This is happening all over the place...
Some homeowners get trapped in loan nightmare
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By ADAM GELLER / AP
May 26, 2007
Questionable lending has grown as a result of mortgage industry’s eased standards
BOSTON — Upstairs at Victory Chapel Church — a cinderblock bunker converted from a long-ago Ford dealership — the pews are reserved for praising heaven.
But downstairs, in a basement rental hall, a pair of women preached of worldly wonders.
On Saturdays they set out folding chairs and Dunkin’ Donuts. And they offered testimony to the bounty of real estate, encouraging their flock to buy the wood-frame walk-ups and rowhouses surrounding this workaday stretch just down from the OJ Carwash.
The key was trust, they told the faithful. Still, Valerie Hayes was a little skeptical.
“I really was thinking it would be at least a year before I’d get a mortgage,” says Hayes, an executive secretary and mother of two. She was wary of borrowing because she was saddled with her own student loans.
But a day later, she was preapproved to buy.
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Soon after, Hayes did buy. The problem, prosecutors say, is that the women put Hayes and others into homes they couldn’t possibly afford by filling their loan applications with details of jobs and paychecks that were all so much fiction.
What happened in the church basement happened elsewhere, too. The rapid growth of subprime mortgages that made so many people homeowners did more than promote questionable lending. It rewarded the gimmickry and manipulation that delivered the loans an industry craved.
Some say it’s fraud. Those accused reject the charges. The case also raises tough questions of whether borrowers, too, should bear some responsibility.
But the bottom line is beyond dispute. Valerie Hayes can tell you about that. Just don’t go looking for her at the home she bought, thanks to the women at Victory Chapel Church.
It’s owned by the bank now, and there’s a real-estate agent’s lockbox on the door.
The making of ‘a huge monster’
Over the past decade, the mortgage industry has turned itself into a very big tent.
Lenders devised new types of loans and eased standards, making it much easier for many people to borrow. Homeownership reached record levels.
But as interest rates rise and the market cools, it becomes clear many people were put into punishing loans.
That is particularly evident in the enormous growth of “stated income” loans — known in the industry as “liar’s loans.”
Stated loans — whose borrowers list income and assets without having to prove anything — were meant for solidly self-employed buyers. Then it “morphed into a huge monster,” says Connie Wilson of Interthinx, a maker of mortgage fraud detection software.
By last year, nearly half of subprimes required little or no documentation of income, according to First American Loan Performance. But the industry overlooked the pitfalls.
A study of stated loans by the Mortgage Asset Research Institute Inc. found almost 60 percent exaggerated incomes by at least half. Another by BasePoint Analytics linked 70 percent of mortgage defaults to “a significant misrepresentation on the original loan application.”
Mortgage fraud is most visible in spectacular cases involving fake buyers, property flipping, vast amounts of money. But that overlooks smaller-scale foul play costing many subprime borrowers their homes, experts say.
Often it’s not considered fraud. It’s pushing the envelope. It’s doing whatever it takes.
“There’s a huge amount of broker fraud out there,” says Kerstin Arusha of the Fair Housing Law Project in San Jose, Cal., which represents low-income homeowners stuck in such loans.
Most real estate agents and mortgage brokers are honest, but too many have stretched the truth, says Jim Croft, founder of the Mortgage Asset Research Institute.
“And they always have the fallback that they’re not dishonest,” he says. “They’re just helping Jill and Joe Six-pack get into the home — and realize the American dream.”
Easy road to approval
Frances Darden dreamed of buying a house.
It would look and feel like her grandparent’s place in the South Carolina of her childhood. It would have a backyard for barbecues and a front porch for conversation. French doors would usher visitors from living room to dining room.
Still, it was a lot to imagine for a hair stylist on disability, reliant on a subsidized housing voucher, and supporting two teenagers.
Then, in September 2004, she spotted an ad in the weekly Banner.
“Want to Buy a Home? Credit Less Than Perfect?” beckoned an ad from Champagne & Associates. “Let’s Make History.”
