Monday, November 1, 2010

Walking away from your mortgage – Risk or reward?

An idea has been making the rounds. That underwater borrowers – owners whose homes are worth less than what’s owed on their mortgages – should stop making payments and let their lenders foreclose.

The thinking is this: because house prices in some markets have declined so steeply it will take years for property to be worth what it was before the economic meltdown, many owners – even those not financially strapped – don’t see the point of continuing to fork out monthly payments, especially if they don’t intend to stay in the house long-term.

But does this so-called ‘strategic default’ really make sense?

On the plus side, the strategy of getting out from under heavy debt and not throwing good money after bad amounts to pulling the plug on a lose-lose situation. Given the months on end it takes lenders to foreclose and repossess property, owners can stay in their houses rent-free while padding their bank accounts with money otherwise thrown down the rat-hole.

Sounds good on the surface. Trouble is, strategic default has serious consequences.


Depending on the state, the defaulting owner may have to pay the deficiency – the difference between the amount owed and the price brought at the foreclosure sale. So, if you have to pay the balance anyway, what’s the point in walking away? Sure, the deficiency might be discharged in bankruptcy, but not everyone is that far in the hole. Bankruptcy, remember, is only for the insolvent – those who owe more than they own.

Keep in mind too that state foreclosure laws vary, especially about whether lenders can go after borrowers for deficiencies. So, persons contemplating a strategic default need to know what their state allows.

Painting with a broad brush, most states east of the Mississippi (Indiana among them) allow lenders to collect deficiencies, while many western states do not. It comes down to state law and the papers signed at closing (mortgages in the east, deeds of trust in the west).

To foreclose mortgages, lenders have to go to court. When that happens, borrowers usually have the right to redeem (buy the property back) and lenders can go after the deficiency. Deeds of trust, on the other hand, allow lenders to take property back without going to court, the trade-off being borrowers can’t redeem but don’t have to pay the shortfall. Then again, some states’ procedures are a hodge-podge of both methods.

To find out what each state requires, check out

Credit scores

Anytime a debt isn’t paid on time or in full, a borrower’s credit score will suffer. So whether a borrower is selling short (the lender agrees to take less than owed), or losing the house in foreclosure, or filing bankruptcy, the borrower’s credit score will drop.

Some strategic defaulters rationalize a credit score hit because they don’t plan to buy another house. They’re over home ownership and perfectly happy to be renters. But credit scores can keep rearing their heads. Landlords run credit checks. So do car dealers. And interest rates on credit cards may be higher as credit scores plummet.


Thanks to the Mortgage Forgiveness Debt Relief Act of 2007, the deficiency forgiven by the lender is not taxable as income to the borrower who has defaulted and is being let off the hook. (The IRS considers debt forgiveness the same as receiving cash, and therefore taxable.) This law provides welcome relief but is temporary, applying to forgiven debt only in years 2007 through 2012. And, it’s limited to debt on owner-occupied principal residences, provided the debt was incurred to buy the house, build it, or remodel it (or to refinance that debt). In other words, debt pertaining to a refinance to take out cash to, say, buy a car isn’t covered. For more on the MFDRA, see my September 27, 2010, blog, which covers IRS Form 1099-C (‘C’ stands for cancellation) that lenders will send forgiven borrowers and IRS Form 982 that borrowers must file with their federal return (even if the cancelled ‘income’ is excluded).

Remember too, the MFDRA is a federal law applying to federal income tax. State income tax laws aren’t affected by it. So, unless a state has enacted a similar law, state income tax on the forgiven debt may still apply.

- Morrie Erickson

Monday, October 11, 2010

Banking – How safe is your money?

Suppose you sold your house in October, 2010, and netted $300,000 after expenses. Because you won’t be closing on your purchase for a few weeks, you deposit your net proceeds in a savings account at your bank so it can earn interest in the meantime.

Should you be worried whether your $300,000 is protected if your bank fails before your second closing? Yes, you should.

In response to the economic meltdown in the fall of 2008, the FDIC came up with a temporary liquidity guarantee program (TLGP) which increased the insurance coverage on bank accounts generally (including interest-bearing accounts) from $100,000 to $250,000 through December 31, 2009. But the TLGP also provided unlimited coverage for non-interest-bearing accounts (so-called transaction accounts) under the Transaction Account Guarantee Program (TAGP). Within certain time frames in 2008 and later, banks could opt out of the unlimited coverage under TAGP, which some banks elected to do because of the fees charged to them by the FDIC for this extra coverage.

In 2009, the $250,000 limit was extended through December 31, 2013. However, the unlimited protection under TAGP was extended only through December 31, 2010, with banks being given another chance to opt out after the first half of 2010. Because the banking sector seemed to be more stable by mid-2010, many banks opted out of TAGP this past July.

Now, back to your $300,000. Is it or is it not protected? After your first closing, only $250,000 of your $300,000 deposit was covered because it was in a savings account that earned interest. The remaining $50,000 in your savings account is not insured, even if your bank didn’t opt out of TAGP (because TAGP doesn’t cover interest-bearing accounts). To be fully protected, you should move the extra $50,000 in your savings account into a regular checking account and make sure your bank is still participating in TAGP. If it isn’t, consider switching banks.

But, let’s fast-forward to January 1, 2011.

Thanks to the Dodd-Frank Wall Street Reform and Consumer Protection Act signed into law on July 21, 2010, banks must participate in TAGP as of January 1, 2011. No longer will banks be allowed to opt out. However, under Dodd-Frank, TAGP will have a limited life of two years, expiring at the end of 2012 – unless Congress extends it in the future.

What this means is during the uncertain economic times we’re in, depositors will need to balance earning interest against protecting principal. Because interest rates are so low, most may prefer the TAGP safety net. Ultimately, decisions will be made in part based on the strength of individual depositors’ banks. A useful tool in finding out your bank’s strength is

By the way, in addition to making TAGP mandatory, Dodd-Frank made permanent the $250,000 FDIC limit for bank accounts generally, including interest-bearing accounts.

