Short Sale: Before the Last Resort

A short sale, this is a relatively new term for a lot of people.  And if you haven't heard the term, I would guess that you live in an area that has not been affected by the housing bubble.  All over the country, people live in homes that are worth less than what they owe on it.  The mortgage term for this is being "upside down" or having negative equity.  Recently, this is a popular term that is frequently used when talking about a person's mortgage.

When a homeowner is upside down, the only way that they will be able to sell the home is if they do a short sale.  In a short sale, the bank agrees to discount a loan balance because of an economic or financial hardship on the part of the borrower.  Typically, a lender will not agree to a short sale if the homeowner is current on their mortgage payment.  Short sales are the last resort for homeowners to avoid foreclosure.  Just because the homeowner is avoiding foreclosure by doing a short sale, don't think that homeowner is going to turn around and buy another home right away.  A short sale looks better on a person's credit than a foreclosure; however, a short sale will report on credit that the mortgage balance was paid off for less than the amount owed.  In addition, by the time the short sale goes through, the homeowner will have late mortgage payments that negatively reflect on their credit report.  Still better than the alternative of foreclosure, which will keep the homeowner from mortgaging another home for at least four years. 

  

Both parties have to consent to a short sale and typically will when the only other choice is foreclosure which involves high fees for the bank and poor credit outcomes for the borrowers.  Short sales come down to is it more profitable for the lender to foreclose or do a short sale.  While losses can vary widely from foreclosures, several independent studies find them to be generally quite significant: over $50,000 per foreclosed home.  It is easy to see why foreclosure is the last resort for a lender.

Before deciding on a doing a short sale, people should first think about where they are going to live when their home is sold.  After doing a short sale, a homeowner's credit will be poor so they will have to rent unless they have cash to purchase a home.  Many landlords will check credit and see that their credit is poor and it is at their discretion if they want to rent to a person who has a history of not paying their obligations. 

There is a new trend in short sales and that is coming from people who can afford their mortgage payments but are upset that their home is now upside down; in addition, these people think that their home values will never appreciate to where their loan balance is so they no longer want to keep their homes.  People in many circumstances do not have a hardship and can afford to make their mortgage payments but choose not to because of a monetary benefit that can be achieved by doing a short sale.  Many lenders are cracking down on this mortgage fraud and prosecuting their victims which are usually homeowners and realtors.  Many realtors have embraced the short sale and use it as a tool to increase their business. 

One last thought that homeowners should consider before attempting a short sale:  a cancellation of debt 1099-C form will be sent to the homeowner from their lender after the short sale.  This cancellation of debt amount is for the difference between the outstanding balance on the old loan and the sales price of the home.  This canceled debt will be taxed as ordinary income and add a significant amount of money to anyone's taxes.  In some areas of the country, it is not uncommon for a homeowner to have a $200,000 mortgage balance and that same home can sell as a short sale for half that amount.  In that case, the homeowner will be responsible for a cancellation of debt in the amount of $100,000.  The $100,000 in extra income will amount to additional taxes of $21,616 in 2011 for a single person.  Don't forget that when your income is $100,000 for the year that puts you in the 28% tax bracket which is where the remaining income that you have will start being taxed and go up from there.  Most people don't have $20,000 laying around to pay taxes and it would be advisable for  them to figure out where that money will come from before doing a short sale.   

2011 Tax Rate	Single
10%	Up to $8,500
15%	$8,501 – $34,500
25%	$34,501 – $83,600
28%	$83,601 – $174,400
33%	$174,401 – $379,150
35%	Over $379,150

Before a homeowner does a short sale, it is in their best interest to try to get a loan modification.  Ask yourself this before deciding on  a short sale:  If my mortgage payment was cut in half, would I still want to do a short sale?  Many people who are getting loan modifications are able to get a new mortgage payment that is half of their original mortgage payment.  When your mortgage is cut in half, your upside down home might be worth keeping. 

Loan Modification or Refinance?

The main reason why you should do a loan modification instead of a refinance is fees, fees, fees, and a couple more fees.  When you do a refinance every time without fail you will be adding thousands of dollars on to the balance of your mortgage.  Separate fees for a refinance will be charged by the loan officer, escrow agent, lender, county recorder, notary, and possibly up front mortgage insurance premiums for your new FHA or VA loan.  These FHA and VA loans are becoming very popular as equity dries up because borrowers can get a loan for the highest amount relative to the appraised value of their home.  The current upfront FHA mortgage insurance premium is 2.25% of your new loan amount.  That equals to $4,500 on a $200,000 mortgage and that is only one expense.  Let's not forget about the monthly mortgage insurance premium that FHA charges of $83.33 paid monthly for five years on that same $200,000 mortgage.  The VA funding fee is slightly higher at 2.75% of the loan amount for a first time VA benefit user and the 2nd time user of VA benefits will be charged 3.75% of the new loan amount.  3.75% of a $200,000 mortgage is an upfront fee paid by the borrower of $7,500.  Uncle Sam's really corn-holing the  Veterans!

