[Caveats: 1. The following information is solely based upon Oregon law. Residents from other states should not assume their laws will result in the same outcome. 2. This post is for informational purposes only and should not be relied upon as “legal advice” for your particular situation. In all cases, you should consult with your own attorney. There are many facts and circumstances that can change results. You need to speak with an expert who is familiar with the terms of your specific loan. – PCQ] As we enter 2012, four to five years following the real estate and credit debacles – depending on your location – we’re still in the doldrums. Drifting, and not moving in any specific direction. So, are there any words of wisdom, any encouragement, any sense that this static economic situation will improve? To those looking for predictions, this post is not for you. I have insights, but suspect they are no better than the next person’s. However, having said that, for those readers interested in a discussion about some of the Portland housing statistics, go to this link. Beyond that, for the present, I will refrain from the temptation to say what I think the future holds for Oregon’s housing inventory or its Realtor® industry. I’m saving that for another time. Rather, the purpose of this post is to provide some degree of encouragement. This is not to suggest that things will necessarily turn around this year – or at least not materially so – but that things could always be worse; that life, by definition, is a series of highs and lows, and events are rarely as good, or as bad, as they may first appear. So what do we make of this housing recession, foreclosure mess, and tight credit, all coupled with lagging employment numbers? What about those – now estimated to be nearly 30% of American homeowners – who are struggling with negative equity, meaning that their total mortgage indebtedness exceeds their home’s value? Here are two scenarios to make the point that this housing crisis has hit everyone differently:
- A home was purchased in 2006 for $200,000, with a down payment of $40,000 and mortgage of $160,000. Today it is worth $120,000. This means that the homeowners have lost their entire $40,000 down payment – in real dollars – and have $40,000 “negative equity” – meaning they owe $40,000 more than their home is worth.
- Compare that to another $200,000 home purchased in 2006 with 100% financing; say, an interest-only 80% first mortgage and an interest-only 20% second mortgage. This home is also now worth 120,000. In this second instance, there is $80,000 in negative equity, but no real out-of-pocket dollars were lost.
Which homeowner is worse off? Is $80,000 negative equity worse than $40,000 negative equity? Both amounts can be staggering, and both sets of homeowners are can feel equally distressed. So, rather than quantifying the unpleasantness, let’s assume that both situations are equally worthy of resolution. So, having concluded that monetizing the unpleasantness leads nowhere, what about homeowner age? One might assume that this is the most significant demographic distinction. The younger the homeowner, the longer their time horizon is going forward. There is more time for recoupment. For older homeowners, say 50 and above, their time for recoupment is shorter. However, both feel the distress equally; the younger homeowners have families, employment, schooling, college, and retirement savings to worry about; the older homeowners have their own priorities: protecting their existing 401Ks or retirement savings, a desire perhaps to relocate to another area nearer children and grandchildren; and significantly, to retire in peace – free of debt and debt collectors. Not only is it impossible to identify which group is impacted most by negative equity, it is probably unfair to even ask. Again, let us assume that both situations are equally unpleasant and equally worthy of resolution. So how are distressed homeowners – regardless of debt and demographics – supposed to deal with the fact that they are drowning in negative equity? Keeping in mind that the loss of down payment occurred in the past, but the existence of negative equity – in some cases – could result in a future loss, should the banks seek to recover some or all of the remaining debt. This can be equally true in the case of exposure to the IRS and Oregon Department of Revenue for income tax liability resulting from debt cancelled by the bank. Although I cannot change any of the facts that have occurred so far, I have found that good reliable information is sometimes the best medicine for distressed homeowners. Armed with knowledge of one’s rights is a valuable tool in combating the unknown. So, here are some thoughts from one who wants to see all Oregonians – regardless of how and why they arrived at this juncture – move forward, free of the oppressive weight of negative equity.
- If you live in your home and have only one mortgage (called a “trust deed” in Oregon and certain other states), the bank cannot recover a penny more than what you are willing and able to pay. In other words, in Oregon, if you cannot afford to continue making your payments (principal, interest, taxes and insurance), the bank can take the home through foreclosure, but can get nothing more. No judgment for a deficiency, costs, expenses, attorney fees or anything else. Nada.