- Morrie Erickson

Monday, September 27, 2010

Short Sales – Taxes & IRS Form 1099

These days, short sales – selling for less than is owed with the mortgage holder forgiving the balance – are as common as college students sporting tattoos. In a depressed housing market, sellers getting off the hook on their mortgage loans might seem like a slice of heaven. But is not having to pay every penny owed really as good as it sounds?

Suppose Carol bought a house a few years ago for $300,000, putting $15,000 down and signing a promissory note and mortgage for $285,000. Today, she needs to sell but can’t find a buyer willing to pay more than $250,000. To make matters worse, Carol still owes $275,000. But because Carol lost her job and is financially strapped, her lender is willing to take $230,000 (sale price minus sale expenses) to release its mortgage. Carol is bummed about her sale price but ecstatic at getting the house off her back.

But are Carol’s financial woes really over?

To figure that out, we have to know what really happened between Carol and her lender. In most cases, there are three possibilities: (1) The lender might expect Carol to pay the $45,000 shortfall later, having agreed to release its mortgage but not cancel Carol’s note. (2) The lender might have required Carol to sign a new note for $45,000 in exchange for releasing its mortgage. (3) The lender might have cancelled the $45,000 balance, taking the you-can’t-get-blood-out-of-a-turnip approach.

If the answer is (1) or (2), the good news is Carol doesn’t have a tax consequence; the bad news is she still owes $45,000. If the answer is (3), the good news is she doesn’t owe the $45,000; the bad news is her lender will send her a 1099-C showing debt cancellation to the tune of $45,000, meaning Carol may have to pay taxes on it at ordinary income tax rates.

You ask, “What do you mean ‘may have to pay taxes on it’?”

Here’s the scoop. When real estate is sold, the seller may incur tax consequences. In Carol’s case, she will receive a 1099-S showing the sale price of $250,000 but she won’t owe a capital gain tax because she’s selling for less than her tax basis (in this case, that’s the amount she bought it for). But she may owe income tax if her lender has cancelled the $45,000 shortfall (resulting in the 1099-C). Why? Because to the IRS, debt forgiveness is the same as income, which means the $45,000 forgiven will be treated as if Carol was handed $45,000 in cash – unless Carol qualifies for exclusions recognized by the IRS.

In the residential real estate world, special exclusions apply to owner-occupied principal residences. Best known is the capital gain exclusion, allowing sellers to enjoy a gain of up to $500,000 for married couples filing jointly ($250,000 for individuals) upon sale of their houses. But there’s another helping hand, thanks to the Mortgage Debt Relief Act of 2007. The 2007 law provides that debt forgiven or cancelled in calendar years 2007 through 2012 is excluded from income realized as a result of mortgage modification, foreclosure, or short sale. In other words if you can’t pay off your mortgaged home and your lender cancels some or all of your debt, you don’t have to pay income tax on the amount cancelled.

Back to Carol. If Carol’s house was her principal residence (and she didn’t move out more than 90 days before the debt was cancelled), she won’t have to treat the $45,000 as income. Otherwise she will, unless she can show she was insolvent (total debts greater than total assets) at the time of cancellation or if Carol’s debts are discharged in a Chapter 7 bankruptcy proceeding.

Tread carefully though, because not all cancelled debt is subject to the exclusion – even on a principal residence. For example, the debt forgiven must have been used to buy, build, or substantially improve the principal residence, or to refinance debt for those purposes. So, if the seller refinanced the house and took out cash – say, to buy a car – the cash portion would not qualify for the exclusion. But if the exclusion does apply, up to $2-million may be forgiven tax-free (married, filing jointly; $1-million if filing separately).

By the way, the onus to give the 1099-C is on all lenders forgiving debt of $600 or more. And sellers must report the amount forgiven on their tax returns using Form 982 (even if the income is excluded).

What if real estate doesn’t qualify for the principal residence exclusion? In most cases, short sellers will be taxed on the amount forgiven – unless they fall into the insolvency or bankruptcy categories or their promissory notes are non-recourse (loans in which the lender can only take the property back). In these cases, the seller will receive a 1099-S in the amount of the forgiven debt, based on the premise that the forgiven debt amounts to the sale price. For deeds in lieu of foreclosure, the seller should expect to receive either a 1099-C or a 1099-A (Acquisition or Abandonment of Secured Property).

In some states, mortgages taken out to buy principal residences are non-recourse by statute (California, for example), but Indiana isn’t one of them. Even in those states though, non-recourse loans can become recourse in cash-out refinances.

As always, sellers should consult their tax advisors for information specific to their circumstances.

- Morrie Erickson

Sunday, August 8, 2010

Indiana’s First Lien Mortgage Lending Act – Death to seller financing

Recently, many real estate lawyers have stopped preparing purchase money mortgages and land contracts for buyers and sellers of 1- to 4-family dwellings (unless the seller has lived in it) or land on which 1- to 4-family dwellings may be built. In other words, seller-financing transactions on non-owner-occupied property have slowed to a trickle.

This radical change is partly because of the SAFE Act, which took effect on July 1, 2010 (see my blog of three weeks ago). As a reminder, “SAFE” is an acronym for the Secure and Fair Enforcement for Mortgage Licensing Act of 2008. But seller-financing has also been shut down by Indiana’s First Lien Mortgage Lending Act (IC 24-4.4-1), which dates back to January 1, 2009. Not heard of FLMLA? You’re not alone.

Double coverage

Both SAFE and FLMLA cover the same ground using practically the same wording. When Congress passed the Housing and Economic Recovery Act of 2008 (HERA) which President Bush signed into law on July 30, 2008, HUD was tasked with assisting in revitalizing of the US housing market, preventing foreclosure, and enhancing consumer protection. Title V of HERA is the SAFE Act. The SAFE Act, or something similar, must be enacted in every state. In states failing to act, HUD's model act will control. In any event, Indiana passed its version of the SAFE Act, which took effect July 1.

