Decisions and Options
If you are in a situation in which you are:
you need to act quickly to address the issue, consider your options and develop a plan.
Let's look at Fred and Felicia Ford. In 2005, when the market was hot, they outbid another couple and bought their home for $275,000. Working with a mortgage broker, they found a mortgage program that didn't make a big deal of their past credit problems. They got a new mortgage for 100% of the purchase price and were able to roll $5,000 of closing costs into the loan. Best of all, the loan was at 4%. Sure, their interest could go up in two years but the market was climbing at 10%. Fred and Felicia thought they could refinance later. The total loan is $280,000.
Fast forward to 2007 - Fred and Felicia still love the house and the neighborhood. They haven't been able to save much in the past two years, but they got a new car. Felicia had a baby and she was able to quit her job. They just got a notice from the bank that their interest rate was going to change to 11% and that their payment will go up over $ 1,300 a month. They know they can't afford that much just on Fred's salary but they have enough in savings to help them make the increased payments for the next three or four months. They decide to sell.
They meet with their Realtor and find that prices in the neighborhood have gone down a little, just 2 or 3%, and that there are dozens of houses similar to theirs on the market. At current sales rates, it looks like about a twelve month supply of houses for sale.
The Realtor tells them that if they need to sell within the next three months they need to price the house at about $265,000 but to expect a final offer of about $260,000. He also tells them that their net proceeds, after selling costs, transfer fees and legal costs, might be around $242,000.
The Realtor reviews their mortgage and tells them it contains a prepayment penalty. They will have to pay an additional $10,000 if they pay the loan off early. So, even taking in account that they have paid down a few thousand dollars of the mortgage in the past two years, they owe the bank $287,000.
They are short by $45,000! The $242,000 of proceeds from the sale can't pay off the $287,000 mortgage.
(Note: This is a very typical situation in the current market. There are thousands of folks out there in similar positions. With values stalling or declining, it does not take much of a percentage change to add-up to big numbers.)
If you're in this situation you need to review your options.
First step
Review your current financial position. First, sit down and make a list of your income and your expenses. You'll need this for the bank if you decide to do anything else but a straight foreclosure (even then, you will need to do it if you declare bankruptcy). Second, make a list of all of your assets and debts. Look them over and see if you can rearrange your finances to either increase your cash flow or generate cash by selling something other than your house.
Next, get a copy of your Credit Report. This is very important. If your credit score is good you stand a better chance of refinancing. However, if it's bad you may have a tough time refinancing. If you've already missed some payments and are behind, your Credit Report has most likely already been affected.
Then, decide if you'd like to try to refinance or ask for a loan modification.
Second Step
Refinance/Modification- Option A:
Contact the bank and explain the situation. Ask the bank to waive the increase in the interest rate or at least work with you to modify the rate so you can afford the payments.
This works best if the mortgage holder is actually a local bank and the loan has never been sold to a loan pool. A local bank might make it work, while a distant Trustee may not have the authority to modify the mortgage terms.
This also may be a great option if your credit rating is good or has improved since you got the original loan.
Refinance/New Loan - Option B:
A straight refinance is another option; however, it may be difficult to pull off.
In theory, you go to a bank and get a new loan. You qualify for the new loan based on your current status - your current income, your current credit report score and the current value of your house. If all works out well, your new loan has a good interest rate and the new loan completely pays off the old debt.
However, if the value of your house has declined, the bank may be unwilling to make a loan large enough to pay off your old loan. Or, if your current income or your credit rating has declined, you are a greater credit risk in the Bank's eyes.
Hopefully, one of these refinancing options will work out.
If neither one of these refinancing options work, you need to move to the next step - investigating a short sale.
As a reality check, you need to know that moving past this point means that you will lose your house and it is unlikely that you will walk away with any money.
Your goals are to avoid future liability from a deficiency judgment, avoid damaging your credit rating too much, avoid foreclosure, avoid taxes and avoid bankruptcy. You goal is not to save your house. That time is past.
The Terms and the Players
Mortgage Holder / Bank - The person, company or trust that owns your mortgage. Years ago this was almost always a Bank. Now it is common practice for mortgages to be grouped together and sold to investors as a package or pool. Because a pool may have hundreds of actual investors they are usually represented by a Trustee who is appointed to act for the owners. The Trustee, in turn, hires others to represent the pool for specific tasks such as loan servicing, legal representation and dealing with troubled loans (negotiating short sales for example). For our purposes, we need to deal with the person authorized to negotiate, and for ease of use, we will always try to call this person or company the Bank.
Deed - a legal document transferring interest in property. It specifies the person or persons to which the transfer is being made and the legal description of the property. This is recorded at the Clerk of Court's Office and is a public record.
Mortgage - a legal document that pledges property for payment of a debt. It references the note and may or may not contain details such as the amount borrowed or the interest rate. It also specifies what will happen if the debt is not paid. This is recorded at the Clerk of Court's office and is a public record.
Note - a legal document detailing the terms of a borrowing. It contains the amount, repayment terms and interest rate. This does not need to be recorded with the Clerk of Court but is produced when a mortgage is foreclosed.
Servicer - the Company responsible for collecting note payments, keeping records, maintaining escrow accounts and distributing net principal and interest payments to the owners of the Mortgage. They may or may not be involved in negotiating a short sale or a foreclosure.
Realtor - a state licensed broker or sales associate who is a member of the local Board of Realtors and a Member of the National Association of Realtors. In a short sale, the seller and the Bank normally ask a Realtor to market the property and agree to compensate him if a sale occurs.
Deficiency Judgment - If the proceeds from a foreclosure sale can't pay off the debt, the mortgage allows the bank to obtain a personal judgment against the former owner. This allows the bank to pursue the owner's other assets and garnish wages.
Second Mortgages and Home Equity Lines of Credit - Potential Problems
Most of this web-site deals with single loan mortgages, short sales and foreclosures. We've done this on purpose. Multiple loans mean multiple problems.
In the block above we discussed the mortgage holder, who we are calling the bank. Having multiple loans may mean two banks.
An easy way to look at the problem of multiple loans is to imagine borrowing money from two people at one time. The three of you sit around a table and you sign the promissory notes and they give you the money. At that instant, they both jump up, run for the door and race to the Clerk of Court's office at the Courthouse, elbowing their way to the front of the line. The first one to get their note recorded is the winner. In the event you default, the first recorded note or mortgage gets first claim on any proceed from the sale of the property. The other guy is second; he gets what's left over.
In reality, bankers agree in advance as to who is in first position and who is second; it's written into the documents.
From the bank's viewpoint, being in first position means that if the second mortgage is behind and the second mortgage holder wants to foreclose - they need to pay off the first mortgage holder.
The second mortgage holder does not have to agree with the actions of the first bank in a foreclosure or short sale. For example, if you and the first mortgage holder agree on a short sale that includes forgiveness of debt, the second mortgage holder is not bound by that decision. They can still pursue a deficiency judgment.
Another difficult situation is when the proceeds from the sale of a house are sufficient to pay off the first mortgage holder but not the second mortgage holder. The first mortgage holder has no reason not to pursue foreclosure. They will recover all that is owed to them plus any expenses. The second mortgage holder gets what is left. In that case, you need to negotiate the short sale including forgiveness of debt with the second mortgage holder.
In short, another mortgage complicates things! You have to be aware of who is first and who is second. Unless the proceeds from a sale are enough to pay off the first mortgage holder, you'll need to negotiate with both parties.
We'll also look at how second mortgages and previous refinances complicate the income tax situation later.
