DEALING WITH A HOME THAT YOU CAN NO LONGER AFFORD

You bought a home, took out a mortgage loan, and looked forward to the seemingly guaranteed rise in the real estate values of the decade of the 2000’s.  Then came 2007, and the recession, the drop in the stock market, and the plummet of the real estate market.  Homes that were purchased in mid-decade, when the bubble was fully inflated, are now “under water”:  their value is less than the mortgage loans that were taken to buy them.  If you bought a home for $500,000 in 2005, and took a loan at 90% of the value, then you have a loan balance of about $450,000.  If that house now sells for $400,000, then at closing you are going to need to come up with $50,000 to sell the home.  The situation was compounded if you took out a home equity loan – and financed 100% of the value of your home.  And of course, if you or your spouse have lost your job, then your ability to even keep up with the payments may be compromised.  While we all may buy that Powerball ticket each week and hope that it is the answer to our financial distress, all of us but the one winner must ultimately deal with the situation on the ground:  what are the options for getting out of a home that you can no longer afford?  In Pennsylvania, here is the general lay of the land.

With a mortgage loan, a borrower typically signs a promissory note and mortgage.  (In some commercial transactions, the loan may be “non-recourse” against the borrower, but that is rarely the case with a residential loan.)  The borrower promises to pay on the note, and if not, the lender can sue on the note or foreclose on the mortgage.  Generally they choose foreclosure – because the property has a certain value; and the borrower who is not paying on the note generally is not doing so because they cannot do so.  If the lender takes the property through foreclosure and sells it for less than the amount of the loan, then in theory they are entitled to seek the deficiency from the borrower.  They have to file that action within six months after the foreclosure sale.  If they don’t then they are barred.  The decision to do so is a business decision, and depends on whether they think the borrower can pay.  No use spending the money on seeking the deficiency, if they are unlikely to recover anything more.

Sale:  To avoid foreclosure, the borrower can first try to sell the property.  If there is equity in the property, that is if the sales price is more than the combined mortgages and transaction costs, then upon sale, the mortgage is paid, and the borrower gets the equity.  That’s the best case. 

Short Sale:  In our current market, many properties are worth less than the amount of the mortgage – they are “under water”.  In these cases, the borrower may want to negotiate a “short sale” with the lender.  A short sale is a sale for less than the amount of the mortgage balance, with the lender agreeing to accept less than the full amount of the outstanding loan balance.  The borrower markets the property, finds someone who makes an offer, and then takes that offer to the lender and negotiates with them to see if they will accept some lesser amount.  Each lender has its internal guidelines; they are dealing with these issues every day and know the market is soft.  So, lenders typically are willing to negotiate a short sale arrangement with a borrower who does not have the financial means to pay the shortfall.  Check with your lender to learn about what they are offering before starting the process.

Debt Forgiveness Can Be Taxable:  When a person is released from debt that they owe, that is generally treated as income to the debtor.  If someone tells you don’t have to pay the $50,000 you owe them, the IRS considers that you have received $50,000, and so you pay income tax on it.  In a short sale, you are being forgiven debt.  You might have to pay income tax on that amount.,  However, when the current mortgage crisis began, Congress passed the “Mortgage Forgiveness Debt Relief Act of 2007”, which essentially provides that if the debt forgiveness relates to acquisition costs for your home mortgage, then during the time this temporary law remains in effect (currently through 2012), the debt forgiveness will not be treated as income (with certain limits and conditions).  When considering a short sale, take this into account.

                                                                                          

Deed in Lieu of Foreclosure:  If the borrower cannot find a willing buyer for the property, then the next step may be to try to negotiate a deed in lieu of foreclosure with the lender.  The borrower is essentially telling the lender “I won’t fight you on the foreclosure; in fact, I’ll just give you the deed to the place.”  The lender saves the costs of foreclosure, but steps into your shoes as owner and takes the property subject to whatever other liens are on the property.  If the lender goes through foreclosure, then they are in the front of the line for lien priority – they typically have the “first lien” ahead of everyone else except federal and state taxing authorities, and a six month homeowners association lien (where applicable), and so for them, it may make more sense to simply go through with the foreclosure, and strip the other junior liens off the property.    To the extent there are not lots of other liens on the property (determined by a title search), then the lender may be interested in negotiating a deed in lieu of foreclosure.  In some cases, they may also allow you to remain in the property under a lease.  However, the lender is not in the business of owning property; they turn around and re-sell it.  If they re-sell for less than the loan balance, then there is a deficiency that is the borrower’s obligation.  Unless the borrower has been able to get the lender to agree to forgive any or all of the deficiency, then borrower is still obligated to pay the deficiency.  So, the deed in lieu transaction, without debt forgiveness, does not do a great deal for the buyer, other than to stop the ongoing default and piling on of interest, late charges, and attorneys fees. 