Interestingly, Indiana already had a law – the FLMLA – which had been in effect for 18 months and which covers the same subject. Nonetheless, two separate provisions now apply, the SAFE Act being a regulation and FLMLA being a statute. The difference is Indiana’s Department of Financial Institutions (IDFI), which enforces SAFE, can change the regulation fairly easily, while the legislature must change the statute. So, tweaking the two provisions to eliminate unintended consequences (did the legislature really mean to prohibit casual investors from using seller-financing on their own property?) may be straightforward on the one hand but rather difficult on the other.

Land contracts vs. mortgages

What’s clear is that both the SAFE Act and FLMLA don’t allow sellers of dwellings to deed their property to buyers and take a mortgage back (unless they’re licensed as a mortgage loan originator or have lived in the dwelling). But some lawyers believe the SAFE Act doesn’t apply if the sale is by land contract instead. Before you think you’ve found a loophole, though, be sure to take a close look at FLMLA, because it clearly outlaws land contracts as well.

While there are exclusions from both the SAFE Act and FLMLA (such as selling your own house and selling, say, a commercial building or a 5- or more-unit residential building), some exclusions are ambiguous enough to discourage lawyers from taking a chance on being considered a mortgage loan originator. The definition is so broad, almost anyone involved in a seller-financing transaction runs the risk of being considered a mortgage loan originator.

There is a way out, but not a very good one. Lawyers could continue drafting mortgages and land contracts on non-excluded transactions by becoming licensed mortgage loan originators. But I think it’s safe to say (no pun intended) most lawyers (including this one) won’t be doing that.

- Morrie Erickson

Wednesday, July 21, 2010

The SAFE Act – Are the days of seller-financing over?

I got a phone call the first week of July that went something like this:

“I’ve sold my duplex near campus and want you to write up a contract,” the caller told me.

“What kind of contract?” I asked, wondering if the caller meant an offer to purchase.

“You know, a contract where the buyer pays me monthly installments then balloons in five years. My buyer has good income but his credit isn’t great, so he can’t get a loan at a bank.”

“Have you ever lived in the duplex?”

The caller laughed before saying, “No, it’s a student rental.”

“Are you a licensed mortgage loan originator?” I went on.

Another laugh. “Of course not. I manage a pizza place and own student rentals on the side.”

“In that case, you can’t sell on contract,” I told him, “or deed the duplex over and take a mortgage back.”

“That’s crazy. I must’ve bought or sold on contract 10 times.”

“Can’t do it anymore. Not since July 1st.” Then I told him about Indiana’s new SAFE Act.

Bad loans, the Feds & HUD

The Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (the SAFE Act) is federal legislation growing out of the recent mortgage loan crisis and is a response to the perception that a lack of oversight of mortgage loan originators (not necessarily actual lenders) contributed to the problem.

The Federal SAFE Act requires all states to come up with their own legislation to govern and control mortgage loan originators (MLOs) or to allow HUD’s version of the legislation to control. Each state’s legislation must be compliant with the Federal SAFE Act, and HUD is responsible for ensuring compliance.

Indiana’s version of the SAFE legislation is contained in Article 9 of the Indiana Administrative Code (750 IAC 9). This means Indiana’s legislation is a “rule” not a “statute”. The rule has been promulgated by the Indiana Department of Financial Institutions (DFI) and requires MLO licensure by July 1, 2010.

What does 750 IAC 9 say?

To get a grip on the new limitations on contract sales and seller-created purchase money mortgages, real estate practitioners should read the rule. Build in some time though, because it’s 20 pages long. The rule is too comprehensive to analyze here in detail, but the main point is that selling on contract or by taking back a mortgage on a 1- to 4-family dwelling is all but prohibited – unless the seller is a licensed MLO.

Whether this is an unintended consequence is hard to say, but given the wording of the rule, it’s unlikely. This is because, in the words of the DFI’s FAQs, “An MLO is an individual who, for compensation or gain, engages in taking a mortgage transaction application or offering or negotiating terms of a mortgage transaction.” Pretty broad, right?

And there’s more. The FAQs go on to say that a “Mortgage Transaction means a credit transaction (loan or credit sale) that is or will be used by the debtor primarily for personal, family, or household purposes and is secured by a mortgage, land contract, or other equivalent consensual security interest on a dwelling or residential real estate. A mortgage transaction includes a credit transaction secured by a mobile home, and a home improvement credit transaction secured by a mortgage or equivalent security interest on the home.”

The actual rule goes further, stating that a “mortgage transaction” includes a security interest “…on a dwelling or residential real estate upon which is constructed or intended to be constructed a dwelling.” (I added the italics.) So, does that mean a person can’t sell a vacant lot on contract? Sounds like it. At least if a residence is going to be built on it.


Happily, there are situations where Indiana’s SAFE rule doesn’t apply – but not many. Among them are transactions:

- primarily for non-personal, -family, or –household purposes;

- primarily for business, commercial, or agricultural purposes;

- originated by depository institutions (banks and credit unions) and the Farm Credit Administration;

- involving the government;

- involving family members;

- involving property that was the lender’s residence; and,

- involving attorneys negotiating for clients unless the attorney is paid by a lender, mortgage broker, or MLO.

So, the good news is an owner can sell his or her own residence on contract or by taking a mortgage back. The bad news is, if the seller hasn’t lived in the property, he or she can’t.


Who are the mortgage police? The DFI. Civil penalties can go up to $10,000 per violation. Restitution can be ordered. What would restitution amount to? Nobody knows at this point, but presumably the offending creditor would have to give the debtor’s money back. Not a good thing, if you’re the creditor.

At this point, the best thing to do is brush up on the new rule and steer clear of trouble.

- Morrie Erickson

Sunday, June 27, 2010

Condos & PUDS – what’s the difference?

Condos and PUDs. We hear and use the terms all the time, but does everyone really know what they mean?

Condos are condominiums, of course, and PUDs are planned unit developments. And while each may look like the other from the street, they’re completely different animals with different rules and laws applying to each. So, what’s in a name? Lots, actually.


