I am sure that you have seen in the news about people giving up their homes as a "stretegic default". You may also be aware that people who lose their principal residence in foreclosure will not be responsible for taxes for the normally taxable event of a "loss forgiveness".
When contemplating a "strategic default" homeowners can presently afford the home in which they are living but decide not to pay. They take the money that would be used for a mortgage payment and choose to put the money somewhere else that would be protected by the laws of the state. In Florida, that could include retirement plans, trusts, life insurance policies, or even another home. They may be protecting the assets but they may not be protecting themselves from personal liability.
Eventually, the home will be foreclosed (probably more than a year in Florida from time of default to foreclosure sale). I will use the example of a $250,000 mortgage on a home that is now worth $125,000. Once it is foreclosed, the mortgage company will potentially have a "deficiency" of $125,000. If the foreclosure was completed prior to December 31, 2012 (this may again be extended by the new Congress), the deficiency balance, or loss forgiveness will not be taxable. However, this does not mean that the bank (or, the subsequent owner of the note) will not be able to pursue the homeowner for the balance.
In a stretegic default, the homeowner would have been able to live "rent free" for at least 12 months. Assuming a mortgage payment of $2,000, they would have been able to save $24,000.00. But, after the foreclosure, they would still have a potential debt of $125,000.00. It is important to be aware that the bank will have five years (in Florida) from the sale date to pursue the $125,000 plus interest and cost.
It is the fear of many bankruptcy attorneys that clients will choose to walk away from their home, forget about the potential liability and five years later be faced with a lawsuit.
There are better options. Homeowners can choose between a "short sale" or "Deed in lieu of foreclosure". With a short sale, the homeowner puts the home up for sale at the market rate. The property must be advertised as a short sale and state that it is subject to the bank's approval. Once a buyer is found, the contract is presented to the bank for approval. There are a lot of internal unknown reasons for a bank to consider a short sale. The bank will not approve a short sale if the property is not being sold for "market value". Why they would reject a short sale is a mystery. As part of the short sale, the bank may require the financial records of the homeowner.
A deed in lieu of foreclosure merely means that the homeonwer is giving the property back to the bank without the bank having to go through the foreclosure process. A Deed in lieu of foreclosure is usually unavailable if there is a second mortgage on the property. If there is a second mortgage, the second mortgage holder will have to approve the transfer as well. (If the first mortgage and second mortgage are held by the same bank, it does not mean it will be approved.) A bank will not likely accept a deed in lieu unless the homeonwer has taken efforts for at least six months to market the property.
Many times the bank will forgive the deficiency indebtedness in the situation of a short sale or deed in lieu. But, it may be subject to the bank's review of the homeowner's financial records.
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You may have recently heard that the banks are temporarily halting their foreclosures. What does this mean and why are they doing it?
When banks like Countrywide went under, the mortgages and promissory notes were "mis-placed". The assets of Countrywide were sold to other banks. When they sold the assets, the mortgages were supposed to go with them. In the rush to get the assets transferred, especially the mortgages (after all, your payments had to go to someone) the banks got sloppy with the paperwork. What the banks got was your electronic information, but not the actual papers.
Then homeowners got in financial trouble and could not pay the debt. The banks stopped receiving payments so they had to foreclose. The problem is, to foreclose in Florida (and most other states), you actually must have the note and mortgage. In a rush to foreclose, the banks hurriedly stamped the notes or tried less honest approaches to foreclosing the property. Although attorneys challenged the ownership of the mortgages, it wasn't until the banks' law firms started getting into trouble that the banks decided to take a deep breathe and review the paperwork.
This leaves mortgages in a state of flux. The question is, who owns the note and mortgage? There are many attorneys out there making a living off homeowners during this process. Some might even be saying that you may never have to pay for your home. This falls under the "too good to be true" category. If you want to eventually give up your home, then stay in it, fight the good fight and stay as long as you can and leave at the end of the process.
