Wells Fargo / Freddie Mac Short Sale Update

Wells Fargo / Freddie Mac Short Sale Update 2/18/2010: We just closed a Wells Fargo short sale (Wells Fargo 1st & Wells Fargo 2nd) by convincing Freddie Mac, the investor behind the 1st lien, to agree to allow the buyer to bring in extra funds to settle the 2nd lien. This is significant as Freddie Mac has a policy whereby they will not allow any extra funds to go to the 2nd beyond what they are giving them. This took an extra month to negotiate but hopefully will set a precedent for future transactions.

Tax Implications of a Short Sale: 1099C, California Taxes & Federal Taxes

*Note* The question of the tax implications of a short sale came up this morning during my appearance on “These Days” with Maureen Cavanaugh on KPBS radio. As there seems to be quite a bit of confusion and misinformation with regard to this topic, I wanted to address it here on our blog. The following is excerpted from the Short Sale FAQ page of www.battiata.com, which can be accessed in its entirety by clicking here:

With regard to state and federal taxes, however, here is the excerpt from Battiata.com -

Q: Will I have to pay federal taxes on the money my lender loses in the short sale?

Answer: There are several different scenarios with regard to whether or not you will owe federal income taxes on the loss the lender takes in a short sale.

When you do a short sale, your lender is agreeing to settle the debt on the property for less than the amount they are owed. The IRS therefore allows them to write off this loss, which is why your lender will send you a 1099-C after the short sale.

The IRS considers “debt relief” to be income for tax purposes. In other words, if your lender writes off $50,000 on your short sale, they will send you a 1099-C for that amount, and you would include that when you file your income taxes. The “C” stands for “Cancellation of Debt” and the law says cancelled debt is taxable as income.

There are however a few exceptions that most people who do a short sale qualify for that exclude them from having to pay taxes on their short sale.

Thanks to the Mortgage Tax Debt Relief Act that George W. Bush signed into law in January of 2008, homeowners who do a short sale on their primary residence, and have a purchase money loan (in other words, they have not pulled cash out of their home with a cash-out refinance) pay no taxes on the loss that their lender incurs in a short sale.

Homeowners who have pulled out cash from their home but have put that money back into their home to “substantially improve” their home, also are excluded from taxes on the short sale.

All other short sale scenarios – if you pulled cash out on your primary residence but spent it something other than upgrading your home or if you are doing a short sale on a second home or investment property – result in a taxable event unless you qualify for the “Insolvency” exclusion.

The IRS does not require you to pay taxes on the loss the lender takes in a short sale if, at the time of the short sale, you are insolvent. Insolvency means your debts (including your mortgage) exceed the value of all your assets. In other words, if, at the time of the short sale, you have more debt than you do money or assets, you are considered insolvent.

Many people who find themselves facing a short sale are in exactly this situation and are thus excluded from paying taxes on a short sale. We recommend you check with your CPA or accountant or go to the IRS website and look up IRS Form 982, which is the IRS form for debt relief and short sales. The IRS gives an explanation of “Insolvency” on this form.

Finally, the time period for The Mortgage Tax Debt Relief Act was originally only slated to go until the end of 2008, however it has now been extended to the end of 2012.

Q: Will I have to pay CA state taxes on the money my lender loses in the short sale?

Answer: California has passed its own version of the federal Mortgage Tax Debt Relief Act. It is Senate Bill 1055, which conforms to the federal law described in detail above, but applies to California state income taxes on a short sale.

There are differences between the state and federal law. For example, the term of the California law was only until the end of 2008. As of Jan 2009, this law is no longer in effect.

However, CA Revenue & Taxation Code Section 17131 provides that, unless there is some specific California statute to the contrary, California law tracks federal law on what income is excluded from taxation. Since there is currently no specific California law on this issue, short sales do not produce taxable income under California law as long as the Federal Mortgage Tax Debt Forgiveness Act is in effect (until the end of 2012).