Loan Modification:  A lender may also consider a loan modification to make it easier for a borrower to pay the loan.  You need to ask the lender whether they would entertain a loan modification, and explore what they are offering.  There are also federal programs in place to encourage this.  Check out the “Making Home Affordable” program at http://www.makinghomeaffordable.gov/.  This government site explains various options, including modifications, refinance, and relocation assistance.  They also encourage short sales and deed in lieu transactions through the Home Affordable Foreclosure Alternatives (HAFA) Program.  
Not every option works for everyone, but you just need one that works for you. 

Fight the Foreclosure:  If a loan is in default, and the lender has begun foreclosure, then a borrower may choose to fight the foreclosure.  Since the main issue is “are you paying the mortgage loan”, and the answer is almost always “no”, the borrower is usually going to lose the legal battle relatively quickly.  However, there are times when a loan has been sold several times, and the paperwork has been lost or improperly done, and a savvy lawyer may be able to construct an argument on why the foreclosure may be ineffective.  In the rare instance, that can stop the foreclosure process.  However, typically the obligation under the note is intact, and so the lender can sue under the note as well. So, this is largely a delaying action, and only postpones the day of reckoning.  And, you must pay a lawyer to do this for you.  At the end of the process, the bank owns the home; when they sell the home, if they collect less than what is owed (loan balance plus transaction costs), then the lender may seek a deficiency judgment against the borrower.  In Pennsylvania the lender has six months following the sale to seek that remedy; otherwise it is barred.  The decision to do so is simply a business decision – do you have money, and is it worth the additional time and effort of the lender to try to collect it from you? 

Bankruptcy:  The borrower’s last line of defense is to file for bankruptcy.  The lender with a valid first mortgage on the property is not going to go away in bankruptcy.  They are a “secured creditor”, and so while bankruptcy can help a borrower by giving them time, and by discharging the unsecured creditors for pennies on the dollar, it still does not shake off the secured first mortgage lien.  A chapter 7 bankruptcy is a “liquidation”:  your assets are identified, and used to pay off your debts, until the money runs out, and the unsecured balances are discharged.  Secured creditors are protected and after some initial delay are permitted to complete their foreclosure.  A chapter 13 bankruptcy allows you to pay back your debts in a proposed payment plan over 3-5 years.  While it does not reduce your first mortgage loan, it can help your situation by stripping out a home equity loan balance, it can reduce or eliminate debt owed to unsecured creditors, and can give you time to pay your arrears on the first mortgage.  So, a Chapter 7 bankruptcy is a delaying action (measured typically in months, not years), but it may also bring the lender to the negotiating table for one of the other remedies – a modification, short sale, or deed in lieu.  A chapter 13 bankruptcy gives a borrower more options, depending on their income and their debts, and so can be useful for the borrower who is up to their waist in debt, but not up to their ears or over their head. 

Your Credit Rating:  In each of these cases, the borrower may also be concerned about their credit rating.  When the borrower fails to make payments on a loan, those failures are reported to credit rating agencies, and start impairing the person’s credit.  A bankruptcy does this as well.  If the borrower is still paying the loan on time while they are negotiating, then they are not impacting their credit.  However, for some remedies, the lenders will not negotiate with a borrower unless they are in default.  So a borrower has to go in to default simply to open the door to the future negotiations.  If that negotiation is successful, then the failure to pay continues only for a short period, and the borrower can always submit a note of explanation to the credit ratings agencies that explains the cause of the default.  That does not necessarily remove the “stain” of the default, but may help to bleach it a bit.

State Specific Programs:  Each state is developing its own programs to try to help citizens dealing with these problems.  Here are five ways that Pennsylvania is trying to help (as reported at eHow - see link at bottom) :

1. Contact the Pennsylvania Housing Finance Agency’s (PHFA) Foreclosure Mitigation Counseling Initiative. The Foreclosure Mitigation Counseling Initiative was established to provide homeowners free financial counseling to find a long-term solution to preventing the house from going into foreclosure. They will analyze the homeowner’s financial situation, as well as the current value of the property in question.

2. Look into the Homeowners’ Emergency Mortgage Assistance Program’s (HEMAP) non-continuing mortgage assistance loan. This loan is provided by the state and is ideal for homeowners who are able to make their current payments, but can not catch up on back payments still owed. The loan would have to be repaid with a minimum payment from $25 per month up to 40% of the homeowner’s gross income.

3. Apply for a HEMAP continuing loan. A continuing loan is for homeowners who have a back owed amount, and are unable to make their current payments at the present time. This is a loan, which must be repaid. It is limited to a maximum of 24 months and $60,000.

4. Refinance to an Affordable Loan Program (REAL).

[The REAL and HERO programs concluded on December 31, 2010. Applications are no longer being accepted.]

