November 1, 2012, Fannie Mae and Freddie Mac implemented a consolidated, more streamlined short sale approach known as the Standard Short Sale / HAFA II.  These new guidelines allow homeowners with Fannie or Freddie mortgages and who have a documented hardship to pursue a short sale even if they are current on their mortgage payments.

If someone is current on their mortgage, they must be occupying the house as their principal residence.  If someone is using the property as a vacation home or investment property, they must be behind on their payments by more than 30 days to be eligible for the program.  The property can be vacant but cannot be condemned.

The borrower’s total monthly debt ratio, which is the ratio of the borrower’s current monthly qualifying expenses divided by the borrower’s current monthly qualifying income, must be greater than 55 percent.  Military personnel are exempt from the 55 percent requirement.  Servicers of will be able to quickly qualify distressed borrowers without waiting for approval from Fannie or Freddie.

The Standard Short Sale / HAFA II program promises a faster process for those who are behind on their payments.  Fannie and Freddie will allow up to $6,000 to be paid to a secondary lien holder.  The subordinate lien holders must agree to release the borrower from any further debt obligation if they are receiving money from the settlement.

The program calls for servicers to review and respond to a signed buyer offer within 30 days of receiving them.  The servicers must provide weekly status updates to the borrower if the offer is still under review after 30 days.  The servicers must make and communicate the final decision to the borrower within 60 days of receipt of the offer and a complete borrower response package.  Note that even though an offer may have been submitted, the servicer is not obligated to respond within the 30-60 day timeframe if they claim that the homeowner did not submit a complete borrower response package.  It is crucial for a borrower to ensure that all the requested paperwork is submitted in a timely fashion.

Fannie and Freddie will waive the right to pursue a deficiency judgment in exchange for a financial contribution when a borrower has sufficient income or assets to make a cash contribution or sign a promissory note.  Someone could be asked to make a cash contribution if their cash reserves, including assets such as savings, money market funds, marketable stocks or bonds (excluding retirement accounts) are greater than $10,000 or six times the monthly mortgage payment including principal, interest, tax, and insurance (PITI).  If the servicer determines that the borrower has the capacity to make a cash contribution, the servicer must initially request a contribution of 20 percent of the liquid reserves, not to exceed the deficiency.  If a borrower who is more than 30 days delinquent is unwilling or unable to contribute 20 percent of their cash reserve, the servicer could potentially accept less as long as there is a specific circumstance that limited the borrower’s ability to make a full contribution.

The servicer must evaluate a borrower for a promissory note if the borrower’s future debt-to-income ratio is less than 55 percent.  If a borrower is deemed to have the capacity to make a promissory note contribution, the servicer must request a five or 10 year term with a payment the borrower can afford in the future.  There will be no interest charged.  If the borrower is unwilling or unable to agree to the promissory note payment, a lower amount could be negotiated as long as there is a specific circumstance that limited the borrower’s ability.

Military personnel who have Permanent Change of Station (PCS) orders will be automatically eligible for a short sale, even if they are current on their payment.  They will not be obligated to contribute funds to cover the shortfall.

If an owner-occupant sells their house, and if they were not asked to make a contribution, they will receive a $3,000 relocation incentive.

The sale must be an arms-length transaction.  All parties will be expected to sign an affidavit to attest that it is truly an arms-length sale.

The program also allows a real estate commission equivalent to six percent of the sale price.  A real estate agent could agree to take less commission.  The servicers are expected to provide list price guidance to the borrower after Fannie or Freddie approves a suggested list price and minimum acceptable net proceeds.

There is a deed restriction which prohibits a resale, or flip, of the property within 90 days after the short sale transaction.

HARP and HARP 2.0

HARP is a federal government program for people who are current on their mortgage payments but have been unable to refinance their mortgage.  To be eligible, the mortgage must be owned or guaranteed by Fannie Mae or Freddie Mac, and it the sale to Fannie or Freddie must have occurred before June 1, 2009.  The mortgage cannot have been refinanced under HARP unless it was a Fannie Mae loan that was refinanced via HARP from March to May of 2009.

The loan-to-value (LTV) ratio must be greater than 80 percent.  That means that there must be at least 20 percent equity in the property.  The borrower must be current on the mortgage, with an on-time payment history for the previous year.

HARP 2.0, a revised version of the original HARP, ends on December 31, 2013.  Not all mortgage servicers participate in the program.  People looking to refinance through HARP will need to complete a loan application and go through the underwriting process.  Refinance fees will be charged.

HARP 2.0 is designed to help borrowers who could not refinance to a more affordable interest rate but still paid their mortgage on time.

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