Now we will take a look at what the fees are on a loan modification.  The fees for a loan modification are free if you choose to do the loan mod yourself.  The one fee that you might have when doing a loan modification would be for notarizing your final loan modification documents.  I took my final loan modification documents to my local Wells Fargo bank and they were able to notarize the documents at no charge since I have a checking account there.  Your lender can also cancel late fees owed to them when you do a modification and add any late mortgage payments onto the balance of your newly modified loan. 

 

If you choose to use an attorney or one of those loan modification companies for your loan mod, then what they charge will be the only expense for your loan modification.  They typically will charge an upfront fee of $500 or more and will charge an additional larger fee once the loan is modified which could be as much as $4,000.  Be wary of any company that charges a high fee upfront, there have been many cases of fraud in the mortgage modifying business.  I have heard more cases of fraud then I have success stories in regards to loan modifications.  It's sad but it's a reality. 

 

In conclusion, when deciding between a loan modification or a refinance, you should always try to modify your current mortgage to save on fees and you can get a 2% interest rate  which you will never get with a refinance.

Loan Modification Leverage, Do You Have It?

When doing a loan modification one must realize that there is something called leverage and either you have it or your lender has it.  It's very cut and dry, you have it or you don’t.  Leverage in regards to a loan modification comes down to is it in the best interest of the lender to modify your mortgage or would they rather foreclose if given the opportunity and sell your home at prices dictated by the current real estate market.  Just like any business decision a company is going to lean towards what is best for the company and ultimately what will make them more money.  Money, isn’t that what it always comes down to for a company?  How to keep more of it or how to make more of it.

The leverage that a homeowner has depends on the mortgage market where they live.  I live in Las Vegas, NV and currently one in seven houses has been foreclosed on and is sitting vacant.  Obviously, the borrowers in this city have leverage over their lenders who can’t handle the housing inventory that they have.  Las Vegas, is the worst city for foreclosures in the country and lenders will try anything to not foreclose.  Typically people in this city can quit making payments for over two years before getting foreclosed on.  The reason why the lenders haven’t foreclosed is because the lenders already have a high inventory of homes that they are trying to sell and they need to sell those first before adding to the inventory.  The lenders know that the longer they wait on selling, the more time they'll have for the market to correct itself.  You can bet when the amount of homes for sale lowers to reasonable inventories, lenders will begin foreclosing on those people who haven't been paying their mortgage.  Until then, lenders will let the homeowners stay in their homes for extended periods without making payments as a way for the lenders to get free upkeep on the home until they foreclose.  

Fannie Mae and Freddie Mac are the two largest lenders and they service none of their own loans.  They use service companies who are in charge of collecting payments, paying taxes, paying insurance, foreclosures and harassing people who are late on their mortgage payments. Loan servicers make a percentage of every payment that they collect from homeowners.  When people quit making payments, servicers are no longer collecting payments but generally have to keep making those principal and interest payments to their lenders.  This gets expensive so either they foreclose or they try to modify the mortgages to more affordable terms for their customers.  Before Helping Families Save Their Homes Act of 2009 (S.896) was passed, loan servicing companies didn't want to modify mortgages because they were fearful of lawsuits from their lenders.  This Helping Families Save Their Homes Act enabled loan servicers to modify mortgages without being sued by their lenders.  Now all of the sudden, it makes more since for loan servicing companies to modify mortgages instead of paying the high fees of foreclosure.  When loans are modified, loan servicers collect lower fees because the mortgage payments are reduced; however, collecting something is better than nothing and they don't have to pay the high price of foreclosure. 

Foreclosure will typically occur when a homeowner has equity in the home and less likely to occur if a person is upside down or has no equity and they quit making mortgage payments.  Above all, foreclosure will be inevitable unless a homeowner pursues a loan modification in either case.  If a person owes $100,000 on a house that will appraise for $200,000, the lender will most likely foreclose on the home if given the opportunity because the $100,000 difference is enough to cover the foreclosure expenses and make a profit.  Now if the loan is for $200,000 and the home is worth $100,000, the lender would rather modify the home because foreclosure would give them a huge loss.

In any situation, a homeowner should pursue a home loan modification.  Under the Making Home Affordable loan modification program, a home owner can fill out a three page application for the opportunity to lower their mortgage payments and it won't cost them anything.

