Loan Mod, Short-Sale or Bankruptcy Oh My!

Many times in today’s economy homeowners are internally wrestling with the question: Do I Modify, Short-Sell or file for Bankruptcy? Yes, you can also throw in do I simply let it go if you would like but for the sake of the post it is not included.

The answer to the question is not a simple one. Many times I find the reason that it is most difficult to decide is the lack of understanding the consequences. Each option comes with serious pros and cons that will have a long term affect on your life.

Important Questions to consider when looking into your options are:

Is my loan a recourse debt or is it non-recourse debt? - Click here for Wikipedia’s Definition of Non-Recourse Debt .

What tax consequences will I face if I execute a Loan Mod, Short-Sale or file Bankruptcy?

What are the Long term Credit Consequences?

How Much do I have to pay to get this done?

How do I find the right Loan Mod company, Realtor or Attorney there are so many? Does this person specialize?

These are only a few of the important questions that you should ask when considering your options. Let’s take a moment to explain in the most basic terms what each of the options mean:

Loan Modification – A Loan Modification is a modification to the terms and conditions of your current note. Common modifications include extending the payback period(amortization), decreasing the interest rate for a set period of time, extending the period of time your rate will be fixed, switching from an adjustable to a fixed rate option, principle reduction or any combination of the aforementioned and more. Loan modifications can be done directly through your lender(recommended) or you can hire a third party Loan Modification specialist (ask if they are approved by the Department of Real Estate). Here is a great place to start for a Loan Modification. Be careful if you get a principal reduction on your loan modification as you may have tax liability on the debt that was forgiven.

Short Sale – A short sale occurs when you sell your home for less than you owe on the property. Your lender has to agree to take a loss for the amount that you will be short.  Ex – you owe 500K and the property will only sell for 400K. You are shorting the lender a 100K plus Real Estate commissions. This is where it can get tricky. If you have a first and a second on the property it is imperative that you consult both a CPA and an Attorney or qualified Real Estate agent. Depending on the type of debt (recourse or non-recourse and purchase money or refinanced loan) there can be tax consequences that can hurt you bad come tax time. See what happens is the amount that you are forgiven by the lender 100K in our example will be treated as income. The lender will 1099 you for the amount that you shorted them and you may have to pay income taxes. There is also other potential tax ramifications. (Consult your CPA as I am not qualified to discuss your tax liability. The above are merely for illustration and example purposes.) If the debt is recourse debt the lender may also come after personal assets that you may have. If the debt was purchase money in the state of California a bill was passed that for a short period of time they will forgive the debt without the tax consequence. Debt must have been purchase money. Will take care of tax consequence but if it was Recourse debt this does not mean the bank will not try for personal assets. Again please see qualified accountant and/or Real Estate Attorney for legal advice. If you are considering a short-sale make sure that you seek out a qualified referral. There are many agents out there that understand the process and will do an extraordinary job for you.

Bankruptcy – In my opinion, this is the last option that I would seek out. My opinion is merely that but in Dave Ramsey’s Total Money Makeover he too advises strongly against this option. In the last few years new Bankruptcy laws have made it harder to file for bankruptcy Chapter 7. Credit recovery from a Bankruptcy is the most difficult of the three options. If you have one slip up post Bankruptcy it will be scrutinized and can ruin your chances of future loan approval. More than that the humiliation of all your items being taken away from you will remain in your mind for a long time. However, this could be the option that best suits you. Chapter 7 is a complete wiping out of the debt. You can apply for a Mortgage 24 months after the Bankruptcy is discharged as long as you have re-established credit. Chapter 13 is the reorganization of debt to a more affordable payment. You can apply for a home loan after 1 year of timely payments on the debt but the loan must be approved by the trustee. Can a home loan be included in a Bankruptcy? In short this is called a Cram-Down and has been argued for and against in light of the economic crisis. Wikipedia gives a good explanation of where we stand but this is continually changing as the need changes and as the voices are heard. For current information please consult a Bankruptcy Attorney.

So the question remains: What option is best for my situation? As you can see the answer is not very simple and will be very different for each family. Please do not take the advice of a friend who short-sold and says this is the right thing for you. Consult your local professionals. Proverbs 24:6 “So don’t go to war without wise guidance; victory depends on having many advisers.” – Basically what is being said is get the advice of many wise professionals. Sift through the information find the consistencies and inconsistencies and determine what route works best for your individual situation.

****Again, I will say that I am not legal counsel and what is posted is meant to be illustrative and thought provoking only. Always consult legal counsel regarding your specific situation. If you need the name to someone that may be able to help you I can always refer you to quality professionals in their respective industries********

Foreclosure Fix: Obama’s plan released

The details of Obama’s Foreclosure relief program have been released. If you bought a home prior to January 1st, 2009 and you owe less than $729,500 on your Primary Residence you may be eligible for a Loan Modification.

Some of the Requirement of the plan include but are not limited to the following:

• Mortgage obtained prior to January 1st, 2009
• Mortgage amount less than $729,500
• Primary Residence Only
• Fully document your income by providing tax returns and pay stubs
• sign a statement of financial hardship
• go for counseling if their total household debt – including auto loans, credit cards and alimony – total more than 55% of their income

Modifications may be structured as follows:

• Servicers are asked to modify loans to meet a 38% total house payment and the government will subsidize servicers dollar for dollar to lower that ratio  to 31%. The interest rate can’t go below 2%.
• lender can extend the term of the loan up to 40 years or shift part of the principal to the loan at no interest. Servicers also have the option of reducing the loan’s balance.
• The new interest rate will remain in place for five years after which the interest rate will Increase 1% per year until it reaches the original rate or the prevailing rate at the time of modification whichever is lower.

Loan Modification plans focus on people who are behind in their mortgage payments or at risk of defaulting on their mortgage. The definition of “At Risk” is defined as those that are:

• suffering serious hardship
• declines in income
• increase in expenses
• facing an interest rate hike
• having high mortgage debt compared to income
• owing more than the house is worth
• demonstrating other reasons for being close to default ie: Extreme Hardship

Both borrowers, servicers and the investors will receive benefits for active participation in the program. Servicers are said to receive $1,000 dollars per modified loan and additional benefits annually for timely payments by the borrower. The timely payments are a result of previous failed efforts of loan modification that have resulted in over half of the modified loans slipping back into default within a year. Investor’s will receive one-time $1,500 incentive for modifying loans that are not yet delinquent and borrowers will receive $1,000 per year in Principal Reduction for timely payments, for up to five years.

There is also a provision for second mortgages to be eliminated but the details of that provision will depend on the cooperation of the second mortgage holders.

The modification program will be in effect until the end of 2012 and is said to help up to 9 million homeowners.

Contact your loan servicer to see how this plan will work for you. Many of the details of the program have been taken from multiple sources of media and listed here for your benefit. I do not have or know the extent of the help further than the explanation above. I stress that each situation will differ so the best source for you will be to contact your servicer for your situation.