Monday Morning Coffee – Politics as Usual

Monday Morning Coffee

Delaying Foreclosures to Get Re-Elected

February 28, 2010

Good morning,

I hope you had a nice weekend.  We had the open house for our Rancho Bernardo office on Friday afternoon and had a nice turnout.  Thank you to everyone who stopped by.  After being cooped up in the house Saturday, it was nice getting out for a walk with Zach before going to the office on Sunday.  Most of Sunday was spent getting data ported over to our new web site which should be up and running by the end of the week.  Things are getting really busy and with the typical spring increase in activity coupled with ramping up the new office and switching over all our web sites, sleep seems to be  a luxury right now.  Very glad the team is running smoothly right now – speaking of team, Cori is doing well enough in her recovery from the multiple back surgeries that she is back handling our property management again.  It is nice to have her involved again.

A couple of quick notes on the market.  Things seem a little slower now than they were a couple of months ago.  Not so much that homes aren’t selling, but instead of 7-8 offers, we are getting 1 or 2.  It could just be that everyone bought when they thought the tax credit was expiring, but it could also be the start of a trend.

I saw an article last week that didn’t make sense.  The headline was: Obama May Prohibit Home-Loan Forelcosures Without HAMP Review.  I know some of you out there are going to make that silly argument about that Constitution thingy we studied in school, but I think there is a clause they didn’t tell us about where the President can ignore certain parts of it if he really needs to.  The effect of a HAMP review would be to delay the foreclosures for about three months (plus another three while they get the systems in place to process everything), so another 6 months of artificially tight supply.

Then, another piece fell into place on Friday.  A colleague of mine who does a lot of work with the foreclosure departments at many large banks and loan servicers was told that the banks are being pressured to keep their foreclosures off the market until after the mid-term elections.  That made me wonder if maybe the HAMP review proposal was designed to keep the foreclosures from hitting the market until after the election in November.  

Ok, so I went back and did a quick re-read of that same Constitution we slept through in high school.  And guess what?  The whole ”ignore sections of this document if they are inconvenient to your current crises or desire to be re-elected” clause never made it in there. 

I know I am making light of a bad situation, but I think that we ought to consult the original rule book every once and awhile to make sure we are still playing the right game.

Ok, enough on the whole Government hijacking the country theme.  Let’s talk about a positive!

We’ve got a great new listing in 4S Ranch.  This home has 4 bedroom suites (1 downstairs), a loft, and a great layout for the growing family.  Due to allergies of one of the children, almost every room has engineered wood flooring and the house is spotless.  If you know anyone wanting to move into the Poway School District, please shoot them over to the site.

We have a couple more new ones, but the virtual tours are not ready yet, so I will have them next week – along with the new web site!

Enjoy the Coffee!!!

Bad Temper

There once was a little boy who had a bad temper. His father gave him a bag of nails and told him that every time he lost his temper, he must hammer a nail into the back of the fence.

The first day, the boy had driven 37 nails into the fence. Over the next few weeks, as he learned to control his anger, the number of nails hammered daily gradually dwindled down. He discovered it was easier to hold his temper than to drive those nails into the fence.

Finally the day came when the boy didn’t lose his temper at all. He told his father about it and the father suggested that the boy now pull out one nail for each day that he was able to hold his temper. The days passed and the boy was finally able to tell his father that all the nails were gone.

The father took his son by the hand and led him to the fence. He said, “You have done well, my son, but look at the holes in the fence. The fence will never be the same. When you say things in anger, they leave a scar just like this one. You can put a knife in a man and draw it out. It won’t matter how many times you say I’m sorry the wound is still there. A verbal wound is as bad as a physical one.”

 Have a Great Week!