With this said, we recommend you review your specific tax scenario with your CPA or accountant and have them answer any tax questions that you have. We are not tax advisors and do not dispense tax advice.

Short Sale Lender Update: Chase

We have gotten word from our clients that Chase has been trying to pursue deficiencies on Chase 2nd liens months after closing the short sale. Fortunately, we negotiate a full and final satisfaction on all of our Chase short sales, so these collection attempts cease immediately once we fax Chase their own short sale approval showing “full settlement”. Word to the wise – do not allow Chase to charge off your 2nd lien (which they will typically do after about 5-6 months of missed payments) – same goes for PNC/Nat City. Once these 2nd liens are charged off, a full and final satisfaction will require a payoff of 60% of the balance.

Short Sale Lender Update: Navy Federal

Navy Federal has started requiring an average of 30% of the balance owed to approve short sales and settle the debt. They typically ask the seller to sign a promissory note however the good news is that we have been very successful of late in negotiating around this so our sellers do not have to sign a promissory or contribute any money. If you have a Navy Federal loan, be sure to ask us about this.

Short Sale Lender Update: Wachovia

Wachovia is hands down the best lender to deal with for short sales. We routinely close Wachovia short sales in 60 days and are able to get 1% credit to the seller at close of escrow.

Short Sale Lender Update: Wells Fargo

Wells Fargo has implemented a policy whereby they will not allow any extra funds to go the second lien holder on Freddie Mac backed loans – even if the 2nd is a Wells Fargo loan and the first lender’s net is not decreased at all. With that said, Wells Fargo is one of the best lenders to deal with when doing a short sale.

Where are all the Foreclosures?

There is a serious disconnect going on in the San Diego real estate market, one that is causing many people to wrongly conclude that the San Diego market is at a bottom and ready for a revival in 2010.

The disconnect has to do with foreclosures – or that is, the lack of foreclosures in the San Diego marketplace.

2009 saw four concurrent foreclosure moratoriums in California – this meant that almost none of the homeowners who were in default and threatened with foreclosure could actually got foreclosed on in 2009.

The purpose of these moratoriums was ostensibly to give the banks time to modify borrower’s loans, but the banks have no interest in modifying anyone’s loans, so all the moratoriums did was put off the inevitable and back up the pipeline of homes that will go to foreclosure. That is why we saw so few foreclosures hit the market in 2009.

The reason we have not yet seen many in 2010 is a different one. The last moratorium ended in September 2009. Since then, the banks have been recording Notices of Default (the precursor to foreclosure) and Notices of Trustee Sale (foreclosure auction) at a feverish pace in San Diego County.

As of January of 2010, there are literally hundreds, and sometimes thousands of homes scheduled for foreclosure on a daily basis just in San Diego County alone. So here come the foreclosures, right?

Not so fast. Most of the homes scheduled for foreclosure auction (aka “trustee sale”) are deliberately taken back by the bank. They do this by designating the opening bid price to be above market value, ensuring that no one will bid on it and the property will go back to the bank. This, despite the fact that the bank will almost always net more money by selling the property at auction versus taking them back, processing them, rehabbing them and then putting them on the market as REO’s (“Real Estate Owned” by the bank).

So why would the banks do this? The answer is simple. The banks are cooking their books to boost their reserves (on paper anyway) and make themselves appear more solvent than they actually are.

For example – when a bank takes back 1000 homes they were owed $500,000 on, they can count these homes as $500 million in assets. Now they know that when they actually sell these assets, they will net significantly less (i.e. in San Diego, maybe half of what they were owed, or $250 million), so they would rather hang onto to them in order to boost their bottom line and inflate their reserves (again, on paper anyway).

Some have speculated that this is so they can pay back the government faster and give their executives bonuses sooner.

Regardless of the reason, eventually the banks are going to have to sell these homes. They can’t sit on them forever, not just because they will eventually need the money, but also since while they do, these homes are falling into deeper and deeper disrepair, and the municipal fines for dead lawns, attractive nuisances, unpaid HOA’s etc. are adding up to bigger and bigger numbers.

