Saturday, September 18, 2010

THE TRUTH ABOUT SHORT SALES, STRATEGIC DEFAULTS, AND WALKING AWAY

THE TRUTH ABOUT SHORT SALES, STRATEGIC DEFAULTS, AND WALKING AWAY

These days, all sort of experts are giving advice about the merits of defaulting on your mortgage and walking away from your home because the value on your property “dropped” and it only makes “good business and economic sense” to “give the house back to the bank”.  Many of these “experts” are the modification companies and/or modification attorneys who are charging a fee for their service to walk you through the process.  Here are the top 4 myths and facts regarding this:

1.       Myth:  “I am getting even with my bank who screwed me over with this predatory mortgage.  This will teach them a lesson.” 

Fact:  Most mortgages today are not owned by your bank but rather Fannie Mae, Freddie Mac, or FHA.  Your bank who you pay every month is probably only the “sub-servicer” or servicer for Fannie Mae, Freddie Mac, or FHA.  What this means is your bank receives a fee to collect payments from you on behalf of Fannie Mae, Freddie Mac or FHA.  They do not, however, own your actual mortgage.  When you stop paying, instead of hurting your bank, you are actually INCREASING their profits.  Remember, they get paid a fee to service your mortgage no matter if you pay or not.  When you default, they are allowed to collect additional fees for legal expenses, property inspections, appraisals, etc.  Most banks own and profit from the companies that provide these services for them.  These additional fees are reimbursed to the bank by Fannie Mae, Freddie Mac and FHA.  Any loss that is incurred by foreclosing on your home is ultimately passed on to the owner of the mortgage, which in most cases is Fannie Mae, Freddie Mac, or FHA.  Who is Fannie Mae, Freddie Mac or FHA?  As you may or may not be aware, they are now owned by the federal government.  The federal government is owned by us, the tax payers of the United States of America.  While you may think you are “screwing” over your bank, in reality you are only increasing their profits.  The people who you are really “screwing” over are yourself, your neighbors and your children who will eventually have to pay higher taxes to pay back the losses that the government is covering.

2.       Myth: “The foreclosure down the street from my home just sold for half of what I owe on my house.  My house must be worth that much as well!”

Fact: Before you begin valuing your home, you need to go out and see at least 10 foreclosures properties for sale.  Many of these homes are in disgusting condition and damaged.  Many are missing kitchen cabinets, have holes in the walls, copper plumbing has been stolen, furnace and air conditioners missing, and they are cockroach infested.  Many of these homes are ineligible for mortgage financing due to their condition.  These homes can only be sold for cash and most likely will be bought by investors who will either fix them and flip them for a profit or rent them out for cash flow.  In addition, even if you can finance the home with a mortgage, many of these homes require $20,000 to $30,000 (or more) in repairs to make them “livable”.  In these tough economic times, how many people realistically have the ability to pay cash for their home?  Also, how many couples who are buying their first home have the ability to save for a down payment plus have an additional $20,000 to $30,000 saved up for the repairs?  Not many.  Therefore, the price of foreclosure properties reflects this fact.  The same people who are now telling you that your home is worth $50,000 are the same ones who told you three years ago it was worth $400,000.  They were wrong then and they are wrong now.  While it is true that until the large inventory of foreclosures are sold and removed from the market that you may be unable to sell your house for a decent price, once they are gone, prices will bounce back rather rapidly.  They will not return to 2007 levels for a very long time (maybe never in some areas) but they will not remain at 2010 prices either.   So what will your home be worth in a couple of years after the backlog of foreclosure properties is sold?  The answer is simple:  look at the rental rates in your area.  Historically (prior to the stupidity of the housing crisis) homes have sold anywhere from 15 times to 20 times the annualized rents for the same home.  If the home down the street that is similar to yours is renting for $1,000 a month, your home will be worth between $180,000 and $240,000 once the foreclosure homes are sold ($1,000 multiplied by 12 multiplied by 15 or 20).  During the peak of the crisis in 2007, many homes were selling at 40 times the annualized rent.  Right now, you can purchase some for 5 times annualized rent.  Both extremes are not realistic.

3.       Myth: “I just want a fresh start with my finances.  Walking away from my underwater home will help me do just that.”

Fact: The reality is that once you lose your home, in many cases your problems are just beginning.  Many people are unaware that if you lose your house to foreclosure, it may trigger rather large and expensive tax bills with the IRS.  If you did a “cash out” refinance on your home, the IRS may treat that amount as income and come after you for back taxes.  Also, any loss the bank incurs will look like income to the government.  All of these events may generate a 1099-C being sent to you and the IRS.  This may further trigger a tax bill for you.  Most ethical modification companies/modification attorneys will tell you that tax implications do exist and that you should consult with a tax expert.  You should STRONGLY heed their advice and sit down with a CPA prior to making any decisions.  The tax laws regarding foreclosures and tax liability are extremely complex and should not be taken lightly.  An expert accountant or CPA can help you determine how your foreclosure may impact you for years to come.  In addition to possible tax consequences, if the bank takes a loss, they can pursue a deficiency judgment against you.  In other words, in many states, any loss they incur with the sale of your home can result in their pursuit of the deficiency for up to 10 years in some states.  The laws regarding deficiency judgments vary from state to state and you should consult an attorney to see if they apply to you.  Remember, just because a bank does not sue you immediately for the loss, in many states they retain the right to do so for up to 10 years.  Five years from now you may find out that the problem you thought was done is starting up all over again. 

Most people are aware that a foreclosure on their credit report will greatly impact their credit score.  What most people do not realize is the other costs associated with this impact.  In addition to not being able to purchase another home for five years of more, your lower credit score will also cost you in higher rates for auto loans, credit cards, and even insurance!  Many insurance companies use credit scores in determining premiums for auto insurance.  Also, most   employers now routinely pulled credit reports on you prior to making a final hiring decision.   If you are competing with another individual for the same position and you have a foreclosure on your credit and they do not, you may lose out.   Think about it…who would you hire if all other factors are equal?  Whatever money you save by renting a cheaper home can easily be offset by the higher costs in credit, insurance, and even your career path!

4.       Myth: “If I sell my house with a short sale, my problems will be done.”

Fact:  A short sale is not a cure all.  While I do recommend this avenue if you have no choice due to unemployment, divorce or other hardships and will lose your home no matter what, short sales can impact you as well.  A short sale is an agreement by your lender to accept a lesser amount than what is owed in order to help you sell your house.  Please remember a short sale does not solve your IRS consequences with regards to deficiency relief that was discussed above.  Please consult a tax professional on this matter. Furthermore, while the bank may agree to release the  lien on your house for the lower payoff amount, they may continue to attempt to collect on the debt that was not entirely paid off and may pursue collection of it for up to 10 years.  Every bank’s policy regarding this is different.  I strongly recommend you consult an attorney to advise you regarding the bank’s rights to pursue a deficiency judgment against you after the short sale.  Also, the process to get an approval for a short sale is similar to that of reapplying for a loan and can be very prolonged and difficult, taking many months to complete. Once the short sale is approved by your lender, the buyer may no longer be interested; there may be changes by the seller’s lender in their approval letter that change the contract substantially so the buyer walks; the house may not appraise by the buyer’s lender for what was offered, the buyer may find there are too many repairs to deal with and many more. If the buyer will not or cannot perform, you may end up with a rejection from your lender. This will result in eventual foreclosure at which time bankruptcy may now become an option and often results in denials and eventual foreclosure.

Please also remember that a short sale may affect your credit very similar to a foreclosure (many banks report them as foreclosures or charge-offs).   As discussed previously, your credit report affects other areas of your life as well.

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