- If you live in your home and have only one mortgage and want to short sell it – that is, sell it for less than the amount of the mortgage debt (and closing costs of the sale) – it is likely the bank will permit you to do so, since they, like you, want to be rid of the home. The most important factor is whether you can present the bank with a viable offer that the bank believes is close to its current fair market value. If the bank wants money from you as a condition to consenting to your short sale, just remind them that if they kill the sale, they will have the pleasure of foreclosing the home and taking it back into their already bloated REO inventory. If killing the short sale will not advance the bank’s financial position, why would they do so? [Note: the preceding sentence is based upon logic and good sense – commodities found to be in short supply at many Big Banks. – PCQ ] In short, there rarely is any reason to pay the bank a significant amount of money for their consent to the short sale; but if you can afford to do so, and it speeds up the process in getting this unpleasantness behind you – by all means, you should consider doing so. If you cannot afford any extra payment, then tell the bank. Remember, they can easily verify this by checking the financial information you already provided at the start of the short sale process. They have been known to back down.
- Today, some Oregon banks are electing to judicially foreclose homeowners – that is, by filing a lawsuit against them, seeking a judgment for the monies due under the promissory note and executing on the home to satisfy some or all of a borrower’s indebtedness. If you live in your home and have only one mortgage, it generally makes no difference whether the bank initiates a non-judicial or judicial foreclosure. They cannot obtain a money judgment against you for any deficiency.
- While it is true that your credit score will suffer from any distressed housing solution (e.g. short sale, deed-in-lieu-of-foreclosure (“DIL”), or foreclosure). But, remember, you’re in pretty good company. Folks up and down the socio-economic ladder are in the same boat. If you have good credit habits and this distressed housing event is the only black mark on your credit, you will pull out of it; just get the event, e.g. short sale, DIL, etc. over with, and then exercise your “credit muscle” on a continuous basis by using your available credit, and repaying it quickly. The sooner the distressed housing event is behind you, the sooner you can pursue recovery. This is generally why short sales are a preferable starting point to dispose of a home with negative equity, since short sales normally occur sooner than foreclosures. It is not uncommon for a short sale to be completed in six months or under; but it is questionable whether a Big Bank can complete a foreclosure in less than 12 months from the first default in payment.
- Big Banks frequently do not want to pursue outstanding unsecured debt in their own name. (This would be the debt that they may otherwise be entitled to pursue following a foreclosure or other distressed transaction.) They will sell the paper for pennies on the dollar. So remember that the debt collector seeking repayment from you likely paid 10% or less for your promissory note. This means, for example, that if they paid, say 5% for a $50,000 note, if they recovered $5,000, they are doubling their money. Money talks when negotiating this unsecured debt. Collectors do not want to carry promissory notes.
- If you are being contacted by a debt collector, either before or after your short sale or otherwise, don’t put up with abuse. Know your rights under the Fair Debt Collection Practices Act. There are some debt collectors that are known for abusive practices. Recently, Bank of America, in an effort to reduce the volume of mortgages it services, sold some of it, especially many non-performing loans, to Greetree Servicing. Greentree has a very bad reputation for its debt collection practices. To read about some of their shenanigans, go to this link.
- Lastly, on the income tax side, here are some tips – which you must verify with your own CPA:
- In almost all cases, the disposition of your primary residence this year, through short sale, DIL, or foreclosure, will not result in the assessment of any state or federal income tax, so long as you lived in the residence for two of the last five years and used all of the borrowed funds to buy, build, or substantially improve the home. These rules apply to a second mortgage, as well.
- This law will expire on December 31, 2012. Hopefully it will be extended.
Conclusion. At this point in time, after four to five years of economic uncertainty, some might say that it is time to move on. Home ownership is still important. But if a home is drowning in negative equity, it is no longer a home. It is a prison. It stifles family plans, migration, employment decisions, and a general sense of well-being. The sad fact is that negative equity is a black hole that will take most current homeowners a decade or more to climb out of – just to equalize the outstanding debt with the home’s value. If that is not a fact that should prompt most people to take action now, nothing will.