Options when you can’t pay your mortgage

As everyone knows by now, the economic meltdown has turned the housing market on its head, leaving millions of Americans faced with losing their homes. Can anything be done to keep people from being put onto the street?

The Federal government has set up programs such as HAMP (Home Affordable Mortgage Program), HAFA (Home Affordable Foreclosure Alternatives) program, and HARP (Home Affordable Refinance Program), but none has been as effective and far-reaching as hoped. But before delving into the specifics of HAMP, HAFA, and HARP (which I’ll save for another day), let’s start with the options borrowers and lenders have when borrowers can’t make their payments.

Foreclosure

This option doesn’t work for borrowers who want to stay in their homes. Foreclosure means borrowers are sued and eventually kicked out, and their home sold at public auction. More often than not, the lender ends up with the house then turns around and sells it – or tries to.

Another downside of foreclosure is that when the smoke clears, the borrower may still owe the lender money – the difference between what the house is worth and how much the borrower owed.

The good news though is that junior liens (like second mortgages) are wiped out. Still, the borrower ends up on the street looking for a new place to live. But if a borrower is so underwater (the house is worth far less than the borrower owes), foreclosure may be the only option. Borrowers who recognize this have been known to turn in their keys and walk away.

Deed-in-lieu of foreclosure

Foreclosure is avoided when this procedure is used, but the borrower still ends up losing the home. Deed-in-lieu amounts to a formal way of turning in the keys and walking away.

No lawsuit is necessary to pull this method off, but the lender has to be on board in order to do it. Because the public auction orchestrated through the foreclosure lawsuit is what wipes out junior liens, no lender is going to allow a deed-in-lieu if the home is burdened by junior liens because those liens would have to be paid off when the lender sells it. So for a deed-in-lieu to work, the home can’t have any baggage that comes along with it.

The trade-off the borrower ought to be looking for here is full and complete release from the debt the mortgage secures. Depending on circumstances, release from most of the debt (instead of all of it) might be acceptable too.

Modification

Without getting into specifics of HAMP, HAFA, and HARP, these are Federal modification programs designed to keep people in their homes. Any lender can modify its borrower’s loan, but lenders don’t keep their loans anymore. Instead, they sell them on the secondary market which packages them as securities and sells them to investors, meaning a borrower’s mortgage may be one in a package owned by a pension fund in East Chainsaw, Oklahoma. So, who does the borrower talk to about modifying? Thus the Federal programs.

Some modifications cut the rate of interest. Others extend the term to, say, 40 years instead of 30. Still others do both. Either way though, the full amount has to be paid back.

But cutting through the red tape, there’s no real reason for borrowers to shoot for loan modifications if they’re not able to pay. Will lenders modify loans for borrowers who’ve lost their jobs and have no income? No. Which means borrowers have to qualify for modifications to prove they can pay. Qualifying means credit scores, income, and debt are checked. For borrowers trying to modify so-called “liar loans” (borrowers who “stated” their income the first time around without having to prove it), this will be their first real shot at qualifying. Most programs also require borrowers to show their income, etc. has worsened since they got the loan they want to modify. But depending on how much they lied the first time around, maybe it hasn’t.

If a modification is pulled off, the borrower gets to stay in the house…at least until defaulting again. I’m not trying to be pessimistic here, but statistics say 20-30% of modified mortgages end up in default.

Modification plus note

An offshoot of a full modification is re-writing the mortgage by lowering the interest rate and knocking off some of the principal, which has the effect of lowering the monthly payment. But most lenders won’t be willing to eat the principal they’ve knocked off. Instead, they’ll require the borrower to sign an unsecured note promising to pay it back over time.

Why do this? To give the borrower a better chance to sell the home. If the home is encumbered by less debt, the sale price can be lowered making it easier to sell. So maybe the borrower will end up losing the home but on more honorable terms than being thrown out.

Short sale

If a borrower is underwater but not too far beneath the surface, a short sale may be the ticket. True, the borrower will be losing the home (by selling it) but will also be off the hook.

In a short sale, a lender agrees to accept less than the full amount owed on the mortgage. This option is for lenders who are practical – they see the handwriting on the wall. Usually, the borrower has been missing payments, knows it’s time to get out from under an unsustainable debt, and decides to sell. The problem is, if more is owed (but not too much more) than the home will sell for, how can the sale take place? It can’t unless the lender is on board. But more and more lenders (the savvy and prudent ones) realize it’s better to cut their losses and move on rather than go through the expense of foreclosure, take the house back, and still have to sell it.

