As a real estate lawyer working in this field and representing banks and borrowers I can tell you the current crisis was not caused by lawyers, but by a system that made a bet based on historical data and lost big time. Since the 1930s real estate has always gone up in value. based on this premise, loans were carelessly made because the view was that even if the loan was bad, the property would still go up in value and get sold to pay the debt.
Secondly, the bundling of loans was designed to aid home ownership. If banks had to make loans solely based on their own deposits the home loan market would be 25% what it is today.
Third, the sloppiness and robo-signer issue is, in my opinion, vastly overrated. I have not seen one case yet where the borrower was not deeply in default.
What I do see is banks failing to properly negotiate, delay short sale approvals and miss loan mod opportunities despite the fact that ultimately they will get less.
On a lighter note, I wish everyone a Happy Thanksgiving!!
Friday, November 26, 2010
Saturday, November 13, 2010
In today’s current real estate market, many owners are upside down on their real estate homes and/or investments. When the property is sold, whether voluntary or involuntary, this shortfall needs to be addressed one way or another and the effect of same can have substantial financial impact.
Being “upside down” means that the amounts owed on all loans on your property, determined at a specific time and in a specific manner, exceeds the value of your property. This “value” can change depending on whether the calculation is being made as a part of a deed-in-lieu, a short sale, or a foreclosure.
In a deed-in-lieu transaction, the owner transfers the property to the lender in satisfaction of the mortgage encumbering the property. If the lender determines that the value of the property in question is less than the mortgage debt, a deficiency arises. By way of example, if the lender is owed $329,000.00 at the time of the deed-in-lieu transfer date, and the lender has determined that the property’s value is only $270,000.00, a deficiency of $59,000.00 would exist.
In a short sale, the deficiency is determined based on the net proceeds received by the lender at the time of the sale. Using the same values described above, if the property is sold for $270,000.00, the net proceeds given to the lender will be substantially less. Assuming a six percent real estate commission, and traditional closing costs (documentary stamp tax, title insurance and tax credits), the net proceeds to a lender on the sale will likely be less than $250,000.00 resulting in a deficiency of over $79,000.00.
Deficiencies in a foreclosure are judicially determined after the foreclosure sale. If a lender is seeking a deficiency, the lender must apply to the court and provide appraisal information to support the valuation. The property owner has an opportunity to challenge the valuation by submission of evidence to support a higher valuation. At the deficiency hearing, the court determines the property’s value as of the foreclosure sale date and then calculates the amount of the deficiency.
If a deficiency exists, there are several possibilities that a property owner might face depending on what the lender chooses to do with regard to the shortfall. This includes debt forgiveness, collection by the lender or sale of the debt to a third party for collection. In addition, in many cases, an owner will have a first and second mortgage on their property. Generally the second mortgage lender gets little or no money, and may take action separate and apart from the action of the first mortgage lender, even if the loans are titled in the name of the same lender (most loan holders are servicing agents who may own a portion of or none of the actual loan and the actual owners may direct that different action be taken on each loan).
If the lender elects to forgive the indebtedness, the lender will send the property owner a Federal tax Form 1099-C. This is notice to you from the lender that the debt is canceled and no collection effort will be made on the debt. The amount of the debt forgiven is determined in the same manner as the deficiency. Canceled debt is generally treated as taxable ordinary income to the recipient of the debt relief unless some exception applies.
For example, if a property is foreclosed and the final judgment amount is $450,000.00, and the property has a value of $400,000.00 at the time of the foreclosure sale, the debt forgiveness will be $50,000.00. This $50,000.00 will be taxable income and treated as if someone paid you the actual money even though you did not receive any payment. If your blended tax rate is 20%, you would owe $10,000.00 in tax on this amount.
There are several exceptions to the taxability of the loan debt forgiveness. However, it is crucial that a Form 982 be filed with a tax return to make sure that the debt cancellation is addressed, regardless of whether the debt relief is taxable. The most common exceptions are as follows:
1. Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.
2. Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
3. Insolvency: If you are insolvent when the debt is canceled, some or all of the canceled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.
4. Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income.
The Debt Relief Act of 2007 was created to address the growing number of foreclosure on property for which the mortgage debt exceeds the value of the property. Effective for the tax year 2007 and valid through 2012, the Debt Relief Act allows homeowners to be exempt from taxation for debt forgiveness for loans up to two million dollars (one million for married couples filing separately) which secured the taxpayer’s primary residence. The Debt Relief Act has certain restrictions which may affect if any tax due as follows:
1. Only the debt given to acquire, build or substantially improve the residence is exempt. People who cashed out their equity via a refinance will only have a partial exclusion. For example, if the home was originally financed with a $300,000.00 loan, refinanced with a new loan for $400,000.00 in a cash out, and the value at foreclosure is $250,000.00 the taxpayer will have $50,000.00 in exempt income and $100,000.00 in taxable income.
2. The Debt Relief Act only applies to an owner’s primary residence. Second homes, rental property, vacation homes and investment property are excluded and debt relief on these properties will result in taxable income, unless another exception applies.