Often, the confusion is caused by appearances. Shared walls, common area, dues, and homeowners’ associations (HOAs) are probably the biggest culprits. Because condos and PUDs generally feature all of these, and because condos and PUDs are usually called ‘units’ instead of ‘lots’, it’s a small step to conclude that property with some or all of these features are condos. But that’s not correct.


When you’re talking condos, you’re talking 3-dimensional space instead of land. Which is why condos are a legal fiction and created by statute (Indiana's Horizontal Property Law, IC 32-25-1 et seq.). Why fictional? Because the statute declares condo units to be real estate even if units are on second and higher floors and don't have ground directly beneath them (thus, "horizontal property").

The surest way to tell if a dwelling is a condo is to look at the plans on file in the County Recorder’s office. If the plans show three dimensions (length, width, and height), you’re dealing with a condo. Condo owners don’t own dirt, bricks, and mortar; they own air space inside the interior walls. Which means a condo can’t exist until the building is erected so a professional architect or engineer can measure its three dimensions. Who does own the dirt, bricks, and mortar? All unit owners together. So, in a 50-unit condo development, each unit owner also owns a 1/50 share of the land and buildings (common area) or a share based on square-footage.

The condo statute is very detailed about what must be done to create a condo and how condos operate. For starters, condos must be created by a document called a ‘declaration’. In turn, the declaration must have specific provisions including bylaws of the HOA. It must also contain a plat (detailed drawing) showing how the building or buildings containing the units are situated as well as a copy of the plans showing the size (length, width, height) and location of each unit. In addition, the declaration must contain all covenants, conditions, and restrictions about its use (CCRs).

So, to be a condo, all the relevant documents MUST be contained in the declaration. Having said that, most declarations (and bylaws) contain general provisions allowing the board of directors to come up with rules and regulations. Often these are implemented at board meetings and documented in the form of minutes. These do not have to be recorded because a proper declaration will say the board has this power, so everyone is on notice.


In contrast to condos, PUD units are 2-dimensional, not 3-. Significantly too, a PUD unit (lot) owner does own the ground beneath his or her feet. Although at some point each lot will have a building on it including a wall shared with at least one neighbor, the building may be erected after the PUD exists. This is because PUDs are traditional real estate (they include land) and don’t have to rely on a legal fiction to exist, although they are controlled by planning and zoning rules.

As with condos, PUD plats show unit (lot) dimensions and locations, and where the common area is. Not much more is required than that, although most PUDs have CCRs and HOAs created by a document most lawyers call a ‘declaration’ (which adds to the confusion). But unlike condos, the CCRs and HOA information don’t have to be in a single document. Also unlike condos, the HOA should (but doesn’t always) own the common area.

Simply stated, the condo statute does NOT apply to PUDs. Still, PUD CCRs have to be recorded to be enforceable, although the simplest PUDs include the CCRs right on the PUD plat. Typically, the CCRs will cover whether there is a HOA (there doesn't have to be) and whether it's a nonprofit corporation (it doesn't have to be). If it is a nonprofit corporation, there have to be bylaws (but not necessarily recorded) because Indiana's corporation law says so. If the HOA is not a nonprofit corporation, no bylaws are needed (but would be prudent).

In other words, PUDs are loose and not governed by statute, although city or county planners may dictate provisions and how they're put together.

But remember the key: check for three dimensions.

- Morrie Erickson

Sunday, June 6, 2010

Exactly what IS a title search?

A title search amounts to combing through the public records for documents affecting ownership of and obligations pertaining to a tract of real estate. The search is performed by the title insurance agent, who then issues a title insurance commitment or other type of report, depending on the instructions of the customer. If a title insurance commitment is issued and the transaction closes, a title insurance policy is issued after the closing.

Title searches are the core work of any title company. Why? Because each state has its own system of keeping track of records of property ownership so there can be an orderly way of knowing who owns what, who has rights to do certain things on specific property, and who can claim an interest in property – for example, based on using the property as collateral for a loan.

“Real property” vs. “Personal property”

The idea is that if property records are kept in a central office, it ought to be easier to figure things out. And it is…in a way. But while in Indiana the county Recorder’s office is the place where most property records are kept, other government offices are involved too, including county, municipality, state, and federal. So-called “real property” records aren’t set up like Indiana’s Bureau of Motor Vehicles, which acts as a clearing house for all vehicle transactions. If you sell your car (a specific type of “personal property”), you sign the certificate of title over to the buyer and the BMV issues a new certificate of title in the buyer’s name. Loans on cars show up on certificates of title, too. So the BMV is a one-stop-shop for proving and transferring ownership for all vehicle transactions.

Not so with real property, which has no central clearing house to document ownership and property rights and claims. Instead, a host of government offices may be involved. Which is why records in all those offices must be checked to figure out what’s really going on.

Which offices & records?

To determine ownership rights and claims of real property, we search records in the offices of the Auditor, Assessor, Treasurer, Recorder, and Clerk of the courts in the county where the property is located. In many cases, though, official records outside the county may be relevant, including proceedings in U.S. Bankruptcy Courts and U.S. District Courts. Depending on the transaction and the title product requested by the customer, searches may extend to planning and zoning offices.

Usually, we request an owner’s policy from the current owner to start our search. Otherwise, we may have to search backwards for at least 50 years to verify the chain of ownership and other matters affecting the property. Some searches are performed in government offices where we pour through books, microfilm, and computer indices (these searches are called “finger searches”) while others are done on our title plant (our database which replicates records in the county Recorder’s office for a certain number of years). Records found in these offices provide a snapshot of a property at a point in time.

Contrary to what some think, unlike the BMV, government offices don’t provide proof of ownership, liens, or other matters. Instead, it is up to the title company to examine all the records compiled over the years – a process called “examination” – to determine who owns the property and who has a valid claim, easement, lease, mortgage (or other lien), or conflicting interest in the property.

Only after all that may title to the property be insured.

- Morrie Erickson

Sunday, May 30, 2010

Underwater borrowers – Non-FHA, -Fannie & -Freddie mortgages

Here we go again.