Darden went to a free seminar with her friend, Annie Neal, at Champagne’s office, and met two women who vowed to help them.
The first was Champagne’s owner, Roberta Robinson, a former mortgage broker who’d started her own real estate shop.
“She had an answer for every question,” Darden says.
The second was Rachel Noyes, a bartender-turned-mortgage broker who promised to unlock the secrets of borrowing.
“I really felt like I was helping people get into homes,” Noyes says. “The one question I always asked, to drill into your mind, is: How much can you afford?”
But those who attended the seminars don’t remember it that way.
“As long as you’re honest with me,” Valerie Hayes recalls Noyes saying, “I guarantee you I can you get you into a loan.”
Organizers asked for Social Security numbers to run credit checks.
“We’re not going to be approved to buy a home in Boston,” Darden recalls thinking.
But a couple of days later Robinson called with good news.
Darden had been preapproved for a loan. Up to $360,000!
Falling into a downward spiral
It only took a few weeks for Darden to find her dream house — a two-family with pale yellow siding, a small front porch and another on the back. But could she afford it?
Darden says Roberta Robinson calmly reassured her. Robinson did not return calls and her attorney declined to comment.
When another bidder pulled out of a deal for the house, Darden says Robinson called with more good news.
“She said, ‘You have some good credit, girl, because you got approved for two houses,’ ” Darden recalls.
“How is that possible?” wondered Darden, who says she told the agents she could afford $1,500 to $2,000 a month.
Renters, she was told, would help carry the load.
Mortgage applications —largely blank — arrived. Darden signed and returned them. In November, Darden closed on the first house. In December, she closed on the second.
She’d been preapproved for $360,000. Now she was borrowing $894,000.
It would cost her $7,194 a month.
Months later, though, after struggling to find tenants and maintain the buildings, Darden wondered what had happened. She studied the finished paperwork.
When she bought, Darden was receiving $1,800 a month in disability payments sometimes supplemented by child support of $150 a week.
But the mortgage application described a woman she did not recognize: a manager for a medical supply company earning $114,000 a year.
Meanwhile, the real Darden was quickly falling behind.
In June 2005, Darden says she went to the Champagne office to demand help in refinancing. By now, efforts to recruit buyers had outgrown the space and moved to the church. Some sessions were drawing 40 or 50 people.
Robinson tried to help her sell the second home. But Darden was going through a divorce — tying up the home’s ownership — and falling farther behind.
A year had passed since she’d become a homeowner. Long enough for the lender to lay claim to the investment property and begin foreclosure.
Learning a lesson the hard way
Darden’s story echoes the others.
Valerie Hayes says she knew something was very wrong when she went to her closing. She’d agreed to $2,300 payments. But the documents listed payments at $3,300.
“I see the real mortgages and it’s apparent to me I got robbed,” Hayes says, “but I’m thinking I’m going to make this work.”
Within months, though, maintaining the building depleted savings already strained by the mortgage payments. Then she noticed the reference to a second job — one she never had — earning a fictional $1,846 a month working for Champagne.
Last year, Hayes moved out and the lender began foreclosure.
In August, Massachusetts’ attorney general filed a civil lawsuit in state Superior Court accusing Robinson, Noyes and their companies of using “unfair and deceptive tactics to target and deceive low-income consumers into committing to mortgages they could not qualify for or afford.”
The women pocketed thousands of dollars in commissions and fees for putting together deals and loans bound to fail, the suit says.
Prosecutors have obtained court orders restricting the women and their companies. Both have closed. While the case awaits trial, Robinson has resurrected her real-estate business in a nearby Boston neighborhood under a new name — Opulent Realty Inc.
Noyes, now in Florida, recently lost by default after she stopped appearing in court. But damages have not been set and she denies any deception.
“With stated income loans ... because there’s no documentation, you’re going by what the buyer is saying,” Noyes said. “Who am I to say: ‘You’re a liar. You don’t make that’?”
The borrowers reject that argument outright. Darden rushes to her bedroom and returns with a copy of the mortgage application she signed. It is all but blank.