In order to obtain the exception, a taxpayer must complete new IRS Form 982 to evidence the debt forgiveness and to calculate the exemption amount. According to the IRS, in most cases the application under Form 982 only requires that a few lines be completed to obtain the appropriate relief.
As part of the debt forgiveness process, a careful examination of the amount forgiven and the value of the home listed on the 1099-C should be checked, especially if tax liability exists. If these figures are incorrect, the lender should be notified and an attempt to obtain a revised 1099-C should be made. If the lender refuses to make the corrections, you should consult a tax professional for assistance in challenging the 1099-C amounts with the IRS.
If the Lender does not forgive the indebtedness after foreclosure, short sale or deed-in-lieu, then the deficiency becomes an unsecured obligation of the maker on the note. In a foreclosure action, a deficiency is created by judicial determination. After the foreclosure sale, the lender applies to the court for a deficiency based on the value submitted by the lender. A property owner can challenge this valuation at the deficiency hearing by presenting evidence (appraisal or comparables) to support a higher value. At the hearing the court then determines the amount of the deficiency and awards the lender a judgment based on that amount.
If the deficiency arises from a short sale or deed-in-lieu, the lender must bring an action on the note against the maker, seeking the shortfall. As part of this process, a challenge to the amount due can be made. At the end of the lawsuit, the lender obtains a judgment against the maker under the note and can begin collection proceedings. In next month’s article we will discuss deficiency judgments and collections.
South Florida provides an opportunity to live in a variety of community types, each which provides both benefits and drawbacks. These include condominiums, cooperatives, homeowners associations, communities with restrictive covenants without an association, mixed communities with both condominium and homeowners associations and a property owners association. Understanding the restrictions each type imposes is an important part of deciding which community type to live in, since many people have a hard time in the more restrictive communities.
Condominiums are statutory creatures created to solve a specific problem, conveying ownership (fee simple) title to an area in space 100 feet above the ground. Prior to the existence of condominiums, the method to convey ownership in vertical buildings was cooperatives, which are described below.
The first condominium in the United States was established in 1958 and Florida enacted its first condominium act in the 1960s. Since then the law in Florida has evolved substantially to create a very rigid framework governing the creation, sale and operation of Florida condominiums.
Condominium ownership is designed to address the problem of many people living in close quarters. This includes prohibitions on parking, noise, type of flooring, leasing and sale restrictions, alterations, use restrictions, pet restrictions and even age restrictions.
In addition to the statutory requirements, all condominiums are created and controlled by the constituent documents created by the developer, the Declaration of Condominium, Articles of Incorporation, By-Laws and Rules and Regulations. These are part of the comprehensive Prospectus required by the Developer to give to all purchasers. These documents and any amendments thereto must be given to all buyers prior to closing.
After turnover, the condominium association is run by its board of directors, elected by the members of the community. The board is supported in its operation of the association by professional managers, lawyers and accountants who aid in the business side of the operation. The conduct of the board, including the conduct of meetings, are strictly controlled by law to allow for open disclosure for the benefit of all owners. The Board also establishes the budget for the condominium, and each owner pays an assessment to support the operation of the condominium.
Before condominiums were created the most common method to convey title to vertical buildings was through cooperatives. In fact many of the older Palm Beach buildings are cooperatives.
Unlike condominiums, which are conveyed by deed like any other property, there is no deed involved in cooperatives. Instead, buyers receive an assignment of the proprietary lease between the Association and the Unit Owner. This is because the entire building is owned by the Association, and the Association leases each unit to the occupant. In addition, each long term owner gets a stock certificate representing their percentage ownership in the Association.
Cooperatives are controlled by a statute similar to the Condominium Act. In addition, like a condominium, the cooperatives are controlled by similar situated documents, Declaration of Cooperative, Articles of Incorporation, By-Laws, Rules and Regulations and Proprietary Lease. Cooperative owners also face many if not all of the same restrictions as condominium owners. Like a condominium, the cooperative association is also run by an elected board of directors and raise operating funds through assessment.
Created as a method to provide uniform restrictions in traditional neighborhoods, homeowners associations were originally simple contracts between developers and the buyers. However, due to a combination of large scale development and a growing perception of problems within these communities, the legislature began to slowly adopt restrictions controlling the operation of homeowners associations. Today’s rules are fairly extensive, but do not reach the level of control imposed against Condominium and Cooperative Associations.
In addition to the statutory restrictions, each homeowners association is controlled by a Declaration of Covenants and Restrictions, as well as Articles of Incorporation, By-Laws, and Rules and Regulations. Many restrictions found in condominium living are also found in homeowners associations. The operation of the homeowners association is controlled by an elected board, with similar restrictions as condominium boards.
Property Owner Associations (POA):
Large communities frequently have multiple types of properties contained within that share common areas and facilities, and which can include both condominiums and planned unit developments, and even commercial condominiums. In order to manage the larger operation, a property owners association is created which oversees the entire project.
POAs or Master Associations are controlled by a Master Declaration, which dictates how the project is operated. Operations of the POA are controlled by a board, which can be formed by elections of all members, or, more commonly, by participation by directors from each underlying association.
