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Thread: more rude awakenings for overextended homeowners ...

  1. #1
    Banned Melonie's Avatar
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    Default more rude awakenings for overextended homeowners ...

    (snip)"If they previously refinanced and their lender decides to foreclose, they may not only lose their house, but the bank also may be able to go after their other financial assets including stocks, savings and their paycheck.

    And even if the bank doesn't go after their other assets, a foreclosure may mean a big tax bill from the IRS and state Franchise Tax Board for any shortfall between what the bank gets for the sale of the owner's home and the value of the loan."(snip)

    "In a study released in February, First American Real Estate Solutions in Santa Ana estimated as many as 8,000 Orange County homeowners could lose their homes to foreclosure over the next four years.

    Some homeowners with little of their own money in their homes may think they will do what strapped homeowners in the '90s did: turn over the keys to their lender if things get really bad and walk away.

    But Hall and other financial experts warn that things may be different this time because so many people have refinanced. The difference is the recourse loan.

    In the past, when a lender foreclosed, the homeowner usually still had the original loan they got when they purchased the house. Original loans, considered purchase money, are non-recourse loans that limit lenders to recovering only what they can get when they sell the house. They can't go after the owner to pay any difference between the foreclosure sales price and the loan balance.

    But in California, refinanced loans, second trust deeds and home equity lines of credit are generally considered recourse loans. In these cases, a lender can file suit and go after almost any of the borrower's assets once they obtain a court judgment.

    "They can literally go after everything you have," Hall says.

    There are a few limited exceptions. Retirement accounts are excluded, and declaring bankruptcy could protect some homeowners."(snip)

    "Even if a lender doesn't go after a homeowner's personal assets, a foreclosure can trigger income tax consequences.

    Hall notes that lenders usually want to get rid of foreclosed properties as quickly as possible and often will sell them at auction prices much lower than the true market value. If the house is listed or sold for less than the loan value, the homeowner will not only lose his house but also may have to pay income taxes on the difference because it is considered debt relief income.

    For instance, if the foreclosed homeowner has a $500,000 loan and the lender sells the house for $450,000, the homeowner will have to pay taxes on the $50,000 difference. The $250,000 tax exemption for singles and $500,000 for joint filers does not apply to debt relief income, in this case the $50,000.

    The tax owed on the debt relief is based on the homeowner's ordinary income tax rate, not the lower capital gain rates. The exclusion, however, may still be available to reduce any capital gains in the difference between the sales price and the homeowner's basis.

    "Some would say that's a disaster, but it's better than having the lender take you to court, obtain a judgment and then go after (your other assets)," Hall says."(snip)

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    Default Re: more rude awakenings for overextended homeowners ...

    You are referring to a deficiency judgement or concept. I have only seen this in the south east US, where sometimes the liability of the debtor is not just limited to the property if the
    the value of the property falls below the mortgage amount. This is the "defincency" or loss to the lender.

    No matter that the lender did a stupid loan, or that it was a high risk loan. Sometimes, if you have waived certain rights in the note, the lender can come after your other assets
    and obgtain a judgement against you for the loss or "defincency." You should work hard in your state to change and eliminate deficency judgement concepts in your home lending laws despite the insurance company and banks controlling this aspect of your state laws.
    (Since most banks throughout the US are not locally owned anymore this is another problem but I digress.)

    The practical effect of this is that the lender is not taking as great a risk on values falling in areas where deficency judgements are allowed.

    In most midwest states, (again a different philosophy is at work behind the scenes) the lenders recourse is only to the collateral or property not the consumers other income or assets.

    Is this one reason why the loans in the midwest are more conservatively underwritten and there are fewer high risk loan deals? It's also harder for younger people to get credit and mortgages in the midwest, but how it works also to protect them from themselves in making really studid deals.

    Each state and certainly US regions have slightly different philosophy behind their debt collection, enforcement and mortgage collateral laws and application of those laws.

    In the midwest there is more emphasis on the lender knowing the market and conservative underwriting, because the lender is going to take the hit on deficiencies if value falls creating a loss on foreclosure turnaround sale.

    The new ingrediant in the mortgage soup throught the country is the no doc no equity ARM loan. We'll see how these play out on collection and falling values.

    I was surprised to find out that routinely in California some lenders allow a "cash back" option on even high loan to value loans. When I asked a lender why, she said so that home buyers can redecorate and "buy a cool new car" and "decent" furniture.

    This is not secured by the real estate collateral folks and is very dangerous, especially in an over priced, high loan to value, no doc, variable ARM rate loan area.

    I remember my parents in their after World War Two Cape Cod had a hard time scraping together money for a stove and refrigerater in the new house.

    Appliances were not considered part of the real estate, and you had to scrape together the money for them, and in the 1950's that meant the money for them in cash not credit.
    General Electric Finance was just getting started and in small towns the appliance merchants wanted the 100% cash up front.

    Non real estate collateral items should not be "cashed out" from the mortgage amount proceeds. These details are being merged into the Wall Street collaterized mortgage pools and not seen because of lack of knowledge of local real estate customs and applications.

    The argument is always "the law of large numbers" will take care of these details in the mortgage pool underwriting. As no one seems to have the authority to say no on bad deals, they are just risk "traunched" and priced differently.

    Large amounts of stupidly underwritten deals produce large amounts of stupid problems no matter how they are priced. Stay tuned on this.

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    Banned Melonie's Avatar
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    Default Re: more rude awakenings for overextended homeowners ...

    ^^^ while I don't claim to know every nuance of the financial laws in every state, the basic principle is this ...

    - original mortgages are legally considered to be 'non-recourse' loans, where the liability on the part of the borrower / mortgage holder is limited to the mortgaged property itself. This principle is what allowed the previous wave of bankrupt homeowners to simply hand over the keys to their houses during the S&L crisis and walk away.