In a short sale, a portion of the debt is forgiven. That’s good, right? Yes, but there’s a catch. To the IRS, forgiven debt amounts to income received. Which means the borrower will have to pay tax on it. And to be sure that happens, the forgiving lender will be sending the borrower a Form 1099.

Short sale with note

This option is like any other short sale except the amount the lender is shorted isn’t forgiven. Instead, the borrower signs an unsecured note promising to pay it back over time. Another good news, bad news situation. There’s no income tax to pay because the debt isn’t forgiven, but that means the debt doesn’t go away.

As with the modification with note procedure, this option allows the home to be sold, getting the borrower off most of the hook. But the “forgiven” debt still has to be paid.

- Morrie Erickson

Why title companies are picky – Recording

This is the first of a series explaining why title companies are fussy about details. For example, when we insist that documents be set up a certain way, we’re not trying to be technical for the heck of it. Instead, we’re being picky for a reason: compliance.

It’s true that our underwriters have rules based on risk assessment and loss avoidance. But more often than not, compliance means bowing to the law itself, whether Federal, state, or local.

Let’s start with names on documents. If Susan owns a house and her deed reads “Susan J. Blake”, that’s how her name must appear on the deed when she sells. But what if her name changes? Suppose Susan marries Alonzo Martin and becomes Susan B. Martin. Fine, but the deed will have to explain the details.

The practical reason for linking the two names? Making it clear the true owner is the seller. But the legal aim is to satisfy recording requirements under Indiana Code 36-2-11-16.

This statute dictates how documents such as deeds and mortgages must be drafted and signed. If not followed, the county recorder may refuse to record them. Obviously, if the closing has occurred, the title company will be up a creek if the deed and the buyer’s new mortgage can’t be recorded. Why? Because the title company must issue (or has already issued) insurance policies, which is the equivalent of saying recording has taken place. To avoid that problem, title companies have to make sure recording requirements are met.

Let’s look at a couple of examples.

If you’ve watched documents being signed, you’ve probably noticed the signature line is always above the typewritten name. Why? Because IC 36-2-11-16(b) says it has to be. The statute also says the signature (seller’s on the deed, buyer/borrower’s on the mortgage) can’t obscure the typed name or vice versa (the tail of a signed y or g can’t make the typed letters unreadable). This is a rule of legibility, and it applies to the notary clause as well.

The statute goes on to say the name of the signer must appear the same way throughout the document. So, if Susan’s name appears with her middle initial in the body of the deed, it’s got to show up the same way below her signature line and in the notary clause. If for some reason it doesn’t, the inconsistency may be explained by an affidavit, provided the affidavit is presented to the county recorder along with the incorrect document. This is why title companies commonly have buyers and sellers sign a “name affidavit” which lists their name variations and states that all the names on the list refer to the same person.

But what if the signature doesn’t resemble the spelling? We’ve all seen signatures so scribbled (straight lines, crooked lines, flourishes, curlicues) they could belong to Susan B. Martin or a complete stranger. That’s where the notary comes in. It’s also one reason we check photo IDs. If the signature on the photo ID matches the version on the deed, we’re good to go. Let’s face it, people sign the way they sign; legibility doesn’t enter into it.

Fortunately, the statute gives the recorder plenty of wiggle room. If it’s clear who the document’s referring to, the recorder can let it pass.

An off-shoot of this consistency requirement is linking the names on the deed and mortgage. The recorder won’t care about that, but title companies and lenders do because it must be clear the owner of the house is the one mortgaging it. So, title companies and lenders have to stay alert. Here’s why. Unless told otherwise when an order is placed, title companies take the spelling of buyers’ names from the purchase agreement. But loan processing follows a separate track, meaning buyers’ names may appear differently on the loan paperwork. Because the title and loan tracks don’t converge until the loan documents arrive at the title company (usually late in the game), corrections are made on the fly.

Savvy real estate agents ask buyers how they want their names to appear on the title documents. Savvy lenders do the same thing. Hopefully, both get the same answer.

- Morrie Erickson

Trusts & companies – How entities own, buy & sell

Human beings aren’t the only persons who own, sell, buy, and mortgage real estate. So do firms and businesses. And don’t forget to add trusts, not-for-profits, and unincorporated associations. Taken together, these groups are often referred to as entities.

To legally exist, most entities must be formed according to state law. In many cases (in Indiana, at least), that means filing organizational documents with the secretary of state. Some would-be entities get forms online at the secretary of state’s website. Others hire lawyers to handle the particulars.

Among the types of entities that have to file with the secretary of state’s office are corporations (both for profit and not-for-profit), limited liability companies, and limited liability partnerships.

