What To Do With Your Underwater House: Options Include Loan Modification, HARP, Short Sale, Foreclosure

We have written before about the current situation across the country in which so many homeowners have mortgages that are underwater. The coming tsunami of foreclosures on distressed properties is bound to have an impact on the slowly recovering real estate market.

If you owe more on a mortgage than the real estate is currently worth on the open market, what can you do to try to avoid losing your property in a foreclosure procedure?

Because so many people are and will be affected by this problem, we spoke about this topic again on our weekly KDOW 1220 AM radio program, Wealth Preservation and You, in an episode called What To Do With Your Underwater House? If you missed this broadcast, you can listen to an MP3 podcast of it in our Radio Show Podcast archive.

A major factor in the collapse of the real estate market was that a few years ago many homeowners used the equity in their primary home to invest in a second property, back when “leveraging assets” was all the rage. When residential property values plummeted, those investors were left with two houses they could not sell.

In response to the collapse of the housing market, many property owners have tried to modify the terms of their mortgage, a strategy known as loan modification, in which the lending institution makes a permanent change in one or more of the terms of the loan, such as eliminating the overdue payments and/or lowering the monthly payments.

A loan modification is difficult to obtain, because several factors exists to determine if you are a good candidate and some of these are out of your control. These factors include your income level, the fair market value of your property, the loan amount, and – perhaps most importantly – who owns the note.

Unlike with previous generations of homeowners whose notes were often held by local banks, today’s mortgages are bundled into a package and sold, along with other loan notes of several types, much like a stock or other security.

The package that contains your loan might have a mix of loans of various levels of risk, from “liar” loans (secured without a statement of income to support its viability) to “A Paper” loans (homeowner has excellent credit), along with a security agreement attached to it that limits the percentage of a particular type of loan that can be modified — for example, only 10% of liars loans in a specific bundle can adjusted.

So, for example, if your loan modification application is received a day after an allowable maximum limit has been reached for that type of loan in the bundle that contains your note, your application will not be approved, regardless of the quality of all of your other eligibility factors.  Therefore, if you own distressed property, you should begin your research as soon as possible to find the best solution out of your underwater situation.

A good place to start your research is the Making Home Affordable (MHA) website, where you can learn about the various government initiatives available to help “struggling homeowners get mortgage relief through a variety of programs that aid in mortgage modifications, interest rate reductions, refinancing, deferred payment or transitioning out of your home while avoiding foreclosure.”

As part of your research, you can learn your current credit score from the three major agencies at AnnualCreditReport.com, “the official site to help consumers to obtain their free credit report.”

We suggest you do not get your hopes up for a loan modification, if you really do not qualify. You will be better off using your time and energy on a viable solution, because in these tough times it is better to come to grips with the reality of your situation sooner rather than later.

To determine the current value of your property, you can use the FDIC’s Net Present Value Calculator. If the calculator determines you are not eligible for a loan modification, the next recommendation for your distressed property could be the HMA’s Home Affordable Refinance Program (HARP).

If you are current with your mortgage payments, but are struggling to keep your head above the water line, you may be eligible for HARP. If not, your next option might be a short sale, a topic we have discussed and written about frequently in the past few months.

Not all lending institutions will agree to a short sale, accepting less for the property than is currently owed on the mortgage, but in some cases that is a better solution for all parties than foreclosure.

Short selling was a strategy that many investors used at the beginning of the housing market downturn, with the help of a real estate agent, to unload distressed properties. However, that option became increasingly difficult as the lending institutions became overwhelmed with all of the short sale applications. As a result, many homes were lost when investors’ mortgages were instead foreclosed.

For more valuable information and insights about this situation, we recommend that you read Underwater Home: What Should You Do if You Owe More on Your Home than It’s Worth? by Brent T. White, a law professor at the University of Arizona.

Go to Radio Show Podcast ArchiveYou can also find, at online or retail bookstores, several other publications about short sales and foreclosures, which may also provide useful information regarding your current situation.

As we stated above, we fear that we will soon be hit by another big wave of foreclosures, as a result of balloon payments becoming due or too-high adjustable rates kicking in, as well as because so many of the government initiatives and other options have been exhausted from the over-abundance of distressed properties across the nation, especially here in California and a few other hard-hit regions.

If your home or other real estate property is underwater, or you think you may be headed in that direction, you should determine your legal rights and realistic options, as well as the financial  consequences and tax implications of the the choices you make.

If you disposed of an underwater property in 2011 and you have already received a Form 1099C for the cancellation of debt (COD), you may have a tax liability for the amount of the loan written off. For this type of transaction, we definitely recommend that you have a professional assist you with preparing your taxes for last year.  Form 1099A is the correct form if you abandoned a property.

The current COD legislation expires at the end of 2012, so that is another fact worth considering if you have tough decisions to make about your underwater property.

As always, we recommend you consult with a tax or legal professional to ensure you understand your options and the related ramifications of each. Create a strategy and a step-by-step plan to achieve your goal, so you can eliminate the stress caused by the property and then move on with your life accordingly.

If you would like a free consultation with Connie Yi, a California real estate attorney and a CPA, about your underwater home, please contact us. We have four conveniently located offices around the San Francisco Bay area.

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