Yes, eventually, these homes are going to hit the market, and when they do, the San Diego market is going to feel it.

Recourse vs. Non-Recourse Loans

A true short sale is a sale in which the bank agrees to settle the debt owed on the property, which means the seller is not going to owe the bank any money, there is no deficiency judgment and the seller is not signing a promissory note – in other words, it’s a done deal and the bank agrees to take the loss and forgive the debt.

So how do you make sure this is the case when you do a short sale? Well, it depends on what kind of loan you have – a recourse, or non-recourse loan.

If you have never refinanced your loan (or loans, if you have a first and a second), you have a purchase money, non-recourse loan, and the bank cannot pursue the deficiency when you do a short sale. For this reason, a lien release from your lender is sufficient when you do a short sale on your primary residence in California. A lien release simply means your lender is agreeing to release the lien and allow the short sale to go through. Because the loan is non-recourse, the bank cannot pursue any deficiency, and the deficiency is automatically considered forgiven debt.

On the other hand, if you have refinanced your loan (or loans), regardless of whether you have pulled cash out or not, you have recourse loans, which means the bank can pursue a deficiency after the short sale, and thus a simple lien release is not sufficient. In this case, your real estate agent needs to negotiate a “full and final satisfaction” from the bank, which means the bank cannot pursue the deficiency and is agreeing to settle the debt, despite the fact that your loans are recourse loans. Without this, the bank reserves the right to pursue the seller for the deficiency after the short sale.

Negotiating a full and final satisfaction with a lender on a recourse loan requires more money going to the lender (usually the 2nd loan) and requires more time and effort. It also usually means the short sale will take longer to get approved and closed, but obviously it is well worth it from the sellers’ perspective. It should be noted that this is not always possible, but this should be the goal in a short sale.

Unfortunately, I hear too many horror stories from sellers who did not get a full and final satisfaction on their recourse loans when they did a short sale and they end up owing the bank the deficiency. I also hear of many instances where the seller’s agent pressured them into signing a promissory note for the balance, instead of negotiating a settled debt with the bank.

Bottom line, if you make the decision to do a short sale, make sure your agent does their best to get a full and final satisfaction on the debt from your lender if you have a recourse loan.

How will a Short Sale Impact my Credit?

Spend a few hours browsing the web on the topic of short sales (as I am sure many who are reading this post have), and one question that you are almost certain to not get a straight, definitive answer on, is how a short sale will impact your credit. Truth be told, getting definitive, consistent, reliable answers on any aspect of short sales, foreclosures, deed-in-lieu of foreclosures, bankruptcy, forbearances, loan modifications or any other related topic is difficult to say the least.

Different websites tell different stories – they can’t all be right since they are offering conflicting information – and since, reading between the lines, they all seem to have an agenda, how do you know who do you trust?

Well, let me give you my 2 cents; I have done literally hundreds and hundreds of short sales over the past few years. I’m pretty sure I’ve done more than any other agent in San Diego (and very possibly in the state of CA), but I have not confirmed this, I may be wrong, and it really doesn’t matter anyway. The important thing is that I’ve done enough of them to have more experience with them than the overwhelming majority of agents, brokers, attorneys and various short sale “experts” out there. This is not to brag – it is simply a statement of fact.

And I have no agenda – in other words, if a short sale is your best option, I will give you all the information, educate you and allow you to make your decision. That’s the purpose of this blog and this website.

Many of the people who contact me about short sales want to get out of their homes – they’ve already made that decision, they just have questions about the process. But sometimes I hear from a client who wants to stay in their home if at all possible. For those people, I tell them to exhaust every possible option to keep their home before going the route of a short sale, and I give them the information to do that too.

So, with this said, I have done my best to address many of these topics on the short sale FAQ page on our website (http://battiata.com/ssfaq.php).

