Short Sales and Loan Modifications in Bankruptcy Matters

Introduction

Historically, owning a home would be the most significant investment for most consumers. Appreciation has averaged almost 6 percent annually, and over the years the required down payment has decreased to as little as 0 to 5 percent. In addition, many people took advantage of the equity in their home by taking a home equity loan, which offered a lower interest rate then a personal loan or credit cards, and also provided the added advantage of tax deductions. Often times, lenders were providing these loans in excess of the property value.

Very few people anticipated the mortgage crisis that we currently face. As of this date, over 250 major mortgage lenders have gone out of business and lending has been restricted such that at least 50 percent of people who would have been eligible in the past are no longer able to obtain financing. Foreclosures have increased by over 55 percent in the previous year and up until recently, foreclosures have reached a high of 300,000-400,000 per month. As a result, for the first time in recent history, home values have continued to depreciate and have fallen in this area anywhere from 5 to 10 percent per year in 2007, 2008 and 2009.

Short Sales

As a result, many people have considered a short sale as a viable option. A short sale is the sale of a home when seller proceeds do not pay off the existing loan(s) and a lender accepts a discounted payoff to fully satisfy the loan. You do not have to be behind on your mortgage to consider a short sale. Mortgage lenders currently recognize the reality of today’s market values. In a short sale, the mortgage company allows the real estate fees and other costs to be paid out of the proceeds. There should be no fees to the seller. Any realtor familiar with representing a seller should not charge a commission to the seller, as the commission is negotiated between the real estate company and the lender. In some cases, the lender may request that the debtor sign an unsecured note for part of the shortage on the property. If this promissory note is necessary to complete the short sale, this debt becomes fully unsecured and may be discharged in a bankruptcy. If possible, it is important from a credit standpoint to avoid a sheriff’s sale. By nearly any measure, a sheriff’s sale is the most damaging event your credit status can encounter—worse than a bankruptcy. In the course of getting your short sale approved, you may miss your mortgage payments and these events will show up on your credit. Generally, a short sale shows on your credit report as “account closed” or “pays as agreed”. Keep in mind 25 percent or more of all homes have debt greater than the current market value. This means that having to do a short sale is a reflection of today’s market, conditions that are beyond your control. By avoiding sheriff’s sale, you may likely to be able to resume normal borrowing much more quickly.

Mortgage Stripdown

Lenders do not approve all short sales. Often times, bankruptcy works in conjunction with the short sale attempt to ensure that the debtor is fully protected. Another option is that rather than a short sale, a Chapter 13 bankruptcy may be appropriate, which may include a stripdown, which is an elimination of a second loan on the property, i.e., home equity loan, second mortgage, etc. A stripdown may only occur if the fair market value of the real estate supports only the first loan and there is no equity to support even $1.00 of the second loan.

Loan Modifications

The Obama Administration has recently introduced A Making Homes Affordable Program. The Obama Administration has guidelines for lenders to modify loans by reducing the payments to 31 percent of your income. The government offers incentives to lenders who modify loans. The most important factor is providing documentation establishing your ability to pay and home evaluations. Currently, less than 15 percent are actually approved. There are other loan modifications that may be offered directly through your lender. The chance of obtaining a modification that reduces your payments will vary with each lender and the type of loan.

Warning: There are many new for-profit companies that solicit homeowners to provide services relating to a modification. These companies usually charge a large fee upfront, promising to get your mortgage modified and very seldom produce. Please be wary of signing with any of these modification companies and research them carefully before making any decisions.

Conclusion

It is important that prior to determining if a short sale is appropriate, you speak with an attorney who can discuss the benefits and detriments as it relates to your individual situation. Other options may make more sense, including a Chapter 13 bankruptcy with a lien stripdown. Furthermore, it is extremely important that if a short sale is appropriate that you list your property for sale with a realtor who has extensive experience handling short sales and dealing with local and national lenders. A short sale rarely resolves all of a debtor’s financial concerns but may be part of the puzzle in providing greater financial freedom.