A DECENT EXPLANATION OF:
LOAN MODIFICATION, SHORT SALE and FORECLOSURE
WHY SOMETIMES IT MAY BE BETTER TO WALK AWAY FROM THE HOUSE
OR NOT!
There is another alternative>>> Click here to become DEBT FREE FAST!
Values on homes have fallen 35 to 40 percent from their 2006 peak and unemployment in California is at 12.2 percent. Nationwide, 32 percent of mortgage holders owe more than their houses are worth, according to estimates from data firm First American CoreLogic. About 14 percent of mortgages are behind on payments, says the Mortgage Bankers Association.
Broadly speaking, there are three options: loan modification, Short Sales and foreclosures. The pressure these days is toward Short Sales, because they offer an upside for buyers, lenders and real estate agents. The one person left out in the cold? The beleaguered home owner.
Here is a guide through the thicket:
I’m struggling to make mortgage payments. Maybe I should just stop paying and see what happens?
You could do that, but it will wreak havoc on your credit score. That score is crucial to future lenders who will decide at some later point just how good a risk you are. Increasingly, it’s also being used by potential landlords and employers. It’s not a figure to be taken lightly.
The score itself is calculated through arcane and patented formulas using data collected from your complete credit history. A spokesman for Fair Issac Corp., which maintains the FICO scoring system, says its purpose is to predict how likely the borrower is to make payments for the first two years of a loan.
Another company called VantageScore has its own formula that does pretty much the same thing. On their scale, which runs from 500 to 990, stopping payments on all your loans will drop you into the low 600s.
Credit scores in the 601 to 700 range are considered sub-prime, and you still haven’t solved the problem of how to make mortgage payments.
Option 1: Loan modifications, or I need a little help from the banks
This seems to be everyone’s favorite homeowner-in-distress option. Under pressure from the federal government, lenders are offering to reduce monthly payments by lowering the interest rate, extending the loan term, or both.
Typically, lenders will offer a three-month trial period with lower payments. If borrowers make all their payments on time, then the lenders will make the arrangement permanent. If the loan modification works, the borrowers get to stay in their house, they keep paying off their debts, and everyone’s happy.
This is why spokespeople for lenders GMAC Financial Services, JPMorgan Chase & Co. and Wells Fargo & Co. all say they prefer a successful loan modification over all the other options.
Loan modifications will have a minimal effect on your credit score. Depending on the nature of the modification, it can actually improve the score a couple of points, or cause a 10- to 20-point drop.
However, lenders do not typically lower the principal of the loan, which means monthly payments remain out of reach for many homeowners. Nationally, half of all homeowners with modified loans still end up in default, according to the Office of the Comptroller of the Currency and the Office of Thrift Supervision.
Option 2: Foreclosure or I still can’t make these payments.
Most people know what a foreclosure is: You stop making payments and eventually the bank takes your house. They are well understood by real estate professionals and lenders, so everyone knows what to do and how.
There are laws written to protect people who are foreclosed on. If the mortgage was directly used to buy the house, even if it was a subprime loan used to cover the down payment, then the foreclosure will cancel the debt, never to return, attorneys say. Note that foreclosure may not clear the debt if you refinanced, as many people did.
On the down side, your future credit report will have “foreclosure” written on it in ugly letters for seven years. Your credit score would lose 130 or so points from the foreclosure, and that comes after a 200 to 300 point drop from becoming delinquent on the loan.
On the plus side, if you get back on your feet and get up to date on loans, then your credit score could start to rebound as quickly as nine months after they take your house, credit scoring firms say. And in three years, at least, you again become eligible for a loan backed by the Federal Housing Administration.
Option 3: Short Sale or I feel kind of bad walking away.
It’s true, you did sign a contract agreeing to repay those loans, and there’s some social stigma on a foreclosure. So, maybe you can sell the house and persuade the bank to take what it can get. If the amount is less than the loan is worth, that’s called a Short Sale.
Usually, the borrower sends a letter to the lender saying they are suffering hardship because of divorce, medical problems, job loss, or something similar, and they offer to go through the whole house selling process of finding a real estate agent, cleaning the place up, enduring prospective home buyers, and so forth. The lender has to agree to accept the selling price.
Complicating matters, there are often multiple lenders with a claim to the property. The signature of the Roaring Aughts real estate boom was cheap money. Many people took out second loans against the house to make home improvements, buy cars or to fund other aspects of their lives.