Scott Voak

Mortgage Foregiveness – May Work in More Situations

I spent several hours Friday on the phone with the IRS and reading through various sections of the Internal Revenue Code and think that I may have found a loophole for people who need to do a short sale or are being foreclosed on a rental property that used to be their primary residence.
Before I go into details let me once again state that I am NOT AN ACCOUNTANT or TAX LAWYER.  Please, use the information I will provide below and do your own research or hand it to your accountant to research.  DO NOT DEPEND ON THIS TO DO YOUR TAXES or SET YOUR FINANCIAL PLAN.

On Dec. 20, 2007, President Bush signed H.R. 3648, the Mortgage Foregiveness Debt Relief Act of 2007.  There are two portions of this law which are important for this discussion:

Section2.(a) which modifies Paragraph 1 of section 108(a) of the Internal Revenue Code of 1986 by adding subparagraph (E) “the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2010.”

and

Section 2.(b) which adds, among other things, to the end of Section 108 of the Code section h of which paragraph 2 reads, “(2) QUALIFIED PRINCIPAL RESIDENCE INDEBTEDNESS. – For the purposes of this section, the term ‘qualified principal residence indebtedness’ means acquisition indebtedness (within the meaning of section 163(h)(3)(B), …”

The result of both these paragraphs are well known.  The first says that if your bank receives less money than you owe them during either the sale or foreclosure of your home, while the bank will still send you a 1099 for the “debt relief gain” (the amount you did not pay back), the Federal Government will not tax you on that gain if the sale or foreclosure is completed before January 1, 2010.   The second says that this holeds for Acquisition Indebtedness (the loan you took out to purchase your home).
There are two points to dig for a little deeper:  What if you re-financed your home, and what if it was your primary but is not any longer (you moved out prior to the sale)?

To look at the question of re-financed loans, I looked at section 163(h)(3)(B) which is below:

(B) Acquisition indebtedness

(i) In general The term “acquisition indebtedness” means any indebtedness which—

(I) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and 

(II) is secured by such residence.

 Such term also includes any indebtedness secured by such residence resulting from the refinancing of indebtedness meeting the requirements of the preceding sentence (or this sentence); but only to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness.

 

What does it mean?
This means (once again, my opinion only) that if you have re-financed your home, you are still covered.  If you pulled money out of the home and used it to improve the home, that money is covered also.  However, if you pulled money out of the home to buy toys or take vacations, that is not covered and you will be taxed on that portion.  For example:

Purchased home for $500k with 100% financing.
Re-financed pulling out $200k.
Put $100k into the yard.
Put $100k in Enron stock which is now gone.
Sell the house and the bank gets $550k back with $700k in loans so they lose $150k.
You will get a 1099 for $150k in gain (the amount the bank lost).
You cannot write off the $100k you used for Enron stock but you can write off the $50k of the loss that was put into improving your home.
Hopefully, you can show that all the money from your re-finances went back into the home.

Now, the second question is more interesting.  What if you didn’t live in the house at the time it sold?  The reason this is important is what if you had rented out your home when you purchased your current home and then have to short sell or foreclose on your current rental (former primary).  My reason for pursing this is that if you sell a home and have a capital gain (wouldn’t that be nice), you can exclude $250k of that gain ($500k for a married couple) if you lived in the home two of the previous five years.  Can we use the same rule here?

Well, Section 2 of H.R. 3648 also adds Section 108(h)(5) to the IRS Code that reads:

(5) PRINCIPAL RESIDENCE. – For the purposes of this subsection, the term ‘principal residence’ has the same meaning as when used in section 121.

Ok, back to the revenue code looking for section 121 (I know, get a life).  There it is.  Section 121(a):

(a) EXCLUSION
Gross income shall not include gain from the sale or exchange of the property if, during the 5-year peiod ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregatin 2 years or more.

What it means:

If you rented out your previous primary residence for a period of time once you purchased your current home, and you have to do a short sale or foreclosure on that home, if you lived in it 2 of the previous 5 years (based on the close date of the sale or foreclosure transaction), the home qualifies as a primary residence and you can exclude the “debt foregiveness gain” from your taxes.  Yes!