If they deserve blame, buyers say, it’s for being too willing to believe. Next time she’ll be wiser, Hayes says, recalling that morning in the church basement.
Subprime loans?
“I never knew they existed,” she says, “until I got one.”
As you may notice...
...this turned out not to be a blog, but a review and comment on the news...
How to improve your FICO Credit Score
Get the best price on a mortgage - Improving your credit score the easy way
Maximizing your FICO score is the best way to save money when buy a home. There are many ways to achieve this goal, but here are some of the best. With a little guidance you should be able to save hundreds on your monthly mortgage payments.
Your FICO score is the most important determining factor in saving money when you buy a home. The FICO score you have will determine the loan-to-value ratio or percentage of the purchase price you may borrow. The interest rate you pay on the life of the loan is dictated by your score; in other words, the impact can translate to hundreds of dollars a month more that you will pay on your mortgage. The FICO score is an automated system designed to evaluate your payment history, derogatory marks (late payments, delinquencies, etc.), active accounts, types of credit used, and the percentage of used credit compared to available credit. A computer software program will bring all this information down to a number to assist an underwriter in evaluating your credit report. With this universal system in place for underwriting credit reports, subjectivity in the process of determining a borrower's eligibility for credit is limited.
With the significant changes that have occurred in the sub-prime and even prime lending market, the demand for borrowers with high FICO scores has become greater today than ever before. For a full documentation loan, in which case pay-stubs and W-2s are provided, the requirements have gone from a 600 FICO score to a score of 660. For stated income loans where no income documentation is required, the required FICO score has gone from 620 all the way up to 700. These numbers all pertain to 100% financing and coming in with a down payment will allow for slightly lower FICO scores.
The first thing you want to look at is the accuracy of the report. Are all the accounts properly reflected? If not, you'll want to contact each of the major credit reporting agencies to correct any mistakes. Paying down the balances on credit cards will produce the greatest improvement in your credit profile because the system calculates the ratio of used credit to available credit on the credit cards. However, this does not apply to installment debt, like student and car loans. If you cannot raise enough extra money to pay down your debt, the next best course of action is to increase the credit limits on your cards. Again the system will calculate the ratio between available credit and used credit, therefore reflecting an improvement in your credit score.
Another technique that can work well is opening another card and transferring the balances. This can free up additional credit and improve your FICO score. When you have a husband and wife with substantially different credit scores an opportunity exists. By adding the spouse with the lower scores on to the credit cards of the spouse with the higher scores, an increase in the lower FICO scores should occur.
It may seem like these changes will take a long time to occur; fortunately, however, when working with a mortgage broker, once the changes are in place the credit report can be rescored. This process is called a rapid re-score and with letters from the credit card companies the changes can occur in one week. Another tool available to mortgage brokers is called a what-if simulator. This allows potential modification scenarios to be played on your credit report, to see what the end result will be before you spend the money and time to make those changes.
In conclusion, as you can see, much can be done to make improvements on your credit score and an experienced mortgage broker can be an extremely valuable asset to have while you are attempting to maximize or repair your credit report.
Co-written by Randy Nathan and James Dedolph, creators of HomeSniffer.com where you can find Homes for Sale in San Diego and LoanSniffer.net where you can find the best rate and terms for Homes Loans in San Diego . Both of these sites are a good resource for information about San Diego No Money Down Real Estate .
By James Dedolph
Published: 5/14/2007
Just as I had suspected... high mortgage payments mean you're forced to save, assuming you have a mortgage that includes principal in the payments...
BAY AREA
Study: high home cost limits debt for some
Chronicle staff report
Friday, May 11, 2007
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Lower-income Bay Area residents may benefit a little from living in a market where they can't afford to buy a house, according to an analysis of borrowing across the nation that the Brookings Institution plans to release today.
The think tank found, to its surprise, that poorer people in more expensive housing markets tend to borrow less than poorer people who live in lower-cost cities.