I also launched a free, not for profit website – http://www.sandiegomortgagehelpline.com/ – a couple of years ago to provide this information to homeowners. This site allows homeowners’ access to counselors who can answer their questions about short sales, loan modifications, foreclosure etc. so they can make informed decisions with regard to their homes and their financial futures.

One topic that comes up consistently, and to be fair, varies from person to person, and situation to situation, is how a short sale impacts your credit.

A short sale is reported on your credit as “debt settled for less than the amount owed.” And as an aside, while we are on this topic, it is not possible to negotiate with your lender to have them report your short sale as anything other than a short sale (i.e. “paid in full”). I have seen lenders do this in error, but this is unusual, it is never done intentionally, and I would not expect it to happen in your case.

So, a short sale will be reported to the credit agencies as a settled debt, but for less than the full amount. The impact this will have on your credit will depend on how established your credit is prior to the short sale. In other words, if you have excellent credit, built up over years of paying your bills on time, the short sale will have less of an impact than if you are just out of school, just bought your first home and have not had time to build your credit up.

The other variable is whether you have late or missed mortgage payments on your credit along with the short sale. Typically, it is the missed mortgage payments that have more impact on your credit than the short sale itself.

Many people, when they do a short sale, stop making their payments, either because they cannot afford their payments, or because they decide to stop putting good money after bad, and make a conscious decision to stop making their payments.

And more and more, borrowers are being forced to do this, as some banks are starting to require borrowers to be delinquent in order for them to approve their short sale.

Either way – whether you continue to make your payments or stop making your payments; whether you have good, established credit prior to the short sale, or not so good, relatively unestablished credit – the good news, and something that the vast majority of people are unaware of, is that it is relatively easy to repair your credit after the short sale is done.

You can do this yourself, or you can hire any number of credit repair companies to do it for you, and often in as little as 6-9 months, you can get your FICO score up higher than it was prior to the short sale and the missed payments.

Finally, a couple of years ago, Fannie Mae & Freddie Mac revised their lending guidelines as far as how they view people who have had a bankruptcy, done a short sale or gone through foreclosure. And in effect what they did is severely penalize people who go the route of bankruptcy or foreclosure – in most cases those borrowers have to wait 5-7 years before than can buy another home.

By contrast, they are rewarding or encouraging people who go the route of a short sale, as they view a short sale as doing the responsible thing in light of the circumstances. The seasoning period for a short sale is only 24 months – in other words, a two year waiting period after a short sale to buy a home.

Keep in mind, this is just for Fannie Mae and Freddie Mac backed loans – there are many lenders out there who do not ensure their loans through Fannie and Freddie, and we are already seeing these lenders extending loans to homebuyers in less than a year after a short sale.

Bottom line, every situation is different, and there are a lot of variables to consider. Make sure you get good advice from someone who knows what they are talking about and will give you honest, unbiased advice, so you can make the best decision for you and your future.

Matt Battiata Talks About Senate Bill 94

I recently appeared on CW Ch. 6 in San Diego to discuss the San Diego real estate market, the coming wave of foreclosures in 2010, the extension and changes to the buyer federal tax credit and passage of CA SB-94, a bill passed by the California legislature that prevents loan modification companies (i.e. mortgage brokers, real estate agents, law firms etc) from charging up front fees for loan modifications.

This bill is a big step in the right direction because it prevents loan modification companies from misrepresenting and exaggerating what they can accomplish in a loan modification in order to get borrowers to pay an upfront fee. Now, these companies can only charge borrowers after they have performed the service and, as is often the case, if they do not do what they promised at the outset, they will not get paid at all.

Still, this bill will only be effective if people are aware of it, and know that it is now illegal to charge an upfront fee, as companies have undoubtedly already figured out ways around it. My advice: if you want to do a loan modification, do it yourself. All it entails is sending in the required paperwork.

There is no negotiating that goes on in a loan modification. The banks do not care if a “forensic audit” by your attorney or mortgage broker turns up violations on your loan application and they will not be intimidated by your attorney threatening to sue them (do you think Chase, BofA, CW, Wachovia etc might have a few attorneys of their own on staff?).

