In October, 2008 I wrote a blog post called “Are ‘Short Sales’ they worth the hassle?” My answer was a resounding and unequivocal “No!” (In fact my view was so lopsided that I think it could be said that it was really “Hell No!) Have things changed? Well, I have received some boots-on-the-ground intel that suggests that there may be some circumstances where the effort may pay off. I’m not ready to do a 180, but there may be circumstances where it’s worth a look. (The italics and bold of all those “mays” and “suggests” is intentional.)
First, let’s go back to the basis premise, which is that most people who bother with short sales do so out of a desire to “do the right thing.” An admirable motive in nearly any business endeavor. But it may not always be in one’s best interests. My objections to short sales is that they (1) Trigger too much effort and frustration, (2) Are prone to falling apart at the last minute, (3) Don’t do much to really salvage one’s credit rating and (4) Require the homeowner to do all the work for the bank. But the part that concerns me most is that in order to get a short sale approved, the homeowner has to open his financial books and records to the bank which may then turn around and use that very same information against the homeowner in a later lawsuit to recover a deficiency. Importantly, in California, a litigant cannot get financial information about the other party during the litigation. This protects litigants from allowing their financial condition to be the tail that wags the dog of the lawsuit: If someone can find out that the defendant is wealthy, they may press a frivolous lawsuit harder in the hopes that the wealthy target will cough up some money to make the problem go away. By giving a bank this information in the process of trying to get a short sales approved, you have now given them a possible road map to an easier recovery. For example, letting a property go in foreclosure forces the lender to consider a bankruptcy risk in their negotiating strategy; if you’ve told them that you have $100k in the bank or a stock portfolio, you have now minimized at least some part of that risk to the bank, and they’ll feel emboldened by knowing that you actually have something to lose. (For a related post on deficiencies after short sales, see my recent blog post about the new California statute CCP §580e which precludes a lender on a first deed of trust from pursuing a deficiency after approving and getting paid off in a short sale. This is a helpful development, but it doesn’t cover all situations.) Of course, the borrower’s ultimate financial exposure is never any greater than what the bank could get in a Chapter 7 or Chapter 13 payout, but making that determination is part of the analysis.
So what has changed? Well, I have been told that, anecdotally, letting a home go by short sale may enable a borrower to re-qualify to buy a new home sooner than would likely be the case in the event of a bankruptcy or foreclosure. In other words, a short seller takes a smaller hit on their credit profile than one who lets the property go by straight foreclosure. Again, this is only anecdotal and I have no proof or verification from any lenders or credit agency that this is true. But I have been told this by enough reputable real estate and loan brokers to believe that there might be something to it.
But don’t make this decision on your own: You need to know your risk of being sued before you make the decision. Get legal help. You should do a complete financial analysis so you know just how tempting a target you make to a bank. A $500 legal check-up may save you tens thousands of dollars–tens of thousands in some places–in later exposure.
Of course, you should never let a short sale go to close of escrow unless the bank gives you a complete waiver of a deficiency, but in the fog of war and after months of exhausting haggling with a bank, these things sometimes go unnoticed.
Call a lawyer before you close a short sale. Seriously. Do it.
As this dog-tired economy continues to drag on, with no relief in sight and no bounce-back in home prices appearing anywhere on the horizon, the single question I am asked most frequently is “Should I walk away from my mortgage, and if I choose to do that, what are my options?”
Usually it comes in the following form. “We bought our house in 200_, for $_______. It’s now worth less than what we paid, and less than the outstanding loan amount. We’re considering our options, but are not sure what to do.”
Sometimes this question comes up because someone has lost a job, or is in the real estate business and hasn’t been able to generate much commission income in the past 2 to 4 years, although sometimes it’s just the economics themselves that trigger the inquiry.
The question about what to do, however, is less a legal decision than it is an economic decision. Of course, once you decide to walk away, then the follow-through becomes a purely legal act, and should only be undertaken after consulting with legal counsel and obtaining a full understanding of what is likely to happen.
First, should you? That all depends on where you think housing prices are going to go in the future, how long you’re willing to tough it out and what your other housing options look like. Obviously, you have to live somewhere, so if you’re not going to own, then you have to have a good understanding of what your rental options are Example: A family of four, with two teenagers, living in a 1,500 square foot house in an expensive neighborhood is going to be looking at a very different set of concerns than a childless couple living in a 4,000 SF home in an affordable location. That seems obvious, but to many folks it apparently isn’t.
So it’s not a straight dollars and cents analysis. Just because your home is worth 20% less than the balance on your loan, no lawyer can advise you on whether you should keep the house and keep paying, or let it go and brave the consequences. All a lawyer can do is tell you what is likely to happen under any particular course of action.