In the market that includes Sunnyvale, Santa Clara and San Jose, for instance, residents on the lowest quarter of the income scale had a median debt of $5,952, including mortgages. The same group used credit the most in Indianapolis, where their median debt was $16,330, including mortgages. The highest non-mortgage debt for poorer people was $9,087, in the Birmingham-Hoover, Ala., market.
Brookings analyzed 14 million individual credit reports from 50 markets across the nation.
The report also found that one-third of poorer borrowers fall behind on their payments, compared to one-fourth of those in the next tier, one-fifth of upper-middle-income borrowers and one-tenth of the highest-income borrowers.
Poor families are the fastest-growing segment in the credit industry, and that growth is concentrated in mortgage lending, according to the report. Find the full report at www.brookings.org.
This article appeared on page B - 3 of the San Francisco Chronicle
OMG... you can take out your equity without taking out a loan?
Product Taps Home Equity
Without Taking Out Loan
By James R. Hagerty
From The Wall Street Journal Online
A small San Francisco investment company, backed by a subsidiary of insurer American International Group Inc., is rolling out a product that lets homeowners tap into their home equity without moving or taking out a loan.
The company, REX & Co., offers to pay homeowners cash now in exchange for a right to part of the proceeds when the home eventually is sold.
The owner of a home valued at $750,000 might obtain $100,000 in cash by giving REX a 50% share of the change in the home's value. If the home sold for $850,000, REX would receive $150,000 -- the original $100,000 invested plus half of the increase in value. If the home sold for $650,000, REX's share would be $50,000, half of what it had invested.
Related Article
Home-Equity Borrowing Stalls As the Housing Market Cools
Thomas Sponholtz, a former executive at the investment arm of London's Barclays PLC who founded REX in 2004, describes the product as an alternative to debt-based methods of extracting cash from a home, such as home-equity loans or reverse mortgages.
REX has completed only "a handful" of transactions, he said. AIG's AIG Financial Products unit acquired a minority stake in REX in December, but hasn't disclosed the terms. Other investors include Mr. Sponholtz and several institutions. REX said its product is available in nine states -- California, New Jersey, Virginia, Florida, Illinois, Washington, Colorado, New York and North Carolina -- but the company aims to offer it nationwide within a couple of years.
Among potential users of REX contracts, Mr. Sponholtz said, are baby boomers who have most of their wealth tied up in a home and want to extract some of it for an annuity or other cash-generating investment.
Today's Rates
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15 yr fixed mtg 5.50% $30K home equity loan 8.26%
7/1 ARM 5.68% $30K HELOC 7.55%
REX aims to reach consumers through mortgage brokers, real-estate agents and financial planners, as well as through its Web site. Brokers and other intermediaries could charge fees as high as 2% of the cash obtained by the homeowner. People who sell the home in less than five years face an "early exit" fee ranging from 5% to 25% of Rex's initial payment.
Jack Guttentag, who operates a mortgage-advice Web site, said REX could be an attractive way for people with lots of home equity to put some of it to work in stocks or other types of investments, diversifying their risks. Deciding whether the cash payment is sufficient, though, would depend on estimates about the likely long-term appreciation of the home.
Inventory continues to rise...
Supply of Homes Continues
To Grow, Reflecting Weak Sales
By James R. Hagerty
From The Wall Street Journal Online
The supply of houses and condominiums available for sale continues to grow quickly in much of the U.S., reflecting weak sales.
The number of homes listed for sale in 18 major metropolitan areas at the end of April was up 7% from March, according to data compiled by ZipRealty Inc., a national real-estate brokerage firm in Emeryville, Calif. The data cover listings of single-family homes, condos and town houses on local multiple-listing services.
The increase was above the seasonal norm. Over the past 22 years, home inventories nationwide have increased an average of 4.5% in April from March, according to Credit Suisse Group. Spring is the busiest time of year for home shopping, as families with children try to get settled ahead of the next school year.
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Interactive chart:
housing trends in 18 metros
Home Sales, Prices Will Continue To Slide, Trade Group Predicts
Some of the biggest increases last month were in the metro areas of San Francisco, up about 19%; Washington, 17%; Orange County, Calif., 15%; and Seattle, 14%. Inventories declined nearly 1% in the Los Angeles area, according to Zip.