For three weeks now, I’ve been going over Federal programs designed to help underwater borrowers with their delinquent mortgages. The first installment covered Federal Housing Administration (FHA) loans – the ones supervised by the Department of Housing and Urban Development (HUD), which is an actual Federal agency.

The past two weeks were spent on programs run by the Federal National Mortgage Association (FNMA), commonly called Fannie Mae, and the Federal Home Loan Mortgage Corporation (FHLMC), known as Freddie Mac. You’ll recall that both Fannie and Freddie are U.S. government-sponsored enterprises (GSEs). Both have been bailed-out by the government which, for all practical purposes, makes both semi-official Federal agencies.

But there are plenty of mortgages out there that aren’t owned or guaranteed by FHA, Fannie, or Freddie. So, what about them?

As part of the overall plans to promote economic recovery and resurrection of the housing market, the Federal government came up with three programs to help struggling homeowners with their mortgages. One facilitates refinances, another modifications, and the third avoiding foreclosure (but still losing the home). Unsurprisingly, the three programs have acronyms: HARP (Home Affordable Refinance Program), HAMP (Home Affordable Modification Program), and HAFA (Home Affordable Foreclosure Alternatives) program. Let’s go over all three.

First, HARP. Unfortunately, HARP applies only to mortgage loans owned by Fannie and Freddie. Since we’re talking about non-Fannie and –Freddie mortgages, let’s scratch HARP right off the bat.

That brings us to HAMP.

HAMP is designed to help responsible homeowners who have been put in difficulty because of financial hardship, whether caused by loss of income or job, or an increase of the interest rate on an adjustable rate mortgage.

For starters, to qualify for HAMP, borrowers have to be able to document their hardship by proving income and expenses. They must also meet the following criteria: 1. be the owner-occupant of a one- to four-family home; 2. have an unpaid balance less than jumbo status ($729,750 for a one-family dwelling with higher balances allowed depending on the number of units); 3. have a first mortgage that was originated on or prior to January 1, 2009; 4. have a monthly mortgage payment (including principal, interest, property taxes, homeowners’ insurance, and homeowners’ association [HOA] dues) greater than 31% of gross monthly income; and 5. show that the mortgage payment can’t be made because of the financial hardship.

Still, there can be obstacles, such as junior liens (i.e. second mortgages, judgments, delinquent HOA dues). It may be that the only way to modify the current first mortgage is to cut the principal balance and base a modified loan on the reduced principal balance. If so, though, what happens to the reduction? Is it forgiven? Probably not. Instead, it may be lopped back in line as a junior lien, which is why an existing junior lien presents an issue. Borrowers need to be sure whether the reduced balance is actually being forgiven or rewritten, either as a junior lien or an unsecured note. Sometimes, these deferred notes may not bear interest for a few years – but they don’t vanish into thin air. Instead, they hang on, even after the home is sold later by the borrower. As always, borrowers need to read before they sign.

So if HAMP won’t work, only HAFA remains.

HAFA procedures help borrowers avoid foreclosure. But HAFA doesn’t keep borrowers in their homes. Instead, HAFA amounts to a way of getting borrowers off the hook of their unmanageable loans by letting them off-load their homes without going through foreclosure. Why should borrowers care? Because foreclosure carries a stigma and causes serious damage to credit, so avoiding it may be a minor benefit. How does HAFA do this? By offering inducements (money) to lenders, borrowers, and junior lien holders and by allowing real estate agents to be paid a commission up to 6%.

The two ways to dodge foreclosure are to convey the home back to the lender (deed in lieu of foreclosure) or to convey the home to someone else for less than is owed to the lender (short sale). Obviously, for either to happen lenders must be on board. To be on board, lenders have to be convinced borrowers don’t qualify under HAMP or have failed the trial modification that HAMP requires. Most likely, lenders will favor short sales over deeds in lieu because lenders won’t have to take back homes themselves if they’re sold to third parties through a short sale. Lenders’ regulators don’t like REOs (the term for real estate owned by lenders) on lenders’ books. Plus, in short sales lenders will know their losses up front. But if lenders take homes back through a deed in lieu, they will then have to list the homes and sell them – maybe for even less.

As with other topics when it comes to owning property and being underwater, be sure to hop on the Internet to check the latest program features. Programs tend to change and be tweaked.

- Morrie Erickson

Sunday, May 23, 2010

Underwater borrowers – Freddie Mac mortgages

For the past two weeks, I’ve been going over Federal programs designed to help borrowers drowning on their mortgages. Two weeks ago I kicked off the topic with Federal Housing Administration (FHA) loans, which are supervised by the Department of Housing and Urban Development (HUD) – an actual Federal agency.

Last week we went over what I call a semi-official program run by the Federal National Mortgage Association (FNMA), dubbed Fannie Mae. Fannie was established in 1938 after the collapse of the housing market in the wake of the Great Depression (sound familiar?). You’ll recall that Fannie is “semi-official” because it’s a government-sponsored enterprise (GSE) instead of being an actual Federal agency, although because Fannie was bailed out by the Feds, it might as well be a Federal agency.

Fannie’s younger brother, the Federal Home Loan Mortgage Corporation (FHLMC), which was created in 1970 and is commonly called Freddie Mac, is also a GSE and a bailed-out, semi-official Federal agency.

Sometime in the next couple of years, Congress will have to decide what to do about Fannie and Freddie. Should the Federal government take them over and turn them into Federal agencies? Should they be privatized and run like large corporations? Or should they continue as GSEs with the implied promise of being rescued by the Federal government if they fall on hard times? Tough alternatives with far-reaching implications for the Federal government, taxpayers, and – especially – homeowners.

But those alternatives are for another day. Right now, let’s deal with Freddie.

As I’ve said before, when you talk about loan programs – whether or not you’re mentioning helping underwater borrowers in the same breath – each type of program is lender- or program-specific. In other words, because HUD runs FHA, HUD decides how FHA borrowers are helped. Same goes with Fannie and Freddie. Because Fannie and Freddie buy loans from lenders, each dictates how their respective loans are set up and – critically in today’s perilous economic climate – how their troubled loans are restructured or unwound.