Top 5 Loan Modification Questions

What is a loan modification?

A loan modification is a change in the original mortgage to benefit the homeowner.  Some of the benefits that a homeowner can receive from a modification are a reduction in interest rate, a reduction in principal, forgiveness of late fees or other penalties, lengthening the loan term, forbearing interest until the end of the loan term, and capping the monthly mortgage payment to a reasonable payment that is affordable to the borrower. 

What is an acceptable Hardship situation?

An acceptable hardship could be many different scenarios such as a loss of income or loss of job, higher expenses, a death or illness in the family, an ARM (adjustable rate mortgage), divorce, an increase in expenses due to a new unexpected debt, federal or state tax issue, lawsuit settlement or any one of a hundred different scenarios that make it harder to pay your bills.

Can I do a loan modification myself or should I pay someone to represent me?

Unlike what most Attorneys will tell you, you can do a loan modification yourself. Your lender will encourage you to proceed with a loan modification without the use of an attorney so you can save money and have more money to make mortgage payments.  Before starting a modification, I would encourage you to do research so that you structure your loan modification in a way that it gives you the lowest possible payment. 

Can I get my principal reduced if the loan amount is greater than the value of the house?

     It is possible to get your principal reduced if you are "upside down on your house", owe more than the house is worth.  This is a scenario that most people wish for but rarely it happens.  Typically, a modified mortgage will consist of a loan payment based on a principal amount with an affordable payment at an interest rate of as low as 2% and stretched out up to 40 years.  If the new principal amount of your mortgage is lower than the original mortgage principal, the difference between the two principals typically will be your new deferred balance or could be a principal reduction.  In most cases the difference will be your new deferred balance.  This new deferred balance does not collect interest and you will not have to make payments on that amount until your new loan term is due in full, typically in 30 years. 

     The difference between your original principal balance and your new principal balance could also be your new principal reduction.  Keep in mind that if your principal is forgiven, you will get a 1099-C form for the forgiveness of debt.  This means that the forgiveness of debt will give you additional income for the year and it will be taxed as ordinary income.  This is a small price to pay for a free gift. 

Do I have to be currently delinquent on my payments to get a loan modification?

     There is a common misconception regarding loan modifications and that is that most people think that you have to be late on your mortgage payment to get a loan modification.  That is not true.  The whole idea of the loan modification program is to help home owners before they go late on their mortgage payments.  Studies have shown that once a home owner is more than ninety days late on their mortgage payment, the majority of the time the homeowner will end up losing their home to foreclosure.  Lenders realize this and want to get help to the homeowners who are on the verge of being late on their mortgage.  The whole idea of loan modifications is to keep homeowners in their homes and stop the foreclosure fiasco.  It does not matter if you are late on your mortgage or on time, you can get a modification either way.

How Difficult is it to File My Own Loan Modification?

The majority of homeowners get intimidated when it's time to refinance their home because they want to make sure that they are not getting ripped off by a mortgage broker who tries to charge as much as he can to achieve a higher commission.  The same can be said for when it is time to buy a new car.  These are times in people's lives that they don't usually look forward to because they are stepping out of their comfort zone.

Recently, our Government has come out with a new modification program HAMP that was designed for homeowners to receive help in lowering their mortgage payments without the use of a third party.  This is another program that creates anxiety for the homeowner who does not typically know how the process works so in many cases they will hire someone to do it for them.  Attorney's and loan modification companies have popped up everywhere doing modifications and charging high fees to do so.   Loan modifications are simple and these companies are charging big bucks to do them and not necessarily giving people the results they wanted.  

We live in a society where we want things done right now and we love services that make our lives easier.  I believe that a loan modification is something that needs to be done right because you will be the one making the mortgage payments for the next 30 years.  And when you want things done right, you should do them yourself.  

To get a loan modification you will need to be able to get the modification application and fill it out.  How hard could it possibly be to read an application and answer personal questions about yourself?  Well, it is not that difficult to fill out the application but the whole idea is to fill it out in such a way that best benefits your situation.  The hardest part and most important part is to fill out the application in a way that gets you approved.  

There are many resources out on the internet that claim they can teach you how to get your mortgage modified but I would be wary unless they can prove their teachings by showing actual results.  The same holds true for attorneys and modification companies that say they have gotten great results but will not be able to guarantee you anything other than, "will do our best".  Talk is cheap but the money you will spend on an attorney is not! 

          

In brief, attorneys and modification companies will sell you on the idea of them getting others great results and they won't be able to guarantee you anything.  Personally, I would have a hard time giving them $3,000 of my hard earned money with the possibility of getting nothing in return.  Why not educate yourself and file the three page application yourself?