Next, if you do decide to walk away, what is going to happen? Well, we all know that such a decision is going to cause significant credit problems. It’s inevitable: If you walk away from a home loan, your credit is going to suffer. But what else?Fortunately, we don’t have debtor’s prison, so despite the loss of the house to foreclosure–another inevitability although the timing may vary depending on circumstances–you may get sued. Obviously that’s no fun, and is something that you should try to avoid, but whether that is likely to happen or not is a very good question to take up with a lawyer. We’re lucky in California as there are very powerful anti-deficiency laws, about which I have already blogged rather extensively. (See California anti-deficiency rules and statutes: When can a mortgage lender in California recover a deficiency after foreclosure?, California Mortgage Deficiencies: What is a Purchase Money Security Interest? and Second Mortgages in California: Deficiencies Not Usually an Issue for full treatment of the subject.)
Last, what about staying and trying to complete a mortgage modification? I’m sorry to say that I’m a cynic on this subject. The process seems capricious and arbitrary at best, and since my experience leads me to the unshakable and firm conviction that, as a class of people, consumer bankers are among the dumbest clowns wandering the planet, the percentage likelihood of any one homeowner or family successfully completing a mortgage modification is nearly microscopic. This is especially true here in Northern California where incomes and home prices are among the highest in the country. They’re not much interested in modifying mortgages for people with six figure incomes and seven figure home prices. And of course, whether that is right or not is beside the point, but you need to understand the reality if you’re going to test the water.
Well, you know by now that the answer is: It depends.
If you file Chapter 7, and either are current or get current with your mortgage(s), then you can most likely keep your home. (Assuming you don’t have an equity interest that exceeds the homestead exemption. As to which, see this blog post: California Homestead Exemptions Increased as of January 1, 2010. Other California Bankruptcy Exemptions will increase on April 1, 2010.)
If however, you are in arrears, and are not able to bring the loan current, then–unless you can complete a mortgage modification that allows you to stay–you are likely lose the home.
On the other hand, if you file Chapter 13, and are able to successfully get a payment plan approved by the Court, then you may be able to stay. This is because in a Chapter 13, you can take the outstanding mortgage arrearages, and pay them back through the Chapter 13 plan over the 3 to 5 year commitment.
But don’t try to do this analysis yourself. Talk to a bankruptcy lawyer before you get too excited. There are lots of nit-picky little rules that can torpedo an otherwise possible successful Chapter 13. You need to do the analysis up front.
The California Homestead exemption (found in CCP §704.730 for those keeping track) was increased as of January 1, 2010.
The Homestead Exemption is the amount of equity in excess of existing liens that the homeowner can protect from levy by creditors. So if your home has a value of $500,000, your existing mortgage balance is $400,000 and you fall into the $75,000 homestead category, then $75,000 of the $100,000 equity cushion in your home is protected from creditors. This works in bankruptcy and out.
Here are the new limits:
- $75,000: Basic homestead for single person
- $100,000: Head of household
- $175,000: Over 65 or physically disabled or under 55 with less than $15,000 in annual income ($20,000 if married).
The full text of the statute appears below.
The exact numbers of the California Bankruptcy Exemptions will be released by the Judicial Council on or about April 1, 2010, and published by the Administrative office of the Courts. The actual published limits are harder than hens’ teeth to find on line, even if you know what you’re looking for. But here is the current published list of California “Current Dollar Amounts of Exemptions from the Enforcement of Judgments.” You can check back here on my site for an update when they release the new numbers on April 1, 2010.
The Wall Street Journal recently ran an article about how, when small businesses are forced to file for bankruptcy protection, the inevitable result is that it usually takes the owners down with it. This is extremely common, and far more frequently the rule than the exception.
Why does this happen? Why, if the proprietor has gone through the expense and trouble to create a corporation or a limited liability company (“LLC”) do these things wind up being just so much superfluous window dressing right at the moment when you really need them to step up and do their job? (Their job being to protect your assets when things go sour.) Because the corporation or limited liability company formed for the needs of the of the small business owner usually doesn’t have adequate assets or resources to give any comfort to creditors–bank lenders most commonly–and so the lender wants as much security for the loans as possible. Enter the concept of the personal guaranty.
If ABC Corp. wants to borrow $1 million for an operating loan but only has assets of $50k of office furniture, computers, fixtures, etc., the bank is going to want some other security. And if ABC Corp’s sole shareholder has a few hundred thousand dollars in equity in his home, then the bank is going to want a security interest in that. Plus whatever else the owner may own. So the bank demands a personal guaranty from owner, which are usually so broad in what they cover that they renders the entire concept of the LLC or the corporation almost completely useless. And it happens with such efficient thoroughness and with such frequency, that it’s probably safe to say that if a personal guaranty is involved, then don’t even bother with the corporation or LLC. (Except maybe for tax or accounting purposes but we won’t go into that here.)
