Her Mortgage Check Won’t Be in the Mail
On the last business day of 1989, I did a very stupid thing.
Not realizing (who did?) that real estate was at its delirious peak, I signed the mortgage papers for my first house, a vintage two-bedroom bungalow in North Long Beach, one of the “affordable” areas of the city I’d lived in for several years. I put 10% down on the $165,000 purchase price and was delighted to snag a 30-year mortgage at 9.75%.
I’ve since come to the conclusion that living far from friends, night life and good bookstores is a drag, that maintaining a big back yard I never use is a nuisance and that my homeowner’s tax benefits essentially are eaten up by my high monthly payments ($300-$400 or more than I’d be paying in rent) and property taxes.
I can’t rent out my house because my mortgage payment is twice as much as monthly rents in my neighborhood.
So I decided to sell. After having been turned down for refinancing last year because I had no equity in the house, I thought I had few illusions about the market. But I had no idea how bad things were.
Although I still owe about $144,000, similar houses in my area are selling for between $125,000 and $130,000. Add selling costs and the agent’s 6% commission, and I’d have to pony up something like $27,000 simply to get rid of my house.
Well, I don’t have that kind of money--most of my savings went into the down payment and some early fix-up projects--and even if I did, I’d be loathe just to throw it away.
I’d heard that many people actually were walking away from “upside-down” loans like mine. But letting the bank foreclose on my property sounded frightening--a black mark on my good credit rating that might have awful repercussions in the future. Wasn’t foreclosure just for deadbeats or for people who have lost their jobs?
After talking to several experts, I’ve concluded that most of the options for homeowners in this situation have major drawbacks in the current market, while foreclosure may not be the dread animal it appears to be.
The most frequent recommendation from experts is a “short sale,” which permits the homeowner to work out an arrangement with the lender to sell the property at less than the remaining loan balance.
Some lenders say they are unlikely even to discuss this possibility with you until you stop paying your mortgage.
At Home Savings, however, homeowners facing financial problems are encouraged to let the bank know “as soon as possible,” according to public relations chief Mary Trigg, rather than waiting until they are no longer able to make their monthly payment. (In some hardship cases, Home Savings has allowed mortgage holders to skip several payments, which were then tacked onto the loan balance.)
The bottom line, however, is that bankers will negotiate for a short sale only in situations of unavoidable hardship, such as loss of your job, unexpected business reverses or heavy medical bills. If you just want out, banks likely will foreclose.
“If there’s a good offer and a good possibility that the property will end in foreclosure two months from now,” said Petra Vazquez, foreclosure administrator at First Interstate Bank in Los Angeles, “most investors will consider the offer. . . . (But) hardship and the loan type play a big role. We had one instance where the homeowner couldn’t stay in her (crime-infested) neighborhood, but financially she had no problem.” Her request for a short sale was denied.
“Each case is different, so there are no set rules,” Trigg emphasizes. But, she adds, “if there is any rule of thumb, it is that you have to have a documented economic hardship.”
If you have private mortgage insurance (PMI), as do most homeowners who put less than 20% down, it will protect 15%-25% of the loan, says Rick Alkire, owner of Mountain View Financial in Hemet, but the PMI agency has to agree to the short sale as well as the primary lender.
Some desperate homeowners may be tempted to sell their title to a company that promises to urge the lender to accept a short sale. The company pockets 1% of your note as a processing fee, and the property becomes a company investment rather than a personal residence. You are told that any losses would be claimed by the company.
Sound too good to be true? Richard Pittman at Consumer Credit Counseling in Los Angeles, a HUD-certified agency, warns that these companies don’t tell consumers about their potential for tax liabilities.
Say the bank is owed $150,000 but the value of the home has slid to $100,000. The bank can let it be sold at $100,000 and take the $50,000 loss, but according to IRS laws, that $50,000 is income earned by the seller--income that should be taxed.
“Right now, the IRS says they’re not sure (how they will rule on such cases),” Pittman said. “This is the first year we’re seeing these things pounce on the marketplace. It’s an unknown element. If this client bails out of their house, they could have a tax lien looming down the road. Whether they (subsequently) rent or manage to buy another house, (the consumer who negotiates a short sale) is in grave jeopardy while the IRS is considering their position.”
Two other commonly cited strategies--a deed in lieu of foreclosure and a wraparound mortgage--are not viable homeowner options in today’s market.
A deed in lieu of foreclosure involves signing your deed back to the bank, thus eliminating the foreclosure process. This tactic is much more common in commercial properties, when more money is at stake.
“In a normal tract home, you’re not going to have any luck” pursuing this strategy, said Jay W. Deverich, a real estate attorney with Call, Clayton & Jensen of Newport Beach.
In any case, Alkire adds, since the deed is a county-recorded document, your credit can still be damaged.
A wraparound mortgage marries a seller with a low-interest mortgage to a buyer unable to find a mortgage at a comparable rate. Common in the ‘70s and early ‘80s, when interest rates suddenly shot up, this scheme has been thwarted by non-assumable loans. Most deeds of trust issued during the past decade have “due on sale” clauses, meaning that any time you wish to sell, the lender can demand payment of the balance in full.
And then there is foreclosure, an initially daunting procedure that seems to be the best way out of my own dilemma. After researching this article and weighing the pros and cons, I decided to stop paying my mortgage in December. Conservatively estimated, that will give me until late spring to hang on to my house and bank the monthly payments before the property is repossessed.