Like Fannie, Freddie has three ways of helping borrowers: refinances, modifications, and short sales. As is pretty obvious, refinances and modifications are designed to keep borrowers in their homes. On the other hand, short sales allow borrowers to unload their property for less than what’s owed – a way of letting over-stretched borrowers off the hook and get on with their lives. Let’s talk about all three.

For borrowers suffering because of the kind of loan they have instead of because of the economic meltdown, Freddie has two options: refinancing through the Same Servicer program or the Open Access program. Both are explained on Freddie’s website: The concept is that if a borrower has an adjustable or variable interest rate that’s gone up, the payment may now be too high to handle. Refinancing to a fixed rate may solve the problem.

Freddie’s Same Servicer program has an expedited procedure for qualifying if the borrower refinances through the servicer the borrower is currently making payments to. On the other hand, Freddie’s Open Access method allows refinancing through any Freddie-approved servicer, but the qualification process is more involved. Of course, for borrowers who have taken pay cuts, a refinance won’t work if borrowers can’t afford even the revised payments. Keep in mind that the full balance of the loan is still owed; only the loan terms are changed. Ultimately, whether borrowers qualify or not depends on the Home Affordable Refinance Program (HARP), a Federal plan encouraging lenders to rework mortgage loans for qualified borrowers. The key word here is “qualified”.

Modifications work differently, although as with refis, borrowers have to prove they can make the new payment through a 3-month trial period. Usually though, modification borrowers are in more dire financial straits than borrowers seeking to refi. Borrowers’ pay cuts are the prime culprit. So if a loan can be restructured to take into account current income, things might be all right. Suppose a borrower could afford the loan if the principal balance were $30,000 less. A modification will lower the loan to the adjusted balance. Sounds good, but what happens to the $30,000? Usually, the borrower has to sign a new promise to pay it back (maybe interest-free for a few years) and it’s treated like a second mortgage. In other words, it will have to be paid off eventually. But as I mentioned last week in Fannie modifications, if there’s already a junior lien, such as a home equity mortgage, a modification won’t work unless the home equity mortgage moves into third position (behind the lowered first and the new $30,000 second).

So now we’re down to short sales.

To work out a short sale through Freddie, the underwater borrower must be unable to pay the loan long-term, must be in default or nearly so, and must have tried to sell the home “as is” for at least 90 days. Proving the attempt to sell requires pricing the house based on an “as is” broker price opinion (BPO), “broker” meaning a licensed real estate agent.

As with Fannie loans, Freddie borrowers can’t pay for repairs and can’t receive cash at closing. (In contrast, you’ll recall that FHA lets borrowers receive up to $1,000 at closing.) The short sale won’t be approved until Freddie approves the offer to purchase and a closing date has been set.

As pointed out last week with Fannie short sales, this process seems backwards. If I’m a potential buyer with a rate-lock and move-in date on my mind, I won’t want to waste time and energy hoping some far-off servicer will approve my deal. In fact, in our office we’ve found the approval process painfully slow (months!) and convoluted (“You talked to who before and were told what?”) for Fannie and Freddie. Not that it matters to underwater borrowers, potential buyers, and real estate agents, but the delays are largely because the short sale process has been dumped by Congress on servicers who are under-staffed and ill-equipped to handle the crush of business. Suffice it to say that programs that pre-approve a sale price make more sense.

As with Fannie, Freddie short sale brokers are allowed a 6% commission (3% if only one broker).

In all short sale transactions, though, beware of unauthorized flips. A flip occurs when a third party or so-called facilitator acquires the home being sold at a discount (with the seller-borrower’s lender taking the hit) then turns around and sells the home for a profit (which otherwise would have gone to the lender being shorted). If that situation presents itself, the parties must disclose all terms of the transaction(s). Over the first weekend in May, 2010, Freddie came out with guidelines for disclosures, making it clear that Freddie must be told all the facts surrounding the transaction so Freddie isn’t mislead. What the guidelines are saying is: would Freddie make the same decision if it knew all the facts instead of just some of them? Those who don’t fully disclose can expect to land in legal hot water, thanks to Freddie’s short sale fraud task force.

Regardless of whether borrowers are refinancing, modifying, or selling short, they need to know whether any shortfall is being forgiven or simply deferred. As with all other serious matters, especially in real estate, the key is to get it in writing.

Be sure to Google Freddie and other program providers regularly because programs are frequently tweaked. Once again, Freddie’s website is Plan to check it regularly to stay up to date.

- Morrie Erickson

Sunday, May 16, 2010

Underwater borrowers – Fannie Mae mortgages

Borrowers of all kinds continue to be up to their necks, or worse, on their mortgages – a problem that isn’t going away. So, it’s worth coming to terms with borrowers’ options, which vary depending on the type of loan a borrower has. Last week I kicked off the topic with Federal Housing Administration (FHA) loans – the ones supervised by the Department of Housing and Urban Development (HUD).

This week, we’ll branch out from an official Federal government program (FHA) and tackle a semi-official program run by the Federal National Mortgage Association (FNMA), commonly referred to as Fannie Mae. I say “semi-official” because Fannie is a government-sponsored enterprise (GSE) instead of being an actual Federal agency, although thanks to Fannie’s bailout by the Feds, Fannie has become a Federal agency for all practical purposes.

Fannie’s younger brother (it was created later), the Federal Home Loan Mortgage Corporation (FHLMC), commonly called Freddie Mac, is also a GSE and a bailed-out, semi-official Federal agency. But Freddie will have its day next week.

For now, let’s talk about Fannie.

If you read last week’s segment, you know that because HUD runs FHA, HUD also makes the rules. Same goes with Fannie. Because Fannie buys loans from lenders, Fannie dictates how the loans are set up and – critically in today’s perilous economic climate – how troubled loans are restructured or unwound.

Fannie has three ways of helping underwater borrowers avoid foreclosure: refinances, modifications, and short sales. Refinances and modifications are designed to keep borrowers in their homes. Short sales are not. Let’s go over each in turn.