Bottom line, you do not need to hire any outside company, law firm, mortgage broker etc to do a loan modification as they are not going to get any different of a result than you will doing it on your own. In fact, I would bet you will probably get a better result doing it on your own based on the horror stories I have heard about most of the companies and law firms doing loan modifications.

The Deal with Loan Modifications

The Obama administration is continuing to put pressure on major mortgage lenders to make a meaningful effort to modify homeowner’s loans so that they can avoid foreclosure and stay in their homes.

Here in California, both the federal and state government passed repeated and virtually concurrent foreclosure moratoriums in 2009 – a total of four for the year – that prevented banks from being able to foreclose on homeowners in default. The express purpose of these moratoriums was to delay foreclosure proceedings and therefore give homeowners and their lenders time to modify loans.

The lenders for their part have put out a huge PR blitz to convince the government, their stockholders and the American public that they are working hard to modify borrower’s loans and help them to stay in their homes. Go to most major lenders’ websites, and you will find upbeat, encouraging information on how to apply for a loan modification, and seemingly sincere letters from their CEO’s telling you how dedicated the bank is to helping people avoid foreclosure.

Bank of America and other lenders are even spending millions of dollars on national advertising campaigns with this same message.The lending industry, under pressure from the US Treasury & HUD, even created a non-profit alliance to assist homeowners in danger of foreclosure, called HopeNow.

This would all be good news if the banks actually had any intention of modifying borrower’s loans to any meaningful degree, but unfortunately they don’t.

At the Battiata Real Estate Group, we get hundreds of calls every month from people in danger of foreclosure who want to do loan modifications. We don’t do loan modifications. We did them back in 2008, at first for a fee with a money back guarantee, and then for free, and then not at all, because we found that homeowners could just as easily do them themselves.

We also found that unlike a short sale, we really could not make a difference with the lenders in a loan modification. You simply submit your paperwork and wait for a response from the bank – there’s no negotiating. They will either do it or they won’t, and most of the time, they won’t.

But we do know how loan modifications work, and we know the criteria the lenders use to determine who qualifies and who doesn’t, so even when we did loan modifications, we were very up front with people as to whether they would likely qualify, and if they did qualify, what they could expect to gain from a loan modification. For this reason, 90% of the people who called us for loan modifications, once they realized their chances of qualifying, and if they did qualify, what they could reasonably expect to gain from a loan modification, were no longer interested. Here’s why:

The overwhelming majority of people who apply for a loan modification will not qualify. This is because the lenders have purposely made the qualifying criteria extremely narrow. In other words, most people either make too much money to qualify for a loan modification, in which case their lender denies their loan modification application because they do not need one in the lender’s opinion, or they do not make enough money, in which case the lender denies their application because they say the borrower could not afford their loan even if they modified it.

In either case, the borrower will not qualify. That accounts for the majority of applications – over 80%.

Now for the small minority who do qualify, what can they expect to gain from a loan modification? The answer: a slight reduction in their monthly payment for a temporary period of time, typically 36 months, after which their payment will go back to where it was originally and the deferred interest they did not pay in the modification period will either be due in a balloon payment or tacked onto the backend of their loan. That’s it.

So, for example, a borrower’s payment typically would be modified from $3,500 down to $3,000 per month for 36 months. At the end of the 36 month period, the $18,000 that the borrower saved in their reduced payments would either be tacked onto the back end of their loan or be payable in a balloon payment.

No principle reductions, no huge decrease in their monthly mortgage payment, no dramatic reduction of their interest rate. For this reason, most people who qualify are beyond disappointed when they find out what the bank is willing to do for them in a loan modification, especially since it has often taken them several months to finally get an answer.

I hope this will change in 2010, but I am not optimistic unless we see a major government intervention that forces the banks to be more aggressive in modifying borrowers’ loans.