In a report issued yesterday, Ivy Zelman, a Cleveland-based housing analyst for Credit Suisse, said her building-industry contacts have been surprised by the weakness of sales recently, "given the typical seasonal bounce that occurs at this time of year." She added, "Our contacts have officially declared the spring selling season a bust." Many people who had expected a recovery by year end "now believe the market rebound will be pushed out until 2008 at the earliest," Ms. Zelman wrote.
After booming in the first half of this decade, the housing market began cooling in much of the country in 2005. Since then, prices have been flat to declining in many areas. In recent months, an abrupt tightening of lending standards has further sapped the market by preventing some potential buyers from getting loans.
The National Association of Realtors yesterday again lowered its forecast, predicting that sales of previously occupied homes will total 6.29 million, down 2.9% from 2006. A month ago, the trade group projected that sales this year would slip 2.2%. Lawrence Yun, a senior economist for the Realtors, said many speculators have fled the market.
"It's good that we're getting beyond the tendency of some buyers to view housing as a temporary asset to accumulate short-term wealth, which is not to be expected in a normal market," he wrote.
Where are home prices going up?
Where Home Prices Are Hot Now
Despite the Housing Slowdown
By Dean Treftz
From The Wall Street Journal Online
The housing news isn't all grim. Even as prices sag nationwide, there are several cities in the country where home values are climbing smartly.
Portland, Ore., Boise, Idaho, Seattle, Salt Lake City, Houston, Austin, and Charlotte and Raleigh, N.C., are among the cities bucking the national trend. Homes' appreciation there between the fourth quarters of 2005 and 2006 far exceeded the national average of 5.9%, according to the Office of Federal Housing Enterprise Oversight. In some markets, like Boise and Seattle, the appreciation jumped well into the double digits.
"All real estate is local, despite the headlines," says Lawrence Yun, the senior economist for the National Association of Realtors. Nationwide, the median existing-home price fell 1.3%, to $212,800 in February from $215,700 in February 2006, according to preliminary NAR statistics.
Location, Location
• In Portland, Ore., Seattle, Salt Lake City, Boise, Idaho, Houston, Austin, Charlotte and Raleigh, appreciation has exceeded the U.S. average.
• These areas missed out on the recent housing boom and are now playing catch-up.
• Most of the cities have educated workers and solid economies with strong central industries. All seem to be luring buyers from depreciating markets.
There's no single secret of these cities' apparent success, but many of them missed the housing boom of the past five years. From 2001 to 2005, annual appreciation in these cities was between 2% and 5%, far slower than the 7% to 12% national average, according to the Office of Federal Housing Enterprise Oversight. (OFHEO calculates appreciation based on repeat sales or refinancings of the same single-family properties.) Now, prices are playing catch-up.
Most of the cities also have one or more strong industries to drive their economies -- colleges and technology in Raleigh, banks in Charlotte, energy in Houston and aerospace in Seattle. And all have education levels above the national average.
These cities emerged from the last recession later than most of the country for various reasons, including the lagging technology, aviation and energy industries, says Mark Zandi, CEO of Moody's Economy.com. Now, their economies are strong and housing prices are still perceived as affordable, luring buyers into the market. For instance, the median sales price for a single-family home in the area of Austin-Round Rock, Texas, is $173,700, according to the National Association of Realtors, compared with $371,200 in the Miami-Fort Lauderdale-Miami Beach area.
So many Northeasterners who moved to Florida have resettled in the Charlotte area in recent years -- both workers and retirees -- that Henry Scala and others in Charlotte refer to them as "halfbacks."
The influx may have helped Mr. Scala when he moved across town in January. "I was faced with selling this house in theoretically a down market," the 36-year resident of Charlotte says. "But there was no down market in Charlotte." Charlotte-area house prices grew 9.09% from the fourth quarter of 2005 to the fourth quarter of 2006 -- the fastest appreciation the metro area has seen since 1982, according to OFHEO. Mr. Scala got his $800,000 asking price in four days.