Some borrowers haven’t been hit especially hard by the economic meltdown but are suffering because of the kind of loan they have. For example, if borrowers have an adjustable or variable rate and their interest rate has gone up, their payment may now be so high they can’t handle it. Refinancing to a fixed rate may solve the problem. But for borrowers who have taken pay cuts, a refinance won’t necessarily work. Why? Because refi borrowers – like all borrowers these days – have to qualify for the refinanced loan. Borrowers with drastic pay cuts will be out of luck. But whether borrowers qualify or not depends on the Home Affordable Refinance Program (HARP), a Federal plan encouraging lenders to rework mortgage loans for qualified borrowers.

Before going on, a word here about how the secondary mortgage market works, because the first question most borrowers ask is: “Okay, I don’t make payments anymore to the lender where I got the loan, so who do I talk to?” Answer: the servicer. Who’s the servicer? The firm the borrower now makes payments to. Does the servicer own the loan? Probably not. Who does? Most likely, a whole lot of bondholders who have bought shares of a pool of mortgage loans which generate income as borrowers make their monthly payments of principal and interest. These are the infamous mortgage-backed securities (MBS) we’ve heard so much about. Infamous because, when borrowers begin to default on their mortgages – and borrowers have defaulted in spades – the servicers have to kick in the missed payment to the pool. Not a good deal for servicers unless somebody’s going to reimburse them. Which is what Fannie does in Fannie loans. Which, in turn, is why Fannie lost its shirt and needed a Federal bailout. Which is why we taxpayers are footing the bill.

So there it is: an underwater borrower who wants to refi needs to contact his or her servicer.

Same goes for borrowers who want to modify. But what’s the difference between a refi and a modification? In both, borrowers have to qualify to prove they can make the new payment. But the chief difference is that modification borrowers are in deeper water than borrowers seeking to refi. Most have taken hits in pay which means they can’t afford their monthly payment, even if they originally could. But if their loan could be restructured to meet their current income, things would be all right. Usually, that means knocking off some of the principal balance to a level borrowers can afford. But the amount knocked off isn’t forgiven. Instead it becomes a junior note behind the newly reduced loan, and it’s secured by a junior mortgage. In other words, ultimately it will have to be paid off. Problem is, if there’s already a junior lien, such as a home equity mortgage – and usually there is – a modification won’t work.

Which leads to short sales.

Clearly, short sales are less favored by Federal programs designed to keep people in their homes. On the other hand, they’re a practical way for unworkable mortgages to be wound down. In a nutshell, the lender agrees to accept less than is owed when the house is sold to a new owner. How much less depends on Fannie.

To take advantage of a short sale through Fannie, the underwater borrower must have a verifiable loss of income or increase in living expenses and must actually be delinquent on the mortgage loan. In addition, the property must qualify price-wise based on a broker price opinion (BPO) based on “as is” value. Borrowers can’t pay for repairs and, unlike FHA short sales, can’t receive cash at closing. The short sale won’t be approved without a closing date, which seems backwards because a potential buyer won’t want to put out much time, energy, and money unless it’s reasonably sure Fannie will approve. Programs that pre-approve a sale price make more sense.

The good news for brokers is they’re allowed a 6% commission (3% if only one broker). Because lenders tried to chisel down sales agents to receive more money themselves, Fannie cracked down on reducing commissions in its Servicing Guide, Part VII, Section 504.02, effective March 1, 2009. See Fannie’s Announcement 09-03 dated February 24, 2009 (you can Google it).

Also, see Fannie’s Announcement SEL-2010-05 dated April 14, 2010, which tweaked certain procedures. Be sure to Google Fannie and other programs regularly because they change often enough to be a moving target. Fannie’s website is It’s a good idea to check it frequently to stay up to date.

- Morrie Erickson

Sunday, May 9, 2010

Underwater borrowers – FHA mortgages

Two weeks ago, my blog post covered an overview of options for underwater borrowers. The alternatives ranged from foreclosures to short sales, with deeds in lieu of foreclosure and modifications in between.

I mentioned Federal programs such as HARP (for refinances), HAMP (for modifications), and HAFA (for short sales) and that not all struggling borrowers are eligible for all programs because applicability depends on the kind of loan the borrower has. This is because different types of loans are supervised by different Federal agencies.

Today’s topic is underwater borrowers who have FHA loans.

Because FHA (Federal Housing Administration) loans are supervised by HUD (Department of Housing and Urban Development), it stands to reason that HUD also controls how FHA loans are implemented, modified, terminated, or otherwise unwound. Keep in mind that FHA doesn’t make loans, it insures them, which is a way of inducing banks and other lenders to make loans to borrowers who have little equity.

In response to the housing crisis and economic meltdown, HUD issued a series of letters to their mortgagees (participating lenders) outlining policies and procedures. Bear with me now while I list a few citations, but if you check these out you’ll get loads of specifics, so I’ll mention a few for your reading pleasure. Mortgagee Letter 2008-43 dated December 24, 2008, outlines procedures for short sales. A second letter – this one called Mortgagee Letter 2009-23 – was issued July 30, 2009, and announced a HAMP program for FHA (appropriately called “FHA – HAMP”) addressing loan modifications. (FHA loans weren’t covered by the original HAMP.) In a follow-up on September 23, 2009, Mortgagee Letter 2009-35 clarified modification procedures. Yet another Mortgagee Letter (this one 2009-52) came out December 16, 2009, and discussed the impact of selling short. All these letters are public and available online. All you have to do is Google them and take a look.

Like all Federal agencies, HUD publishes regulations. For those who like to hear it (or in this case, read it) from the horse’s mouth, check out 24 CFR 203.355 for FHA lenders’ options on default. For short sale procedures see 24 CFR 203.370 and, for modifications, 24 CFR 203.616. Google these and you’ll get plenty of hits.

In a nutshell, here’s what you’ll find. To be eligible for an FHA modification, the borrower must be at least 4 months but not more than 12 months delinquent. If the money situation improves (but not too much), the borrower may resume making payments but must be unable to catch up the shortage or payments missed. In other words, the borrower must be suffering from changed circumstances (changed, that is, from the time the borrower originally got the FHA loan).