Summary

Many of you are learning to jump straight to the end as I spell things out in great detail.  The main points here are:

• I need a hobby
• Your may be able to exclude the debt foregiveness gain on your home even if you have re-financed, but only up to the amount that the refinance was used to absorb your purchase price and add any improvements, but not any funds used for anything other than your home.
• You may be able to exclude the debt foregiveness gain on a prior primary residence if you lived in that home 2 of the previous 5 years.
• However, what I suspect, and is the case with the client I did the research for, is many people refinanced their first home and used the extra money to purchase the second home.  The extra money used to purchase the second home is not eligible for foregiveness, you will still be taxed on that portion of the debt foregiveness gain.
• This says nothing about the right of the bank to pursue you for a deficiency.  If you have refinanced your home and the bank accepts less that full payment in a sale or foreclosure, they can pursue you for the balance.  That is why if you are doing a short sale, be sure to use someone who has experience (like the guy who needs a hobby) so that they can try and negotiate with the bank to give up their deficiency rights.

Short Sale Primer – Part 3

In this post, I will look at the advantages and disadvantages to a homeowner using a short sale.

A seller will have to consider a short sale when, for any reason, they need to sell their home and will not be able to fully pay off the mortgages with the proceeds from the sale. If this is your situation, you have a couple of options in addition to the short sale:

• Bring in extra money at close of escrow to cover the negative. This makes a lot of sense if you a) have the money and b) want to preserve your credit so you can buy a home in the near future.
• Let your home go back to the bank in a foreclosure.
• Negotiate with the lender to accept a short sale (see Part 2).

By far the best option if you can do it, is to bring in extra money at escrow. This can obviously be expensive, but can save your credit. If you do not have the cash, but have extra income that you can put towards a loan, the bank may be willing to take an unsecured loan for the balance you owe.

If you chose the foreclosure route, not only will it be hard to purchase a home for a few years, but if you do buy a home, your interest rate will be higher. In addition, with a foreclosure on your record, your interest rate will be higher on car loans and credit cards.

With a short sale, you loan will usually show as “settled” on your credit report. This is not as bad as a foreclosure because it shows you did not completely abandon your responsiblity, but tried to do the best you could. However, in talking with several banks and lenders, nobody can quantify the difference between a “foreclosed” and a “settled” on a credit score because the scoring system is closely guarded and the exact methods of scoring are not known.

An additional issue to consider is the tax consequence. Under current tax law, owners who do either a foreclosure or a short sale are liable for taxes on the amount of the loan that was not repayed. (The easiest way to understand this is if you re-financed your home and took out $100,000 which you used to buy a very nice car, you took that money out of your home tax free. If then you sold you home and did not pay back the $100,000, you would have purchased your car with tax free money.) This assumes you have re-financed. If the loans on the property are purchase money loans (the loan you took out to buy the home), the lender takes the property as payment in full and there may not be a tax issue. While this law makes sense in the above situation, it also punishes individuals and families that have fallen on hard times. With the rising number of short sales and foreclosures, Congress is currently working on a bill that will eliminate (in most cases) the tax on debt foregiveness in a short sale or foreclosure. However, if you are thinking of a short sale or foreclosure, please do not plan on the debt being forgiven until and if the bill is passed and signed into law.

