Foreclosure Alternatives
First, Some Clarity About the Foreclosure Process
In California, “Mortgages” are not used. Instead, a Trust Deed or Deed of Trust (the terms are interchangeable) is prepared. It is a three-party instrument securing a loan or other obligation. It names the Trustor (Borrower), the Beneficiary (Lender) and there is a third party, the Trustee. The seller executes a grant deed giving the property to the trustor, and the trustor immediately executes a trust deed giving the property to the trustee to be held in trust for the lender/beneficiary. It is normally recorded with the County Clerk for the County where the property is located as evidence of and security for the debt.
Trust Deeds differ from mortgages in that trust deeds always involve at least three parties, where the third party holds the legal title, while in the context of mortgages, the mortgagor gives legal title directly to the mortgagee. In California, the trust deed contains a special “power of sale” clause that permits the trustee to exercise these powers, or basically start the foreclosure process.
The biggest reason Trust Deeds are used in California is that they allow for a speedy Non-Judicial method of foreclosing. A Trustee Sale can be held in about four months if everything goes smoothly. There is a three month Notice Period and then there is a required twenty-one day advertising period. Lenders prefer this speedy no-court involved method of foreclosing, and for this they give up certain aspects of foreclosure.
It is generally understood that when the Trustee Sale Action is used, the lender is not entitled to a Judgement Deficiency against the Borrower. Simply put, they cannot come after your other assets if certain conditions hold; they can only take the property. This however is not an absolute. It is determined by whether the loan is “recourse” or “non-recourse,” and there are other exceptions to the law limiting deficiency judgments. Fraud is one such limitation; mis-stating income on a loan application would be another example of this.
This is where the Government’s HAFA or Home Affordable Foreclosure Alternative program can be helpful. See the information under Legislative Help from The Government.
Legislative Help from the Government
Prior to 2009, the major federal program aimed at homeowners in distress was limited to the Mortgage Forgiveness Debt Relief Act of 2007 (H.R. 3648).
H.R. 3648 amends the Internal Revenue Code of 1986 to exclude discharges of indebtedness on principal residences from gross income, thereby making it a (federal) tax free event. Normally, if you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable. In simple terms, the Mortgage Forgiveness Debt Relief Act of 2007 allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.
This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion, $1 million if married filing separately. The Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes.
Making Home Affordable Program (MHA)
Then in February 2009, the Obama Administration launched the Making Home Affordable (MHA) Program; it’s primary function to support home retention and stabilize the housing market and help struggling homeowners get relief and avoid foreclosure. A month later the Treasury Department issued uniform guidance for different initiatives within the Making Home Affordable Program for participants in MHA across the mortgage industry. Treasury subsequently updated and expanded that guidance to include the Home Affordable Foreclosure Alternatives Program, or HAFA, to provide borrowers with an alternative to foreclosure through a Short Sale (defined below) or Deed-In-Lieu of foreclosure (defined below) when a loan modification is not available.
Making Home Affordable Initiatives
HARP – the Home Affordable Refinance Program. This program was announced in April of 2009, and extends through June 30, 2011.
HAMP – The Home Affordable Modification Program. This program was also announced in February 2009 and will remain available through December 31, 2012. HAMP helps homeowners retain their homes through loan modifications.
HAFA – the Home Affordable Foreclosure Alternative Program. Provides Borrowers with an alternative to foreclosure through a Short Sale or Deed-In-Lieu of foreclosure when a loan modification is not available. It requires that the Borrower be fully released from future liability for the forgiven debt amount and provides financial incentives to Borrowers, servicers and investors. (As recent as December 2010, the Treasury modified MHA to include Servicers of Non Government Sponsored Entity Mortgages (Non-GSE mortgages)
The Relationship between HAMP and HAFA
The HAFA program complements the HAMP program by making the transition into a short sale easier for the Borrower if they do not quality for a loan modification.
The Goal for the Borrower is primarily home retention using either a HAMP or Non-HAMP modification. That is generally the first preference and focus of the program.
If the HAMP modification effort fails, HAFA is required to be considered and offered by participating servicers.
Definitions
Deed in Lieu of Foreclosure – is a deed instrument in which a borrower conveys all interest in their property to the Beneficiary to satisfy a loan that is in default and avoid foreclosure proceedings. Both sides must enter into the transaction voluntarily and in good faith.
If there are no other liens on the title, the Beneficiary may agree to take the property back. But, unlike a trust deed sale, a deed in lieu of foreclosure does not cut off the rights of junior lien holders, so the Beneficiary would be taking the property back subject to other liens on the property.
Short Sale – A short sale is a sales transaction in which the Lender agrees to accept a payoff of less than the balance that’s due on the loan. The trustor, with approval from the Beneficiary, sells the property for less than the outstanding balance of the loan. The Trustor then turns over the proceeds of the sale to the Beneficiary.
Unlike a foreclosure, Borrowers are usually able to mitigate damage to their credit history and partially control the debt. A Short Sale does not necessarily extinguish the remaining balance unless settlement is clearly indicated on the acceptance of offer and there can be tax consequences to the Borrower.
GSE, or Government Sponsored Enterprise – are a group of financial services corporations created by Congress to enhance the flow of credit to targeted sectors of the economy and to make them more efficient and transparent. The desired effect of the GSEs is to enhance the availability and reduce the cost of credit to the targeted borrowing sectors. Congress initiated GSEs in the home finance segment of the economy with the creation of the Federal Home Loan Banks in 1932. The residential mortgage borrowing segment is by far the largest of the borrowing segments in which the GSEs operate. GSEs hold or pool approximately $5 trillion worth of mortgages. [wikipedia link]
NON GSE: Non-Government Sponsored Enterprise – Non Government Sponsored Lenders are also known as Portfolio Lenders, who both originate loans and hold on to them (in their investment portfolio), rather than selling them to other lenders on the secondary market. These lenders do not take advantage of the Fannie and Freddie secondary market for liquidity.
Disclaimer
In all events an individual who is in a short sale, foreclosure, workout or similar situation on a residence (including condos) should consult a tax adviser to determine what, if any, relief provisions might be available, and an attorney to review any legal implications.