Entities that don’t have to file with the secretary of state to exist legally are partnerships, unincorporated associations, and so-called grantor or living trusts.

But, when it comes to entity-owned real estate, keep in mind that the entity itself is the owner, as opposed to the people who make up the entity. Human beings who are entity-owners (members, shareholders, managers) often forget this, thinking the entity they created is a mere formality. It isn’t. It’s the owner. So, for the entity to act officially, it must play by the rules it made for itself as outlined in its entity documents.

That means if an entity is borrowing or is selling, buying, or mortgaging real estate, title companies will ask for documents they don’t otherwise ask human beings for. For example, if Jim Jones is selling his house, the title company will be satisfied that Jim can sign the deed over to the buyer if Jim proves he’s Jim by showing a valid, government-issued photo ID. Jim won’t have to prove he exists (we can see and talk to him, after all, and match him up to his photograph). All he’ll have to do is link his physical person as the signer of the deed in this transaction to the name on the deed by which he took title to the house.

Not so with an entity. Unlike Jim, amorphous entities don’t have a physical existence. The entities’ owners do, but not the entities themselves. So, title companies need to verify the entities actually exist and can do what the entity is trying to do.

That means title companies ask for proof. For entities formed by filing papers with the secretary of state, title companies will want copies of those filed papers with the secretary of state’s seals and filing dates clearly visible. Because entities which file must renew their filings periodically or automatically cease to exist, title companies will need proof of that too.

There’s more. Because entities can’t do more than their official papers allow them to do, entities must prove they have the right to do what they plan to do (sell, buy, borrow, mortgage). And because entities can’t sign papers themselves – people involved with the entities must do that for them – title companies must have proof who the authorized signers are.

So, when a title company asks for copies of various documents and for an official entity resolution that authorizes the transaction and who can sign the documents, please don’t be offended or put up a fight. The title company isn’t trying to meddle in the entity’s affairs, only to verify that the transaction can proceed as planned.

Trusts are a little different, although the concept is the same. Most of the trusts title companies run into are formed by individuals and are revocable – meaning they can be cancelled at any time. These trusts spring to life with a trust agreement which doesn’t have to be filed anywhere (secretary of state, county recorder, or anywhere else). Usually, the reason trusts are created is to avoid probate. Although I’m painting with a broad brush here, when a person who owns real estate dies, heirs may have to go to court to determine who inherits the property. Trusts avoid this issue because the person (grantor) who forms the trust designates a beneficiary who becomes the owner automatically at the grantor’s death.

These trusts are a lot like wills and are not filed publicly. Unfortunately, what many owners (grantors) forget, is that once the real estate has been put into the trust, the grantors no longer own the property. Instead, the trust owns it (actually, according to Indiana Code 30-4-1-1, the trustee owns it). And, of course, what the trustee can and can’t do with the property (sell, buy, borrow, mortgage) depends on what the trust says. Which is why title companies have to see it.

Often, when title companies ask for copies of the trust, the trustee (who usually is the grantor) resists, thinking the trust provisions – who gets what when the grantor dies – are private and confidential. But, as with other types of entities, title companies need to know that the transaction is permissible and who is authorized to sign. Title companies don’t care who gets what at death, only that the i’s have been dotted and the t’s crossed so the transaction they’re handling will be valid. And, keep in mind that title companies need the whole trust, not just snippets here and there that the trustee thinks are pertinent. Because some clauses can override others, title companies need to see the whole shebang.

As for unincorporated associations – like some small churches – their existence may not be blessed by the secretary of state (although can be if the association files as a non-profit). But they still must have an organizational structure with rules about who governs, what types of actions the group can take, how decisions are made, and who can sign. So, title companies will ask for the same kind of paperwork, minus the official part from the secretary of state.

- Morrie Erickson

Title – What it is & how to hold it

If you’re new to real estate ownership or an experienced hand who wants to brush up, it’s a good idea to go over what “title” means and how buyers should hold it when they buy a house. If you’re a lender or real estate agent, you’ve probably heard all this before. Still, it never hurts to confirm what you already know or be reminded of what might have inched to the back of your brain.

First, a little clarification. I’ve referred to holding “title” in connection with buying a house. The same rules apply to buying commercial property, although non-residential property often is acquired in the name of a firm (i.e., partnership, corporation, limited liability company). That’s a separate topic we’ll save for later.

For now, let’s think residential.

Title companies who prepare deeds and insure ownership always ask how buyers want to take title. But that’s actually the second issue. The first is what sort of title are the buyers getting. Do I mean there’s more than one kind of title? Yes, although in residential transactions, owning less than what might be called full ownership is rare.