Another place where this pops up is in the single purpose LLC formed for the purpose of owning real property. I have taken quite a few people through Chapter 7s recently who had a bunch of LLC’s (or the increasingly popular Delaware “Series LLC”) that had been formed to own real estate. The problem is that banks won’t lend money for investment real estate to an LLC on the same terms that then will lend for owner-occupied residential property. They usually want 30% to 40% down depending on the asset. Why? Because the bank wants the owner to have “skin” in the game so that he won’t walk away.
So here’s what happens. (Or what was happening until things crashed in 2007.)
California resident finds great deal on 3br new construction home in Anytown, Utah (for example only). His real estate broker hooks him up with a loan broker to line up the financing. Owner has nothing to put down, and has read somewhere that investment real estate should be owned by an LLC to “protect his assets.” So Owner goes out and pays some lawyer $1,500 to form a fancy “Delaware Series LLC” for the purpose of owning the investment real estate in Utah. But here’s where the fancy plan derails: Bank won’t lend100% to an LLC, and the loan broker is usually too 1.) greedy 2.) stupid 3.) dishonest 4.) clueless to properly advise Owner. So Owner gets the stack of loan docs, all of which show that it is Owner as an individual, not Owner’s Delaware Series LLC that is the actual borrower on the loan. Deal closes and Owner gets his house. At this point Owner may transfer title to the LLC in the misguided belief that he is actually using this fancy legal device that he paid the lawyer $1,500 to create for him. After that Owner installs tenant, hires management service, and sits back to starts to collect the rent.
Things go great until 2007 or 2008 when the when the world comes crashing down. The house that Owner bought for $265,000 is now worth about $200,000 or less, the tenants have moved out, and because of the crash in housing prices, Owner can’t rent the property for enough to cash flow the loan, taxes and other expenses. Owner is now officially upside down (or under water) and is having to send checks form California every month just to meet the expenses. So Owner goes to a new lawyer. In many cases, this is me.
Now, first off, I know that the title I’ve chosen for this post is about as unsexy and non-juicy as it can be. That’s okay. I can take it. It’s boring. I can hear marketing consultants hollering about how I need to make my title more grabby, sticky, etc. Yawn. What can I say? Trying to make this stuff fun and exciting is like trying to turn a root canal into a spectator sport. And besides, if you’re reading this, you didn’t come here to be entertained. Maybe someday I’ll change the title but for the moment it stays.
So, anyhow, on the subject of deficiencies…
Far and away the most common question I get asked by clients and potential clients is whether they will be liable for what’s called a “deficiency” after they let a property go in foreclosure. Please note that the discussion below is limited to California law. If your property is not in California–it doesn’t matter where you are; what matters is where the property is–then the discussion below will not apply to your situation because the laws in each state about foreclosures and deficiencies is unique to each state’s laws.
First, what is a deficiency anyhow?
A deficiency is, simply defined, the difference between what you owe on your loan(s) minus the value of the property at the time of the foreclosure. Here’s an absurdly over-simplified example: You owe $250,000 on the loan. At the time of the foreclosure, the property value is $200,000. If the lender is entitled to a deficiency (and that’s a HUGE “if” in California) then it would be calculated at $50,000 ($250,000 – $200,000 = $50,000)
Lots of people right now are trying to weigh their options about whether they want to let a property go in foreclosure, file bankruptcy, do a “short sale,” try for one of those “deeds in lieu” or even try to work something out with the lender. (Right!) What I am seeing quite frequently is that decisions are being made based on completely wrong information about the extent to which they are at risk for
Next, how do you evaluate the risk of being chased for a deficiency by a lender after foreclosure?
Here are the rules in as simple a way as I can articulate them. Remember: THESE APPLY ONLY TO LOANS SECURED BY PROPERTY IN CALIFORNIA. If you don’t live in California, then these rules DO NOT apply to you.
1. There can be no deficiency on a purchase money loan. Ever. This means that if the loan was used to purchase the property, then no deficiency is possible. It doesn’t matter if the holder of the first, second or third forecloses. If the loan on which a lender is trying to get a deficiency is a purchase money loan, then no deficiency is possible. There are wrinkles in this: A HELOC can be purchase money. A loan taken out to refi a purchase money loan cannot. If you have multiple loans, then you have to think about the purpose of the loan. Let’s say you have a purchase money first, and then you later took out a second. The second, because the loan proceeds weren’t used as “purchase money,” that lender is not barred from pursuing a deficiency in a lawsuit.
2. There can be no deficiency if the lender exercises its power of sale and conducts a non-judicial foreclosure by the mechanism of a trustee’s sale. In order to get a deficiency, the lender MUST file a judicial foreclosure action. That means that they have to sue you in Superior Court. Some people seem confused about whether that piece of paper then got in the mail was a lawsuit or something else. It’s hard to miss: It’s a big 8.5? x 11? document called a “Summons,” and it says in unambiguous writing: “Notice to Defendant….You Are Being Sued By Plaintiff.” See a copy of one on my post “Second Mortgages in California: Deficiencies Not Usually an Issue.”