Assessments for POAs are used to operate the Master Association. Some POAs direct bill the members and have a lien against individual owners. In other POAs, the assessments are paid by the Associations themselves, who collect the assessment form their members and then pay them in bulk to the POA.
Many communities are not governed by an Association, but are still subject to restrictions, usually in the form of Protective Covenants. This is especially true of planned communities developed prior to 1980. The Protective Covenants establish the restrictions on use, which generally include size requirements, home styles and some use restrictions. Since there is no Association, the only way to enforce the restrictions is for the other owners to file suit for breach.
Each community type imposes different and various types of restrictions. Fully understanding these restrictions before purchasing is a crucial to successful ownership. Failure to fully understand these restrictions can result in substantial conflict between an owner, other owners and the Association.
The Treasury Department has adopted, effective April 5, 2010, a new program to facilitate short sales for residential property owners. Prior to the new rules, homeowners who applied for short sales faced a long approval process, problems with second mortgage holders, lost buyers due to delays or extra costs, and frequent problems. The new regulations are designed to address the perceived shortcomings by changing the rules for the participating lenders.
In order to be eligible for the new Home Affordable Foreclosure Alternatives Program (HAFA), borrowers must first seek approval for a loan modification under the Home Affordable Modification Program (HAMP). Borrowers who are unable to obtain a loan modification, are unwilling to accept the terms of the proposed modification, or if after approval are unable to stay in the program are potentially eligible for short sale under the new guidelines.
Assuming a borrower is eligible the next step is the establishment of an acceptable sales price. Prior to this program, most lenders would not establish a fixed sales price, but instead would wait until an actual offer was received to determine if the price was acceptable. Under this new program, a borrower can submit an approved appraisal or broker’s price opinion. Once this value is accepted by the bank, the property can be listed, marketed and sold for at or above that price without treatments of the sale as a short sale.
Traditional short sales were often difficult to market and sell since many buyers were not willing to wait to see if their offer was acceptable. Others often gave up due to the delays in approval. By eliminating this issue, sales above the approved price can close in the normal course.
One of the biggest complaints about the short sale process is the failure of lenders to timely respond to short sale offers. Most short sale offers require lender approval within sixty days of submission. In many cases lenders would fail to respond and buyers would walk from the contract. The new rules require lenders to review and decide on properly submitted applications within ten days from the date of submission.
I do have a concern with this requirement solely due experience with lenders in the past. If lenders had trouble approving short sales within sixty days, how can they fairly decide now in ten days unless they commit many more resources to this matter. I am concerned that since it is easier to deny the application, many more short sales will be denied. Only time will tell if this is an accurate statement.
Once the short sale application is approved, borrowers will have a 120 day window in which to market and sell the property at or above the set price. During this window, no foreclosure action will be filed, and any pending action will be stayed.
Another key element of this program is debt forgiveness. Over 30% of all homes in South Florida are underwater. While most lenders have been forgiving debt after short sales, the lenders would not commit to that in writing, leaving many homeowners wondering whether or not they would face collection at a later date. Under this program, debt forgiveness is guaranteed. Homeowners must remember to properly address the debt forgiveness in their tax return to avoid a claim for income tax on the balance forgiven.
In order to encourage defaulting borrowers to consider a short sale in lieu of foreclosure, the lenders will now permit the borrower to receive up to $1,500.00 from the sale closing proceeds to assist them in moving and relocating expenses. Previously, in most short sales the borrower received no compensation at closing on the sale.
Many homeowners have both a first and second mortgages (including equity lines and helocs). This was often a large impediment to short sale approval, even though the second mortgage lender would generally be wiped out in foreclosure. To encourage these second position lien holders to release their lien, they can be compensated up to $3,000.00 at closing from the first mortgage lender’s proceeds.
Finally, to encourage lenders to approve short sales, the Treasury department will reimburse lenders up to $1,000.00 for each short sale completed under the new program. In the past, loan servicers benefited from avoiding short sales and completing foreclosures because they were able to recover extra late charges and foreclosure expenses from the loan investors. This payment is designed as a partial replacement for these lost funds.
Overall, this new program is another small but encouraging development in the correction of the residential real estate market. By creating a better mechanism for short sales, it is hoped that there will be less foreclosures and more short sales. Foreclosures can lead to empty, blighted neighborhoods, while short sales help keep a community occupied with new buyers. Unfortunately regulation rarely translates into real action unless the parties who support the regulations participate in good faith. Many homeowners want to avoid short sales to stay longer in their home, and many others simply cannot find willing buyers. Lenders and their servicers often avoid short sales because they do not want large sum of debt forgiveness on their books, especially when they have generally weak financial numbers. However, if properly implemented this new program could lead to many more (and faster) turnaround for some borrowers and lenders.
Friday, November 12, 2010
Welcome to my blog where it is my intent to educate and inform the public on a variety of issues relating to Florida real estate law. I have been a real estate attorney since 1985, and I am Board Certified by the Florida Bar in Real Estate. I am also rated AV Preeminent by Martindale Hubbell, the most respected attorney rating service.
I welcome comments and questions.
I welcome comments and questions.