In a Short Sale, the first lender has first claim to the money. If the sale is enough to pay them off, the second lender gets the rest, but that’s rare. More commonly, the sale won’t cover the mortgage and the first lender persuades the second lender to sign off by offering a token payment of $1,000 to $5,000. But second lenders can and have held up Short Sales with demands for more money.
Well, at least Short Sale clears me of debts without defaulting, right?
Think again: Short Sales don’t necessarily let you off the hook. Be sure to read the fine print on the bank’s Short Sale agreement. Better yet, see a lawyer.
Recall that a foreclosure means that purchase money loans will be canceled. BUT in a Short Sale, it’s an open question whether the lender gives up its right to the underlying debt on a purchase loan. The agreement you as the seller sign with the lender will usually have a clause stating the lender still has the right to go after you for the difference between the Short Sale price and what you owed the lender on the property at the time of the Short Sale.
And when a home is refinanced, or the second loan has some other purpose, then the loan becomes something called a “recourse loan” meaning the lender can try to get the money back for up to four years after the property has been disposed. We have at least one case where the second trust deed lender on a refinance sued the borrower after the foreclosure.
Short sellers in this predicament can sometimes arrange to get the underlying debt cancelled, depending on the lender in question.
Bank of America (and its Countrywide unit) has a policy against ever giving up the right to this debt, a spokesman said. Chase and Wells Fargo will sometimes negotiate away their rights to the debt. And the standard contract for Wells Fargo subsidiary Wachovia specifically releases the seller from debt. Point to remember. Read the contract before you sign it. If the lender has the right to sued you for the remainder of the debt, you may be better off with the foreclosure.
But the point is that Short Sale does not necessarily provide all the protections that come with a foreclosure. Just when you think you’ve righted the financial ship, they may come after you.
And then I heard something about tax implications?
Chris Sorensen, who runs a real estate education nonprofit organization in Riverside County called USA Homeowners Educational Learning Program, said that without the right paperwork, a Short Sale can be represented as income. He said there’s an IRS form the lender needs to fill out before the deal is closed. Without it, the difference between the remaining debt and the sale price will be reported as income for the borrower.
Still, when I go for another loan some day, the bank will be happier to see that I did a Short Sale instead of letting a foreclosure happen, right?
Not really. Before giving out a loan, a lender checks your credit score. Watts from FICO says the company’s formula sees no difference between a Short Sale and a foreclosure. VantageScore’s formula does draw a distinction, but it’s very slight: a Short Sale only offers 5 to 10 points less of a ding than a foreclosure, and in many circumstances there is no difference at all.
Your credit report will also show “settled debt” instead of “foreclosure.” But “settled debt” is merely banker-speak for a debt that was closed without being fully paid.
Lenders do look at more than just credit scores in the application, but Short Sales and foreclosures will be part of your overall financial history. Chase said it makes no distinction between potential borrowers with a Short Sale or a foreclosure on their records. A spokeswoman from GMAC said that if the short seller avoided having any late payments, then that will help them, but a Short Sale with delinquent payments is no better than a foreclosure.
The government views Short Sales slightly more favorably. A short seller can get an FHA-backed loan in just two years, instead of three.
So, in a Short Sale I’m still on the hook for my debt, my credit score gets killed, and I might get a huge tax hit? Why am I not just abandoning ship?
Certainly everyone else wants you to short sell: The buyer is hoping for a good deal on a house, the lender gets rid of the property faster and more cheaply than it would through foreclosure, and the various real estate professionals get to collect a fee or a commission. Plus there’s the societal pressure against walking away from an obligation, which, truth be told, you agreed to.
But Brent White, an economist at the University of Arizona, argues that STAYING IN AN OVERVALUED HOUSE IS FUNDAMENTALLY IRRATIONAL. He writes in a paper titled “Underwater and Not Walking Away” that lenders exploit fears of a bad credit score and cultural mores against foreclosure to keep people in houses. “This imbalance is exaggerated by the credit reporting system, which gives lenders the power to threaten borrowers’ human worth and social status by damaging their credit scores — scores that serve as much as grades for moral character as they do for creditworthiness,” he writes.
Many homeowners in trouble may be better off taking the plunge into foreclosure.
From No. County Times 11-23-09. Eric Wolff
OR NOT!
There is another alternative>>> Click here to become DEBT FREE FAST!