Let’s look a little deeper.

In real estate, “title” to property means ownership of a specified interest in that property. The ownership interest can take several forms, including “fee simple” (full or outright ownership), “life estate” (ownership limited to the length of someone’s life), and “leasehold” (long-term tenant’s rights under a lease for a specified period, often 30 or more years). It’s unusual for buyers of houses to acquire less than full or outright ownership or to share ownership with somebody else. That’s because most buyers want total control and because their lenders require it. How many lenders would be willing to lend money to buy a house if the buyer’s ownership ends when the buyer’s 80-year-old grandmother dies? Or when the buyer dies?

But, assuming buyers are acquiring full ownership (as mentioned above, the legal term is “fee simple”), do lenders care how title is held? Probably not, so long as the buyers are creditworthy and qualify for the loan. If one of a pair of buyers has credit problems, though, lenders may require that only the qualified buyer hold title. This is because regulators (or upstream purchasers of loans in the secondary market) don’t want a person with bad credit on the loan. There are reasons for this too, having to do with loans being packaged and sold in the form of mortgage-backed securities (MBS). Unless you’ve been hiding under a rock during the recent economic meltdown, you’ve undoubtedly heard of MBS. In any event, who holds title may be credit-driven instead of buyer’s preference.

Does who holds title (whose names are on the deed) really matter? Read on and decide for yourself.

As mentioned above, an owner holds “title” to whatever interest in the real estate is being acquired. Usually, that interest is “fee simple”. Full or “fee simple” ownership can take several forms if the real estate is co-owned (tenancy in common, joint tenancy with the right of survivorship, tenancy by the entireties), each form having different attributes and consequences.

Ownership as “tenants by the entireties” is reserved for married couples, so let’s save that for last.

First then, “tenants in common” and “joint tenants with right of survivorship”. Simply put, if two people own as tenants in common and one of them dies, the surviving co-owner does not inherit the decedent’s share. Instead, that share goes to the decedent’s heirs (among whom could be the co-owner but not necessarily). In contrast, if two people own as joint tenants with right of survivorship, on the death of one co-owner (sometimes co-owners are called “co-tenants”) the surviving co-owner becomes the owner of the decedent’s share. Casual friends who are co-owners may opt to own as tenants in common because each prefers for his or her share to end up in the hands of his or her heirs. On the other hand, co-owners who have more than a casual relationship (family members, domestic partners) may prefer the survivor to take it all. As mentioned above, typically lenders don’t express a preference how title is held unless the creditworthiness of one of the co-owners rears its head.

Now, “tenants by the entireties”. Unlike the other two forms of co-ownership, tenants by the entireties must be spouses. As with joint tenants, the surviving spouse inherits from the deceased spouse automatically. However, tenancies by the entireties provide other protections of marital property from the folly or misfortune of either spouse. For example, except for the lien of taxes filed by the IRS, in Indiana the debts of one spouse will not become a lien against property owned as husband and wife. This is because in Indiana a magic shield ring-fences spousal property. Conversely, neither tenants in common nor joint tenants enjoy similar protections. Most deeds conveying real estate to spouses refer to them as “husband and wife” instead of “tenants by the entireties”. But both terms mean the same thing.

What about states in which so-called domestic partners are allowed to marry? Are those domestic partners allowed to own real estate as tenants by the entireties? Probably so in those states, although a real estate lawyer in the particular state should be consulted to be sure. Having said that, I’m unaware of any Indiana court case which has addressed this issue. So, for a same-sex couple legally married in another state to expect Indiana (which has not blessed same-sex marriage) to honor tenancy by the entirety rules for Indiana property is risky.

So, boiling all this down, here’s where we end up. In a typical house sale, “title” is transferred by the seller to the buyer when the seller signs the deed and the deed is given (“delivered”) to the buyer. Deeds are then filed in the county Recorder’s office. In turn, the “title” is insured by a title insurance policy. The official owner is the person whose name is on the deed.

Let’s close with a practice tip. Say two people (married or not) want to co-own a house but one of them doesn’t qualify for the loan because of credit problems. Is there still a way for them to co-own? Yes. At the closing, the creditworthy person can take title alone and sign all the loan papers. Then, after closing, the creditworthy buyer can sign a deed to the two of them (which designates how title is to be held: tenants in common, joint tenants with right of survivorship, or tenants by the entireties) then record it. Most lenders don’t have a problem with this, but before doing it be sure to check.

And don’t forget to tell the title insurance company so it can change the name of its insured to the creditworthy buyer and his or her co-owner.

- Morrie Erickson