ARE YOU BEHIND ON YOUR HOUSE PAYMENT?
OVERVIEW of the
Legal pathway addressing your delinquency and the consequences
A homeowner who can no longer afford to make their payments, or payments are not made on time; the debtor/owner
begins what is called the pre-foreclosure period of time. The term utilized within the real estate profession is that of a
This is a very serious step and should not be considered an easy way out of a house that has become “too expensive”.
The process is very difficult, emotionally and financially. My first question to an individual is “Can you rent out the
house to cover your costs and rent a cheaper place for you to live?”.
If the answer is yes, then seriously consider this step. Read on to gather more detail on the difficult process of losing a
DEED IN LIEU OF FORECLOSURE
“Give the house back to the bank”
If a home owner only had a single mortgage on the property through their lender, a procedure known as deed in lieu of
foreclosure is a viable option. Under this arrangement the homeowner issues a deed to the lender and conveys title to
the lender. The homeowner transfers title to the lender with very little legal costs to the lender.
Obviously a lender would prefer this outcome over a full blown foreclosure. The question still remains as far as the total
overall debt the homeowner owes the lender after the deed transfer. Would the lender forgive any additional debt
money owed by the homeowner or require payment of the excess over the value of the property? This, of course, would
be negotiated between the homeowner and the lender.
If the involved property had several secondary liens on the property, the lender would not be interested in pursuing a
deed in lieu of foreclosure. The lender would not want to be held responsible for the secondary liens on the property.
“Sell the house for less than you owe”
With all the problems that have ensued regarding mortgage liens and the real estate market as a whole over the past
years, lenders have shown a willingness to accept less than full satisfaction of the mortgage debt that they have issued.
As you're aware, these satisfaction maneuvers have often been accomplished through the sale of property to a third
party owned by the debtor. Unfortunately, the usual sales price is not enough to pay off the total mortgage debt. This is
known as a short sale.
This short sale situation is often caused by a homeowner who can no longer afford to make the regular mortgage
payments. When payments are not made on time, the debtor/owner begins what is called the pre-foreclosure period of
time. The term utilized within the real estate profession is that of a distressed homeowner.
A short sale would be the most involved process of settlement with the lender. It would also be the most time
consuming procedure. Some of the "How To" books bestow as many as 28 separate procedures in the completion of a
In fact, one author stipulated 100 separate problems that can arise within a short sale transaction. The main problems
stem from the involved lender and the legal ramifications.
Those of you who have represented a buyer in a short sale transaction are well aware of working with the involved
lender. Your best buyers are those who plan to live within the home. Working with investor buyers who are low balling
an offer are usually placed in the bottom of the in-basket for the lender. You want to work with a buyer that will make
an offer as close to market value as possible.
It is fairly common for lenders to take 45 to 90 days or more of time to make a decision whether to accept or reject an
offer from a buyer. There are plenty of stories of lenders simply ignoring offers. One of the main reasons for the delay is
the loss write-off that is placed on the lender's books for any short sale. This is especially true in areas of the country
where real estate values are beginning to increase.
First of all, realize that lenders who survived the economic downturn are not magnanimous lenders that wish to help the
seller. They have a bottom line that they must meet for stockholders and the bonuses paid to the upper management.
As stated earlier the lender may:
1. Accept, reject, or ignore the short sale offer
2. Agreed to forgive the debt which creates a possible exposure to a tax liability
3. Release the mortgage obligation, but still require the seller to pay additional amounts owed
4. Approve a short sale but require the buyer to close within 30 days
IRS Form 982 - Discharge of Indebtedness
This form has to do with the forgiveness by a lender of an indebtedness owed the lender. Whenever a lender forgives a
debt owed the lender, it can become a taxable debt.
Example: You owe $15,000 on a credit card and the lender says pay $10,000 in cash today and we will forgive the
additional $5,000 you owe them. The $5,000 can become taxable income and reported on Form 982.
This can become a problem for a homeowners who had 2 nd, 3 rd, and 4 th liens on their principal residence.