Today's declining prices nationwide are in part the result of an earlier explosion of short-term investors in Florida, California and other booming markets. Recently, both investors and long-term homeowners have been cashing in or cutting losses in formerly hot markets and settling in areas that avoided the boom, such as the Carolinas, parts of Georgia and Tennessee, areas of Texas, the Western mountain states and the Pacific Northwest.
"We're cutting and running," jokes Mark Hoover, 47 years old. Mr. Hoover and his wife, Melissa, 35, are both in the mortgage business, and they are moving from Florida to Austin to work for PRO-30, a mortgage lender based in Novato, Calif. But the Hoovers' move hasn't been easy. Their vacation home in Wellington, Fla., near West Palm Beach, has been on the market since October with a price tag of about $900,000, and their $1 million-to-$1.5 million primary home outside Fort Lauderdale, Fla., has sat since February.
Now, the Hoovers are ready for stable, low-cost, "homey" Austin, where houses appreciated at a steady 6.7% annual rate between the fourth quarters of 2004 and 2005, even as Fort Lauderdale's prices skyrocketed more than 30% before dropping off recently. The Hoovers recently paid about $400,000 for a home on five acres outside Austin and have plans to move in the next two months.
Related Story
Supply of homes continues
to grow
The growth of Portland, Salt Lake City, Boise and Seattle can be attributed in part to an influx of former Californians and people opting out of slumping Las Vegas or Phoenix. The trend may have created smaller echo booms -- especially in Boise and Salt Lake City -- which have slowed in the past several months, with each city experiencing a slow winter. Other areas, too, have experienced faster-than-average appreciation, including the New York City borough of Manhattan and New Orleans.
While some worry that a new group of cities could face a boom-and-bust cycle, local real-estate agents and economists predict stable growth for the near future. Since the cities have strong economies and builders, lenders and investors are increasingly cautious, homes are less likely to become extremely overvalued than in booming markets in the first half of the decade.
Mr. Yun of the National Association of Realtors predicts prices nationally will bottom out sometime this summer. Mr. Zandi, of Moody's Economy.com, isn't so sanguine. "I'd be shocked if [prices stop depreciating] this summer; it's more likely next summer," he says.
Laura Chung, an interior decorator who recently moved to Portland, Ore., from Cambridge, Mass., sees the strong market as the ultimate stress reliever. Mrs. Chung, and her husband, Eric, are considering sprucing up their new home and selling it if they find a house more to their liking -- a prospect that wasn't so simple back in Cambridge. "It's not this perpetual worry that we're not going to sell" the 2,500-square-foot house, she says. While Mrs. Chung's move to Portland had nothing to do with the housing prices, they "definitely ease the wallet a little."
After sitting on the market from June to December 2006, the Chungs' 1,200-square-foot Cambridge, Mass. townhouse condominium sold for $70,000 less than the asking price. "The number of condos in our price point was at some record high," Mrs. Chung says.
To attract a buyer, their real-estate agent suggested purchasing a flat-screen TV and including it in the price of the house. When the home finally sold, the buyer didn't want the TV.
Something else you may not have thought of if you're in house trouble...
Foreclosure and Short Sale Taxes - Home Sellers Might Owe the IRS
From Elizabeth Weintraub,
Your Guide to Home Buying / Selling.
FREE Newsletter. Sign Up Now!
Taxes Due IRS When Selling Foreclosures / Short Sales
The IRS says there is no free lunch. If you transfer title on your home, whether voluntarily through a warranty deed or grant deed, or involuntarily through foreclosure, you have sold your home. You might be subject to taxes, even if you sold your home at a loss, either on a short sale or by foreclosure.
It doesn't seem fair. What's worse is you might not even find out that you owe taxes until the day you open your mail to find a 1099.
I spoke with Julian Block, an attorney in Larchmont, NY, who has been cited by The New York Times as a leading tax professional. Here is what he has to say about taxes, gains and losses on distressed sales such as foreclosures and short sales:
Julian Block on Gains and Losses
"Sellers who have owned their personal residences for lengthy periods still will realize gains.