I am afraid many homeowners will buy into the chance that they will own their house without having to pay for it. Then, one day, after not having paid the mortgage for two years, they will be shocked when their home is sold in a foreclosure sale.
There must be a lot of money to be made in debt negotiation. Just listen to all the advertising. Do you think they are out there for your benefit? They are trying to make money off you. It has gotten so bad that Attorney General's throughout the country are shutting the worst offenders down.
Here is my perception of how they work. First, your creditors will not negotiate with you when you are current with your payments. So, you must start missing payments. The reality is, you have to miss about six payments before you can get to someone with authority to settle the case. While you have missed six payments, late fees and interest accumulate. Thus, your debt becomes higher.
If you are using a debt negotiation company, they will likely charge you a monthly fee. At the same time you will start to put money away. After six months, when creditors are starting to talk to you, or the negotiator, a lump sum settlement amount will be negotiated. While it may seem like 50% of the amount owed, in reality it is probably closer to 75% or 80% of what it was 6 months earlier considering the new late fees and interest that has accumulated. And, you have ruined your credit.
A better approach may be to make minimum payments on certain debts each month while dedicating extra money to the lesser of your credit cards. Eventually, you will pay off that creditor. When that creditor is paid off, you move on to the next creditor until you are debt free.
Of course, this is much easier said than done, and takes a lot of discipline. But, the reward is worth the sacrifice.
It seems that many Americans are more concerned with their credit score than their net worth. I have many clients that have $50,000 or more in credit card bills that are more worried about how bankruptcy will affect their credit score than they are with getting rid of the debt. Each month they are paying $1,000.00 per month or more to pay off credit cards. They are killing themselves with worry and stress to pay this debt. They aren't working for retirement or a financial future but instead are working to pay debts.
As I have stated before, I think bankruptcy should be a last resort. There should be a plan to get out of debt before resorting to bankruptcy. But, if it is impossible to pay off the debt due to income limitations or illness, bankruptcy is a very good financial option. It is certainly better than being a slave to your debt.
How will bankruptcy affect your credit score? It will affect it between 100 and 200 points. Now, we've got that out of the way, what does it mean? Bankruptcy stays on your credit report for 7-10 years. However, once you obtain your discharge in bankruptcy, you can begin to rebuild your credit.
As you make each car payment and each mortgage payment, you are rebuilding your score. When looking at your credit score, examiners will see higher income and low debt levels (debt to income ratio) because you have just discharged your debt in bankruptcy.
While rebuilding your credit score will take time, rebuilding your life will be easier.
I always thought this was an obvious point, but after having many clients ask me, "what if I give the property to my (insert family member)", I think this issue should be addressed.
When one files bankruptcy, they have a duty to disclose their entire financial picture, including any transfers they have made over the past two years. The failure to knowingly list a transfer may result in the denial of the debtor's discharge, meaning that there was no reason to file bankruptcy. Or worse, the Debtor could be subject to criminal prosecution for bankruptcy fraud.
Sometimes a potential client may have an asset that is not subject to being exempt (that is, untouchable by the trustee). Sometimes it is a car. After going through the scenario of either losing the car in a chapter 7 or paying for the car in a chapter 13, I often get the question, "what if I transfer the car to my brother?" One is free to make the transfer, but the transfer must be disclosed in the bankruptcy.
If the transfer was done without consideration, that is, the person who the property was transferred to gave nothing in return, the bankruptcy trustee can recover the property. The bankruptcy laws give a lot of authority to the trustee. The trustee in a bankruptcy case has a duty to investigate a debtor's financial affairs. Within that investigation is the examination of any transfers from the debtor to anyone else. The Trustee can apply the law of the state and look back four years in Florida.
Even if the transfer was done with no intent to hide the asset and was given as a repayment of a debt, the Trustee could still seek recovery of the asset. Transfers to family members within one year of the filing of the bankruptcy, even if it is for the repayment of a debt, can be avoided by the Trustee as a "preference".