Mortgage Meltdown

Everybody from mortgage brokers, to real estate agents, to mortgage investors and homeowners are asking how this meltdown happened. To help explain, I’d like to use a fictional (sort of) story to show how easy it was for everyone to get into this position.
There was a lady I met, let’s call her Mona, who was already in trouble when I met her. Her story is not unusual, but it goes something like this:
Mona purchased a home in 2001 in a new development in San Diego. She bought it from a builder and put 5% down on her $400k home. As an elementary school teacher close to retirement, this was a stretch, but property values had been going up and her friends told her it was the right thing to do (she was convinced to do this because “everybody else was doing it”). By the time Mona closed on the house, it was worth $450k. She couldn’t believe it. In six months she made almost as much as she did teaching class for a year! Two years later, with her home worth $650k, she was looking for another investment so, she bought another home from a developer in North San Diego County. This one was 10 miles from the freeway, miles from shopping on a new golf course. The plan was for her nephew to live in it and pay the mortgage. They would split the profits when they sold it in two years. She qualified for the home ($600k) by “stating” an income that was higher than she really made. She thought this was no problem because everyone else was doing it. Her nephew decided he didn’t like the house, so he moved out, leaving Mona with a payment on an empty house. No problem. The house was now worth $700k so she re-financed and used the money to make the payments.
In the meantime, there were some new homes in her old neighborhood and she jumped in line to buy one, refinancing her residence (now worth $850k) to make the downpayment (like everyone else, she was now stating an income much higher than her actual income).
How was she able to do this? Foreign investors were so hungry for loans made on US property that they bought all the standard 30 year fixed loans and wanted more, so the banks gave them adjustable loans and they bought those too. Then the banks created interest only loans so they had more loans to sell these investors. Everyone was happy. More people could buy houses which pushed the value of the houses up creating the feeling that everyone was wealthy. People ran up their credit cards buying expensive cars and living like they were millionaires when in fact they were just using their homes to treat themselves like spoiled kids. Still, the investors wanted more loans. What to do? The banks figured it out. How about creating a loan where we don’t check how much money people make. We will let them tell us whatever number they want and we will make them a loan based on that income level (never mind that in overstating their income, people were committing fraud – everyone was doing it). Still the demand from investors in the secondary market was huge, so they relaxed the standards even more so that people with marginal credit could state their income and buy a home.
So, where does this leave Mona? This was the point at which I met her. She owned three homes. One was rented by the room to 4 individuals (the rent did not cover her mortage payments), she was living by herself in the newest home – a 3,500 sf home in a gated community, and she had a vacant home with a loan of $700k on it. Oh yea, she made about $60k as a 62 year old elementary teacher working in Los Angeles (she drove up every Sunday night and home on Friday because the pay was more). When we met, she wanted me to sell her vacant home that had no upgrades (vinyl floors, etc.). She wanted to get $750k for it despite the fact that the home accross the street that was the same floorplan had been on the market for six months for $750k and had hardwood floors, crown molding and a built in spa in the backyard. It was impossible. But, that was ok because Mona found a very helpful mortgage broker who was willing to put her deeper into the hole. (Due to the incredible money being made in real estate sales and lending, it seems like everyone with a high school diploma who couldn’t get a legitimate job found themselves in real estate trying to counsel people who had legitimate jobs on how to manage and purchase million dollar properties) This lender found an appraiser who appraised the home for $800k based on a 9 month old sale of a home in a better neighborhood. He re-financed the house for the $800k (no doubt making about $16k in the process – but hey, everyone was doing it) and Mona was able to make the payments for another few months. However, at the end of that time, she lost the house to foreclosure which destroyed her credit, making it impossible to re-finance her other homes. Plus, she was due to receive a 1099 for the amount of money the bank eventually lost (probably close to $150k, the tax hit of which would wipe out one year of her income).
On top of that, after she lost the first house, she still had a lot of equity in her original home (the one rented out), but she did not want to sell it because her friends were telling her not to (she also faced significant tax consequences in terms of eventual capital gains by holding the property). So today, Mona is close to 65 with terrible credit, loans that are adjusting upward with no way to re-finance them and a depleted savings account. Mortgage payments (plus taxes) on her two homes run over $11k a month and her income sits at $5k a month. Add in the $3,500 a month rent she takes in and Mona is losing $2,500 a month at a time she should be looking to retire.
Somehow, “everybody’s doing it” doesn’t sound so comforting anymore.