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"But sellers of residences acquired within the past two years or so are going to incur losses. Even assuming no price declines, losses will result because of expenses for real estate brokers, lawyers and the like. Sellers will not be able to deduct those losses. Makes no difference that they are forced to sell because of, for instance, job changes or health reasons.
"Besides problems for sellers of personal residences, there are tax troubles for investors who, say, bought several condos in places like Florida and are unable to flip them because prospective buyers are waiting for further price declines. Often, it is not worthwhile for those investors to rent their places; what they receive as rent payments will be insufficient to cover their real estate taxes and mortgage interest. Their only option is to sell at a loss."
Block on Offsetting Losses Against Gains
"Sellers can offset their capital losses against capital gains. But in the absence of capital gains, the yearly cap is $3,000 ($1,500 for married couples filing separately) on the amount of losses they can offset against their "ordinary income," meaning income from sources like salaries, pensions and withdrawals from retirement plans. The law allows them to carry forward unused losses to later years."
Block on Tax Rules for Foreclosures
"The IRS has tax rules for foreclosures or repossessions by lenders of homes of owners who have fallen behind on their mortgage payments. There can be severe and unexpected tax consequences for an owner who simply walks away because he or she has little or no equity and the lender takes over and sells the place.
"In that situation, cancellation or forgiveness by the lender of the debt usually means the debtor has reportable income, though there are some exceptions -- for instance, insolvency."
Block on Personal Liability
"An example: Brown buys a condo and uses it as a personal residence. He pays $300,000, down payment of $15,000 and takes a mortgage loan of $285,000. He is personally liable for the mortgage. When the remaining balance of the loan is $280,000, Brown defaults and the lender bank accepts his voluntary conveyance of the unit, canceling the loan. Similar condos at the time sell for $230,000.
"The tax code treats the transaction as a sale. Brown incurs a nondeductible loss of $70,000, the amount by which his condo's adjusted basis of $300,000 exceeds its market value of $230,000. No deduction for the loss because Brown uses the condo as a personal residence.
"Brown also has reportable income of $50,000 when the bank cancels the loan. The $50,000 is the amount by which the debt of $280,000 exceeds market value of $230,000.
"Enter the IRS when the mortgaged property is foreclosed or repossessed, and the bank reacquires it, or the bank knows Brown has abandoned the property. The bank sends a Form 1099-A to Brown and the IRS. Using the numbers in the example, the 1099-A indicates the foreclosure bid price ($230,000), the amount of Brown's debt ($280,000), and whether he was personally liable. Debt cancellation (here, $50,000) is taxed at the rates for ordinary income, same as for salary."
Secured Debt Without Personal Liability
According to Kleinrock Publishing, the IRS says sellers who are not personally liable for a debt will realize an amount that includes the full canceled debt, even if the value of the property that is security for the debt is less, which can be offset depending on your adjusted basis in the property. Purchase money loans secured by real property in California carry no personal liability.
For example, Ms. Smith buys a home valued at $300,000, puts down $30,000 and takes out a mortgage of $270,000. Smith stops making payments. The bank forecloses on a loan balance of $260,000, and the market value of the home has fallen to $250,000. Smith has an adjusted basis of $265,000, due to a $5,000 casualty loss. The amount Smith realizes on the foreclosure is $260,000. Smith figures her gain or loss by comparing $260,000, which is the amount realized, to her adjusted basis of $265,000. She has a $5,000 realized gain.
Before Foreclosure or Selling, Plan Ahead
Before you sell on a short sale or go through a foreclosure, seek legal and tax advice. Do tax planning ahead of time, before it is too late.
For more information, contact a Certified Public Accountant or check the IRS Web site.
Source: Attorney Julian Block's books include "The Home Seller's Guide To Tax Savings," praised by law professor James Edward Maule of Villanova University as "An easy-to-read and well-organized explanation of the tax rules.” To order his books, visit Julian Block's Web site.