If the borrower qualifies and a modified loan is put in place, the arrearage isn’t forgiven. Instead, the borrower is required to sign a junior promissory note and mortgage for the arrearage which gives taxpayers hope the loan will be paid in full. This junior note and lien requirement is a problem if the borrower already has a HELOC (home equity line of credit) in place, but with most FHA borrowers putting only 3% down at date of acquisition, there shouldn’t be a HELOC. But if there is, a modification is probably out.

That’s when a short sale enters the picture.

To be eligible for a short sale, the borrower must be in default and have negative equity, but the property can’t be in foreclosure yet. The borrower also must be the owner-occupant (not an investor, although there are a few hardship exceptions) and have been actively trying to sell the property for 3 months. So, timing is critical.

Generally, for a short sale to be considered, the property must be listed for sale at its “as is” appraised value as determined by an FHA appraiser. A real estate commission up to 6% is allowed, assuming more than one sales agent is involved. Otherwise, the maximum commission is 3%. The seller may not make repairs as a seller concession (with some exceptions), the goal being to maximize the sale price and minimize the shortage to the lender (and, in turn, the cost to FHA and taxpayers).

The actual sale price allowed (compared to the loan balance) depends on a tiered pricing structure, based in part on how long the house has been on the market. As an incentive to underwater borrowers, FHA allows the seller/borrower to receive $750-$1,000 cash at closing (for first and last month’s rent since the seller/borrower won’t be buying another house). Incentives up to $1,250 go to outgoing FHA lenders too, with another $250 thrown in for title searches and recording fees. There’s more. Despite senior lenders’ not liking to pay junior liens when they’re not being paid in full themselves, FHA will allow up to $2,500 of the sale price to make junior lienholders go away. And, up to 1% of the new buyer’s loan may be used for seller’s closing costs if the buyer is obtaining a new FHA loan.

So, the FHA programs are in place, with short sales likely trumping modifications in most cases. To answer your questions – or at least to get a strong start – read Mortgagee Letter 2008-43. It contains loads of details.

- Morrie Erickson

Sunday, May 2, 2010

So, you want to close at month-end?

It’s a request we get month in, month out. And there are good reasons for it…sometimes. But month-end closings can present problems. So, like most choices in life, balance is critical: the upside has to outweigh the down.

First things first. Why are month-end closings so popular?

For buyers getting new mortgages, the nearer to the end of the month a settlement takes place means less interest paid up front. For example, if closing occurs on March 30, the borrower’s first mortgage payment won’t be until May 1 (which includes interest for April). Consequently, at closing the borrower will have to prepay interest for only two days (March 30 & 31). That’s a good thing.

But suppose closing occurs on April 2. The borrower will have to prepay interest for 29 days (April 2-30). Whoa! That’s a lot more than a measly two days. But consider this: the first mortgage payment won’t be until June 1. So, which is better? Coughing up 29 days interest in advance and putting off your first payment for almost a month more or paying less at closing but starting your mortgage payments a month earlier?

For borrowers squeezed for cash, closing late in the month makes sense. But if cash at closing is not an issue, why jockey for a closing date when title companies and lenders are busiest? It’s no secret that the end of the month is when title companies’ closing schedules get hectic. Which means closings are stacked up hour after hour. In turn, efficiency suffers and the chances of mistakes go up. In fact, if problems do occur, the closing may have to be delayed until the following month. Meaning more up-front money. Not a good thing for borrowers who can’t afford it.

These days, end-of-month (and Friday) closings have another issue to deal with: wire transfers. In Indiana, all funds of $10,000 or more (per person, per lender, etc.) must be sent to the title company by electronic transfer. Often, lenders don’t send funds until all closing requirements are met – in other words, at the closing table. Given that many banks cut off sending wires at 2:00 p.m., afternoon closings probably won’t be funded until the next business day. Sometimes, the next business day is the following Monday – or Tuesday if Monday’s a holiday. And it all goes downhill from there, because if sellers haven’t received their money (and they won’t until funding occurs), most sellers won’t let buyers move in. So, if the buyer has a moving van waiting to unload, the movers will have to cool their heels until funding. Definitely not a good thing.

What do month-end closings mean for sellers? As just mentioned, there’s the downside of waiting for their funds, which can create a domino effect. If the seller intends to use the money from the sale to buy another home later that day, the seller’s purchase will have to be delayed. You don’t even want to think about the consequences if it’s the seller’s last day to close or the seller’s (soon to be buyer’s) new mortgage rate-lock expires. Late funding also means the seller’s outgoing mortgage won’t be paid off as early because the title company can’t wire the payoff until the sale has officially closed, adding extra days of interest and possibly late fees. Worse, if the seller has an FHA mortgage, the cash outlay racks up even faster because FHA charges interest for the whole month regardless of when payment is made. So if the closing is pushed back from the end of March until the first of April, the seller will have to pay all April’s interest (even if closing is on April 1st). Most sellers won’t be pleased. Some April Fool!

With the first-time homebuyer tax credit deadline looming (June 30, 2010), savvy sellers, buyers, and their brokers won’t want to risk a late June closing. The consequence of losing the tax credit because something went wrong at the last minute would be devastating. This deadline is written in stone, unlike a rate-lock that might be able to be extended. But Uncle Sam doesn’t extend. Either the closing occurs on or before June 30, or the tax credit goes down the drain.

The word to the wise, first-time homebuyer or not, is to plan ahead – and conservatively. Shoot for early or mid-month. Don’t take a chance on saving money and getting the deal closed. And remember, not only will title companies be pulling their hair out end of month, so will lenders. Just as title companies can close only so many sales within a certain period of time (only so many hours in the day), same goes for lenders who can process only so many loans. Because most lenders will be pulling out all the stops, mistakes can be made which may cause delays.

So get your deal closed early and rest easy while the ones who didn’t plan ahead break into a sweat.

- Morrie Erickson