    - certain recently written re-fi'd mortgages, piggyback mortgage loans, home equity loans etc. are legally considered to be 'recourse' loans, where the liability on the part of the borrower is equal to the amount of 'dollars' borrowed plus agreed interest and penalties (with no direct linkage to the property value). Thus if a bankrupt homeowner holding a recently re-fi'd mortgage, home equity loan, piggyback loan etc. attempts to simply hand over the keys to the house they can no longer afford, the lender will auction off the foreclosed property as before. However, because these loans provide the lender with 'recourse', any shortfall between the total amount of 'dollars' owed versus the amount of 'dollars' recovered via auction sale of the property is a valid (delinquent) 'dollar' debt owed to the lender which the borrower is still responsible for. The major difference that makes this issue so risky today is that, for the first time in many many years, declining real estate market prices plus creatively financed and/or low down payment mortgage credit terms are increasingly leading to situations where the auction price of a foreclosed property does fall short of the total amount of 'dollars' still owed by the borrower.

    Thus if foreclosure and auction of the property do result in a 'shortfall' of dollars owed vs auction price, the lender can now attempt to recover the remaining dollar debt from the borrower via forced liquidation of other assets owned by the borrower i.e. their car, home furnishings, bank and investment account balances etc. About the only assets which are safe from lender 'recourse' in such a situation are accredited retirement accounts (per a recent Federal court ruling).

    To make matters even worse, if the foreclosure and auction sale do result in an auction price for the property which is above the original purchase price (nonwithstanding the fact that the homeowner may have re-fi'd, used a home equity loan, or otherwise already extracted part of this appreciation and already spent the extracted cash) the IRS has ruled that any 'realized gains' accruing to the bankrupt homeowner during the auction process, i.e. any actual increase in property value realized at the time of auction vs the property value at the time of initial purchase, is to be considered as taxable income. Put another way, if a homeowner bought a house 5 years ago for say $200k, did a re-fi with equity extraction 2 years ago for $300k (based on a new appraisal), but has now been forced into foreclosure with the auction yielding a sale price of say $275k, that homeowner will still owe the bank $25k in shortfall between the $300k refi loan and the $275k auction price. Additionally, that homeowner will also owe the IRS approximately 25% tax rate * ($275k-$200k) or another $25k in income tax on the 'realized gain'! Thus both the bank and the IRS can then go after any other assets held by the homeowner to satisfy these remaining debts (except accredited retirement accounts per the Federal court).


    As to your comments on midwest collateral requirements, I think that you'll find that gov't directives to Fannie Mae and Freddie Mac in the late 90's, with the specific purpose of providing 'looser' financing / down payment / creditworthiness standards in order to foster greater home ownership among specific targeted groups of Americans, caused a de-facto federal override of more restrictive state mortgage laws. This in turn allowed non-GSE mortgage lenders to offer their mortgages under the same 'looser' standards in effect for FNM and FRE.



    as usual, 'good intentions' have led to unintended consequences
    ~
    Last edited by Melonie; 07-15-2006 at 08:57 AM.

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    Default Re: more rude awakenings for overextended homeowners ...

    I doubt that federal intermediary regulations override state foreclosure and state administrative procedures under state laws. This would be a constitutional challenge of the federal republic we live in as states tend to govern the laws of property withing their domains.

    In the midwest, liability tends to be limited to the value of the property, and if the value of the collateral (property) falls it is the lenders problem.

    Are you trying to tell me that people would sign away this right and still do very risking ARM deals with 100 % loan to value, (maybe 115% loan to value of inflated price), deals?

    In the midwest even if they waive their rights, they have a case under the standard foreclosure laws and the laws of equity if in foreclosure.

    What will be interesting is the how foreclosures are done in the west as the vaolues there are highly inflated. I suspect that in California the deficency is the lenders problem not
    the borrowers.

    When lenders make stupid loans and the CMBS pools on Wall Street buy them, the lenders and money sources should suffer, not the consumer.

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    Default Re: more rude awakenings for overextended homeowners ...

    ^^^ That's what they said about credit cards before the new bankruptcy laws...

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    Default Re: more rude awakenings for overextended homeowners ...

    ^^^ many provisions of last year's new bankruptcy law were specifically written to override previous individual state exemptions from home foreclosure and liquidation. The largest change written into the new federal bankruptcy law is that recently purchases homes (i.e. less than 40 months before filing for bankruptcy) are limited to a $125,000 exemption regardless of provisions of state law. In California, $125k buys you a garage.

    These provisions were motivated because some 'unscrupulous' people with a knowledge of strong state laws protecting homeowners had deliberately maxxed out every ounce of credit available to them, had invested the proceeds in a house in Florida or another state where homes were immune from bankruptcy under state laws, who then filed bankruptcy on all of their creditors under chapter 7 (total write-off), waited two years for the bankruptcy to clear, and then sold their 'protected' house for $1 million ... which, with the debts discharged under a chapter 7 bankruptcy ruling, the creditors couldn't touch!

    hat will be interesting is the how foreclosures are done in the west as the vaolues there are highly inflated. I suspect that in California the deficency is the lenders problem not
    the borrowers.
    My original post was from the Orange County California Register ! Yes the original mortgage is the lender's problem, primarily. Fortunately, there has been enough appreciation in property values in Cal that, despite recent downturns, the primary mortgage holder can usually recoup the outstanding balance at auction. However, second mortgages, re-fi's, home equity loans etc. are the borrower's problem, as these creditors are second in line after the original mortgage lender at the bankruptcy 'trough'. And nobody is being more aggressive about the 'realized gains' tax than the California Franchise Tax Board.
    ~
    Last edited by Melonie; 07-16-2006 at 04:41 PM.

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