The rationale for these recoveries is to put all creditors on equal footing. The court does not distinguish American Express from Aunt Millie.
Maybe as a result of the market, or because of the bailout, there has been a lot of success with loan modifications. Some banks are more willing to work with you than others. You have to be patient with the results. In what seems like a good gesture on their part, the bank may initially allow you to miss a few payments if you come up with a significant down payment towards your past due amount. This will not be the best offer the bank can make. Nor will it likely be in your best interest to take what they offer.
There are various companies offering to assist with the modification. Some of these companies have good success. Others really do not do much for you. If you are going to try to do a loan modification, make sure you use a reputable company.
When seeking to modify, you will need to provide:
hardship letter tax returns for 2008 and 2007 a month of paystubs bank statements original loan closing statements list of income and expenses
Modification should be an option that you should examine thoroughly. It could lead to a good result for you.
With the depreciated real estate market, many of my clients wonder if they should continue to pay for a home they can barely afford. Of course, I can't make this business decision for you, but here are some alternatives for you to consider.
ALWAYS CONSULT AN ATTORNEY OR ACCOUNTANT BEFORE MAKING THESE TYPES OF DECISIONS.
1. Stay in the home if you can afford it. Take a hard look at the realities of the numbers. Can you find a new place to live for a lot cheaper? Or, will it be marginally cheaper. Sure, your house is worth less than you owe. But, if you can afford it, stay there. The market has to move up sometime, doesn't it?
2. Try a short sale. To do a short sale, your mortgage company has to agree to the sales price. This can be difficult, if not impossible, if there is a second mortgage. The second mortgage company has to agree to take a very low price, or even nothing at all. Sometimes the second mortgage company will agree to the short sale if the buyer agrees to sign a new promissory note to repay the debt. DON'T DO IT.
3. Deed in Lieu of Foreclosure. This means you give the bank the house instead of them foreclosing on the home. The reality is, banks don't want your home. They are in the business of money, not real estate. They would rather a short sale. Sometimes they will agree to this. But, this cannot be done if there is a second mortgage on the home.
[Note as to numbers 2 and 3: banks are sometimes requiring proof of hardship to accept either a short sale or a deed in lieu of foreclosure. If you are an investor, you may not be able to do either. It is easier to do if it is your primary residence]
4. File Chapter 13 Bankruptcy. Bankruptcy can be used as a tool to strip off a second mortgage. The second mortgage has to be completely unsecured. That is, if the property is worth $200,000, the first mortgage has to be more than $200,000 to "strip" the second mortgage.
Bankruptcy can also be used to catch up on your mortgage. Instead of coming up with a lump sum payment to catch up on payments, bankruptcy can be used to pay the arrearage over time.
5. Modification of mortgage. Banks are trying to make deals to redo the loans. I have yet to see a mortgage amount be reduced in principal. So, if you owe $275,000, you will continue to owe that amount, but the bank may offer a lower interest rate. At the end of the day, you still have to be able to afford the payment.
6. Just walk away from the home. Many people are choosing to walk away from their homes. The ramifications for this action are yet to be brought to light. Many attorneys wonder what will happen 5 years from now. Although the mortgage companies are not trying to collect on the notes for the homes, there is a fear that 4-5 years from now, the notes will be sold to debt buyers who will try to sue you later.
7. Obama to the rescue? The President Elect promises changes. But, will he be able to do it fast enough. One possible change expected to be proposed is allowing bankruptcy judges to value homes at their present values. Great news for me as a bankruptcy attorney, and great news for someone whose home value has plummeted. Under the hoped for legislation, a home owner who owns a home worth $175,000 but owes $300,000 could go to a bankruptcy court and have the judge rewrite the loan for $175,000. It's hard for me to get my head around the machinations of this, so I am doubtful whether it can work. But, we can hope.
As always, the above information should not be relied on to make a decision. Consult an attorney.