The Emergency Stabilization Act of 2008
The Federal government allows an exclusion from taxation of debt forgiveness on a principal residence. This applies to
debt forgiveness for the years 2006 to 2013. However . . . there are some forms of debt that do not apply to this debt
If a person's home has gone down in value below the primary mortgage debt, the debt forgiveness exclusion from
reportable income is a whopping $2,000,000. This obviously benefits the total gambit of taxpayers.
Example: A residence was security for a $1,000,000 mortgage. The lender forgave $300,000 of debt in a short sale for
$700,000. The $300,000 would not have to be reported as income on the seller's 1040 form.
Example: A residence was security for a $800,000 mortgage and a $200,000 revolving equity loan. The lender forgave
$300,000 of debt in a short sale for $700,000. Now, only $100,000 would not have to be reported as income on the
seller's 1040 form. The $200,000 of general equity loan debt does not qualify for the exclusion. $200,000 would have to
be reported as income unless declaring a Title 11 bankruptcy insolvency.
The form of lien with a forgiveness amount is not a requirement. Liens that qualify include:
1. Standard mortgage lien
2. Trust Deed lien on the property
3. Land Sales contract
4. Property Money Mortgage
It is the lender under the Promissory Note and backed by one of these vehicles that have the forgiveness characteristic
under the Act.
This $2,000,000 exclusion applies to the "claimed" principal residency of the homeowner. This claimed residency is
usually the address specified on the individual 1040 form.
Additional 2 nd (3rds?) that qualify for the exclusion as well include:
• Loans for substantial improvement to the principal residence. These would have to be appurtenances to the
home or property and NOT personal property. The improvements would remain with the house if sold or
Example: Loans for a swimming pool, addition to the home, landscaping, etc
Forms of Forgiveness by a Lender
It doesn't matter the form of debt forgiveness. The forgiveness could be in the form of:
1. A short sale to a buyer
2. Issuing a deed in lieu of foreclosure
3. Refinancing with a lower debt amount
If a deed in lieu of foreclosure or a short sale is not completed, the only alternative is foreclosure by the lender against
the property in question.
With the advent of the growing problem of foreclosures, more and more lenders are placing non-judicial foreclosure
procedures/clauses into their lien documents. The original Trust Deed lien allowed a 3 rd party, the trustee, to implement
foreclosure procedures without having to go to court. The former Washington Mutual Savings Bank utilized a lot of Trust
Deed lien forms under this arrangement.
This reduces a lot of the legal costs associated with foreclosure in that the lender does not have to go to court for most
of the foreclosure procedures. In Washington, most of the non-judicial Foreclosures occur on the courthouse steps or
similar setting on each Friday morning. This type of foreclosure essentially wipes out the "redemption period" for an
owner to come up with payment of the debt obligation. In some cases the redemption period was over one year. In the
mean time, the owner could live within the subject property during this "redemption period".
A full blown Judicial Foreclosure is probably the last option for a lender. This is the most costly form of settling a lien
with a non-paying debtor/owner. Full use of the courts, lawyers, and the sheriff sale would drive up the costs for the
lender. This form of foreclosure facing a lender would be the standard mortgage lien. Pretty much all mortgages prior to
5 years ago, did not have non-judicial foreclosure procedures
FICO Credit Rating of the Debtor/Owner
The FICO scoring systems comes from the Fair Isaac Corporation (FICO) in California. Pretty much all lenders use their
credit scoring system. The FICO credit rating of 850 is the maximum credit rating that a person can have. The absolute
worst is a score of 300. Most people are in the 600s as far as their FICO score.
A short sale or issuing a Deed in lieu of foreclosure on an owner's property is known as a "settlement" on the system.
Settlements for less than the actual debt can be accomplished on credit card debts, auto loans, the IRS, etc. These
settlements normally drop the credit score around 150 to 200 points.
Foreclosure would almost be the worst factor on the existing credit record of the debtor/owner. Historically, this would
drop the existing FICO credit rating by 250 points. The worst credit factor would be a Title 11 bankruptcy that includes all
personal debts as well as the foreclosure on the subject property. Some Title 11 settlements have dropped FICO scores
by 350 points.