Which Way is the Pendulum Swinging Now!

30 May Which Way is the Pendulum Swinging Now!

Since I am on a stay cation, I have another article that follows on the heals of Andrew Bers short sale article a few weeks ago.

Attorney and CPA, Jo Ann Koontz, of Koontz and Associates, PL penned a fantastic article concerning, has the pendulum shifted concerning short sale strategy. Enjoy the article!

Over the last several years there has been a steady increase in the number of borrowers pursuing short sales.  Some of these borrowers have been forced to seek this alternative as a result of job loss, divorce, medical problems or some other change in their life circumstances.  However, an increasing number of borrowers have deliberately chosen to part with their property at a loss as a strategy to avoid financially supplementing a losing investment.  Because so many homeowners have substantial negative equity in their properties and have little hope of ever seeing values return anywhere close to the outstanding loan balance, short sales are being viewed not as a failure to meet their financial obligations, but rather as a necessary step in righting their financial ship.

By participating in a short sale, sellers may receive partial or full relief of their loan obligation, avoid a substantial deficiency judgment and suffer a lesser negative impact to their credit as opposed to allowing the property to be foreclosed upon.  Lenders receive the fair market value of the property, possibly insurance proceeds, and avoid the expense of lengthy litigation and of maintaining the foreclosed property.

Fortunately for this growing group of sellers, the trend with first position lienholders has increasingly been to provide full waiver of deficiency, which is the difference between the net sale proceeds and the outstanding loan balance, in exchange for a relatively small cash contribution.  When short sales first became commonplace, full waivers of deficiency were not customarily granted and only resulted from diligent negotiation on the part of the attorney and negotiator.  Lenders frequently required the seller to contribute to the loss incurred in the form of a lump sum cash settlement, promissory note, or both.  Lenders are under no obligation to release the lien nor provide a waiver of a deficiency in full or in part.  The determination of a seller’s ability to participate in the lenders’ loss is made by reviewing the seller’s financial information.  Obtaining approval of the short sale from the lender is the least difficult portion of the process, provided the offer is reasonable. The treatment of the deficiency and the contribution on the part of the seller are the most critical aspects of the negotiation in a short sale transaction, particularly for high income or high net worth sellers.

In 2010, the Home Affordable Foreclosure Alternatives program (HAFA) was created by the federal government.  HAFA is a program that provides up to $3,000 in relocation assistance to sellers attempting to short sale their property and guarantees a complete release from the underlying debt.  In some cases, the result may even carry less negative effects to a seller’s credit score than a conventional short sale.  Eligible mortgages include those owned or guaranteed by Fannie Mae or Freddie Mac.  The seller is required to have a documented financial hardship, and must have lived in the home within the last 12 months with an outstanding first mortgage balance less than $729,750.  Currently this program is set to expire in December 2012.

In 2011, many of the major lenders implemented similar short sale incentive programs which offer sellers cash incentives, in addition to full debt forgiveness.  The terms and incentives vary by lender, by investor and by the particular circumstances of each loan and property.  These incentives should certainly not be expected by short sale sellers, as they are the exception not the rule.  In general, the eligibility requirements for these programs were very similar to those of HAFA.  However, second mortgages do not qualify for assistance, sellers must have occupied the property no less than 90 days prior to application and no offer may have been made on the property at the time of application.  Many of these lender incentive programs expired at the end of 2011, although there have been reports that many of the lenders are considering extending these programs as well.

Because the transaction is relatively fast to complete and keeps the property in better shape for resale than foreclosing on the property, lenders have an incentive to encourage short sales.  It is ironic, however, that just a few years ago many struggling borrowers who desperately needed a waiver of deficiency received no relief, yet today many borrowers with substantial income or net worth are being paid to walk away from their property.

By contrast, second lienholders are becoming less generous in their deficiency settlement negotiations and in some cases are pursuing deficiency judgments following the close of the short sales.  This may be due in part to the lack of assistance offered to second lienholders by the federal government and the fact that most do not hold mortgage insurance policies, which mitigate a lenders’ loss resulting from a defaulted loan.  Private Mortgage Insurance (“PMI”) is insurance coverage that lenders require of borrowers who obtain loans that are more than 80 percent of their new home’s value.  The insurance company collects a monthly premium from the borrower and agrees to pay the lender a certain amount of money if the loan defaults (typically 15%-30% of the loan amount).

PMI may also explain, in part, why there are so few loan modification approvals compared to short sale approvals.  Lenders who approve loan modifications will incur a loss by way of a reduction in interest or principal which will not be recovered by an insurance claim.  Whereas the short fall in a short sale may be covered, potentially in full, by the mortgage insurance claim.

However, it is also important to note that often the PMI company must approve a short sale because the policy is only triggered in the event of a foreclosure loss.  A short sale is a voluntary loss incurred by the lender and often does not qualify for coverage.  Therefore, the PMI company may approve or disapprove the offer or, more commonly, require whatever they choose in terms of repayment from a seller in the form of a lump sum or promissory note.  Each lender typically maintains a pre-approval letter or agreement with the PMI company as to the maximum loss that may be incurred on any transaction.  So long as the loss falls within these fixed ratios, the lender may negotiate terms and approval of the short sale independent of the PMI company’s approval or review.  However, if the loss exceeds the fixed ratios, the PMI company will be provided the entire file for review and will participate in the negotiations.

In the last year or so, additional layers and factors have arisen in short sale negotiations including short sales involving foreign sellers, which may be impacted by the Foreign Investment in Real Property Tax Act (FIRPTA), release of IRS tax liens, and release of judgments from Homeowners Associations. Because short sales are more complex than an average real estate transaction, it is important for sellers to retain experienced counsel to negotiate the transaction.  With the various incentive programs, implications of PMI, potential income tax consequences and lack of legal expertise held on behalf of many spreading what they believe to be facts, most clients are misinformed and do not understand the true implications of a short sale.  For that reason it is important to manage their expectations regarding the potential outcome of these matters.  Sellers must be educated on the various aspects of the transaction, the lenders’ remedies and enforcement rights, the implications of PMI, the potential tax consequences and the reality that full debt forgiveness is a possibility but by no means a guarantee.  When the seller thoroughly understands what to expect from the transaction, it is remarkably rewarding to see the relief when the burden is lifted and the rebuilding of their financial lives can begin.

Koontz and Associates PL assists clients throughout Florida in legal matters relating to Residential and Commercial Real Estate (including short sales), Business Law and Tax Law. From their Sarasota offices they serve clients in Sarasota County, Manatee County and throughout Florida.

The information provided in this article is for general informational purposes only and nothing contained herein should be taken as legal advice for any individual case or situation. The information contained in this article is not intended to establish an attorney-client relationship.

Jo Ann M. Koontz, Esq., CPA

Koontz & Associates, PL

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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