To be sure, friends have reacted with astonishment and even indignation (“Isn’t that fraud?” someone asked me sternly). And, yes, I do worry about the inevitable blot on my credit rating. But I figure that the quality of my life has to be more important than the temporary status of my credit file. Life’s too short to feel so frustrated, too short to hang on to a piece of property in the feeble hope it will substantially appreciate a few years from now.
As Deverich explained, if you have defaulted only on the original “purchase money” loan with which you bought a house with one to four units and it is your personal residence, then your loan is considered “non-recourse” under California state law. That means your lender cannot pursue your personal assets if the bank forecloses on your home.
There are some exceptions, Deverich says, relating to fraud (you told a lie to get the loan) and a murky area called “bad faith waste.” For example, as a final angry gesture, you maliciously damaged your house.
But if you refinanced your house, as hundreds of thousands of homeowners did the past three years, Deverich said, “all of a sudden the magic purchase money protection goes away.”
Still, there is hope. If the loan is secured by a deed of trust on the property--as is usually the case--the lender has two options: a judicial foreclosure (a lawsuit to foreclose the deed of trust) or a non-judicial foreclosure (also called a trustee’s sale).
Happily, non-judicial foreclosures are by far the most common. They take about four months and involve publishing notices of default and sale in a newspaper. You lose your property, of course, but under California law your lender can’t sue you personally (unless you have committed fraud or bad faith waste). So you don’t lose your credit cards, your wages, your car, your savings or other assets.
As the name implies, a judicial foreclosure involves a lawsuit. For the most part, lenders are loath to get involved in this time-consuming and expensive process. They prefer simply to resell the property. At First Interstate, Vazquez said to her knowledge the institution has never initiated a judicial foreclosure.
Normally, Deverich said, the only reason the bank would pursue a borrower through judicial foreclosure would be “if they’re owed a whole bunch of money and the property isn’t (worth) even close to what they’re owed.” To justify the time and expense involved, the lender also would have to be fairly certain the borrower had sufficient assets to execute against.
If you have an FHA mortgage, Consumer Credit’s Pittman said, “by their regulations, they have (the) right to go after deficiencies for all loans. But their theory is, if a person didn’t have enough to work with and had to get a FHA mortgage, what’s the chance there’ll be anything to recover?”
Still, Pittman pointed out that a judgment is good for 10 years, and it can be extended for another 10-year period. So if your career takes an upswing a decade later or you inherit money, you may still be liable for that loan.
“It’ll be interesting to see, as more lenders are facing more foreclosures and short sales, whether they’ll consider judicial foreclosure,” Pittman said.
Deverich echoes these sentiments. Not only has the court system in California speeded up in recent years, but property values have dropped significantly, “so the potential deficiency that lenders are looking at having to swallow is growing compared to past years,” he said. “The incentive is increasing for them to consider chasing the borrower who has assets. They’re not so adverse to doing that anymore.”
If you have a second or third deed of trust on your home, the situation is more complicated. The rule is that if the first deed of trust forecloses, it will wipe out the second (and any additional deeds of trust). In legalese, the second lender becomes a “sold-out junior,” meaning they no longer hold the junior deed of trust.
The bad news is that the borrower who signed the “sold-out junior” second is not protected against a lawsuit. “Unless there’s just a tiny amount of money at stake or the lender knows the borrower has no assets, there’s no reason why they wouldn’t bring that lawsuit,” Deverich said. In such a case, the borrower might need to file bankruptcy.
Deverich advises homeowners contemplating foreclosure to consult a knowledgeable mortgage broker. Still, he says he believes “99.9% of homeowners probably wouldn’t have to worry” about being sued in connection with a foreclosure.
“My personal opinion is that banks would probably not do that for your normal type of home loan just because there’s not enough money at stake. Your normal tract house loan is not going to generate enough of a deficiency.”
In calendar terms, you have about six months of breathing room from the day you stop paying your mortgage until the day the bank sells your house.
At First Interstate, Vazquez said there is an average of three months before a delinquent loan is referred to the foreclosure department.
“If there are some other considerations (such as unemployment or illness), we work with people,” she said. “Sometimes, while waiting for their proposals, we will (hold off) for maybe another two or three months.”
After that three-month period, a notice of default--the first legal action--is recorded and mailed to the homeowner, who then has 90 days to reinstate the account or sell the property. If it’s still in default, the bank will advertise the sale of the property, which happens four weeks after the 90-day period ends. So the entire process takes about 120 days.
But “there are always exceptions to the rules,” Vazquez said. “We would rather have the property sold through escrow than foreclosure.” Again, however, bear in mind that the “exceptions” are created by hardship cases.
What about that rule you always hear--that you have to wait seven years to buy another house after going through a foreclosure? It turns out the waiting period, if any, is “strictly up to the lender,” according to Pittman.
But you don’t get a free ride. “You won’t get the low-cost mortgage,” he cautioned. “You’ll be paying premium rates. You better have a larger down payment. And you better not have any other credit problems.”
What about renting? That depends on the landlady or management company. “Some areas are begging for anybody who can come up with a half-month’s rent,” Pittman said. “(But) if you want be on top of the knoll looking over the ocean, forget it. . . . You have to be realistic.”
If you do opt to rent, try to bank the difference between your old mortgage and your current rent, Pittman advised. Then, when you want to get a car loan three years from now, you can explain to your banker, “Yes, I walked away from my house because it was a losing proposition. But I started saving $500 a month and now I’d like to put $15,000 down on that $20,000 car.”