5. Homeowner’s Equity Recovery Opportunity Loan Program (HERO).

[The REAL and HERO programs concluded on December 31, 2010. Applications are no longer being accepted.]

Read more at eHow:  How to Stop Foreclosure in Pennsylvania 

For a wealth of other information on programs in Pennsylvania, go to the Pennsylvania Housing Finance Agency website. 

CONCLUSION

Sorry!  There are no easy answers.  But there are a variety of programs, and a variety of remedies available.  You need to educate yourself on what ones may work best for you.  Assess your situation, and then contact your lender, or a government assistance agency, to begin the process of finding out what’s right for you.  You are likely to be dealing with large and inefficient bureaucracies.  Remember that the people on the other end of that phone are dealing with hundreds of people with the same financial problems as you every day.  Don’t treat them rudely and try to terrorize them into responding to you.  They have piles and piles of documents just like yours, and they can decide which ones to process and one ones go to the bottom of the pile.  But, don’t be afraid to ask for names, and keep notes of every phone call.  Write follow up notes confirming important conversations.  When you personalize the contact, you create a relationship with a person, but you also hold them accountable for what they tell you.  It is more effective in future negotiations to be able to tell them exactly who you talked to, on what day, at what time, and what they said, then to simply complain that “somebody told me it was okay”.  Stay organized.  Large bureaucracies have lots of places for your file to hide.  Scan documents so that if you are asked to re-send them, you already have them scanned and in a legible form, and you reduce the frustration of jumping through the same hoops over and over again.  That is likely to be part of the process.  Don’t rage against it.  Bend with it and bounce back.  Give them exactly what they want and make their job easier rather than harder. 

You are in a hole.  You need to dig your own way out, and you need to do so one shovelful at a time.  Keep focused on the goal.   Control what you can control.  Let go of what you cannot control.  Buy the weekly lottery ticket, but until that hits, you need to do what you need to do to dig your way out.

Doug Humes has been a practicing attorney in Pennsylvania since 1980.  He has experience in real estate, community, corporate and small business law, and estate planning.  In 2003, he opened his private general practice at the Millridge Manor House in Bryn Mawr, Pennsylvania.  You can contact him at Tel: 610-525-7150, or via email at humeslaw@verizon.net.

The Estate Tax is Back!

Beginning in 1916, the federal government began taxing the estates of those who died each year.  Without more, people could on their deathbed give away their entire estate by gift, thus evading the estate tax.  So, the next move was to tax gifts made during life – this was added to the tax structure in the 1930’s.  At the higher estate levels subject to these taxes, the next planning device was to make gifts that skipped a generation or two.  Gifts of accumulated wealth to a grandchild or great-grandchild moved the wealth past one or two generations without taxation.  So that hole in the system was plugged with the generation skipping transfer tax – which then taxed those transfers which otherwise would have skipped a generation or two of estate taxes.  By 2001, the three-legged system applied to estates over $1 million, and applied a highest tax rate of 55% to those estates. 

In 2001 Congress enacted changes to the estate tax:  they gradually raised the exemption amount from $1 million to $3.5 million, and lowered the highest tax rate to 45%.  In 2010, the estate tax (but not the gift tax) was eliminated entirely.  In 2011, the system that was in place in 2001 was scheduled to return unless Congress acted.  In the last days of the lame duck Congress, they finally acted, and so the estate tax is back.  For estates of those dying in 2011 and beyond, if you have an estate of over $5 million, then you will pay estate tax that reaches a top rate of 35%.  Below that amount, there is no federal estate tax due.  (But remember that you are not home free in that circumstance, as many states still have an estate or inheritance tax in place.)  

In 2001, the total federal estate tax returns filed were 108,071, of which 51,736 were taxable.  In 2009, the total returns filed were 33,515, of which 14,713 were taxable.  According to the New York Times, “less than one-half of 1 percent of people who die in 2011 will be hit by the estate tax.”  Clearly, fewer estates are being taxed because of the higher exemption rates.  However, the change is not yet permanent:  Congress has kicked the can two years down the road.  In 2013, the 2001 rates and levels will arise from the dead, unless Congress acts again.  Will they act in 2012?  That’s a presidential election year, and so it is more likely that they will not act, and we will again be playing chicken with the estate tax after the 2012 election.  But, we have some certainty for the next two years, and those to whom the revised estate tax law may apply can now plan accordingly.  For the rest of us, the estate tax is a non-issue for the next two years.  But keep your eye on that can!

©2011  Douglas P. Humes

Doug Humes has been a practicing attorney in Pennsylvania since 1980.  He has experience in real estate, community, corporate and small business law, and estate planning.  In 2003, he opened his private general practice in an old mansion in Bryn Mawr, Pennsylvania.  Contact him at Tel: 610-525-7150, or via email at humeslaw@verizon.net.