DISTRESSED PROPERTIES – PALOS VERDES AND SOUTH BAY SHORT SALE EXPERT
The Certified Property Expert designation demonstrates that I have the specialized knowledge to advise homeowners on how best to deal with home loan delinquency issues, foreclosures, and short sales. If you are facing loan delinquency issues, please feel free to call me to discuss your options. It is important that you work with a Realtor who has experience in these areas as there are many complex issues involved. Some of these options and information about foreclosures and short sales follow:
The Foreclosure Process:
In California, the foreclosure process is generally a non-judicial process through a trustee under a deed of trust, where the lender is precluded from pursuing a deficiency judgment against the borrower. For the steps in California for foreclosure see https://www.courts.ca.gov/1048.htm?rdeLocaleAttr=en
The vast majority of California foreclosures are of the non-judicial variety. There is absolutely NO redemption period after the Trustee’s sale, except for the exceptions listed below. A non-judicial foreclosing lender is also forbidden to seek a deficiency judgment against a debtor if proceeds from the sale are insufficient to cover the indebtedness and all associated costs.
In the event of a judicial foreclosure (often when foreclosing over a court-awarded judgment, almost never when foreclosing over a loan default), there is a redemption period of . . .
(a) Three months if the proceeds of the sale is of sufficient value to cover the indebtedness and all associated costs;
(b) One year if the sale proceeds are insufficient. .
Exception #1: If there is an IRS lien attached to the subject property, the IRS has an automatic 90 day right of redemption regardless of the kind of foreclosure (judicial or non-judicial). Exception #2: New for 2006, it appears that homeowner associations that foreclose non-judicially for an amount equal to or exceeding $1800 will also create a 90-day right of redemption. (Associations may no longer foreclose for amounts less than $1800)
Cancellation of Liens after foreclosure in California: In California, liens have a priority generally based upon the date that the lien was recorded. Two exceptions exist, the first is that property taxes and other governmental special assessments have special priority over other liens. In addition, the priority of a mechanics lien is based upon the date that the work started and not the date that the lien was filed, although there are certain rules requiring timely filing of notices to the property owner. A bidder at a foreclosure auction bids in an amount and they are then liable for any lien equal to or less than the amount bid. Any lien holder who wants to preserve their rights to collect the amount of lien would need to bid in an amount including the amount of their lien as well as the amount of all liens higher in priority than theirs.The following is an article about unpaid HOA fees in California, which does not give unpaid HOA fees a “super priority lien” status: http://www.facebook.com/note.php?note_id=104374597398 ..
Deficiency Judgments:
Although California has “anti-deficiency statutes” that may protect borrowers from deficiency judgments, the exemption against deficiency judgments only applies to the initial loan used to purchase the property (limited to residential properties of 1 to 4 units), referred to as a “purchase money” mortgage, and would not apply to a subsequent refinancing. See my discussion on deficiency judgments in California below.
This legal chart provided by the California Association of Realtors is intended to provide a quick and easy guide to determine when a borrower may be liable for a deficiency judgment. There are other factors and conditions which may change the result (such as fraud by the borrower and bad faith waste) and as noted below, these issues are complicated and sometimes ambiguous as they relate to short sales.
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Residential 1 – 4 units, Owner Intends to Occupy a Unit in the Secured Real Property |
Non-owner Occupied or Other Real Property |
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Lender Purchase Money Loan or refinance of lender purchase money loan |
Seller Financed Purchase Money Loan |
Refinance Non-Purchase Money Loan e.g., a cash out or new principal loan |
Lender Purchase Money Loan |
Seller Financed Purchase Money Loan |
Refinance (Non-Purchase Money Loan) |
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▼ |
▼ |
▼ |
▼ |
▼ |
▼ |
|
NO |
NO |
YES (But YES if lienholder is a “wiped out” junior**) |
YES (But YES if lienholder is a “wiped out” junior**) |
NO |
YES (But YES if lienholder is a “wiped out” junior**) |
* If a senior lienholder forecloses on the property, the “wiped out” junior lienholder who no longer has a secured note may not sue on this promissory note for those categories indicated in the chart.
Alternatives to Foreclosure:
There are a number of alternatives to foreclosure for borrowers in financial distress . These include:
Negotiation with the Lender: Several options are available to a borrower who wants to retain ownership of their property.
a) Forbearance Agreement and Repayment Plan: If a borrower has missed several payments, this agreement includes an agreement for the borrower to begin making their full payment plus a partial payment to “catch-up” their delinquency over several months. This is usually done when the cause of the delinquency is short term
b) Refinancing the mortgage: If modified terms of the mortgage would enable the borrower to afford the on-going mortgage payments, and their is sufficient equity in the property, the borrower could refinance the mortgage with the current lender or a new lender. This could result in lower monthly payments by reducing the interest rate or reducing the monthly payment required through an interest only loan.
If there is no longer any equity left for the borrower to protect, two options are available to avoid the foreclosure process:
Deed in lieu of Foreclosure: This option is where the borrower executes a grant deed to the lender instead of the lender going through the expense and delay of the foreclosure process. This process, however, has risks for the lender as they accept title to the property, including liability for other junior liens on the property, including mechanics liens, etc. that otherwise would have been extinguished and removed during the foreclosure process. This option is also preferable than a foreclosure process for a borrowers credit rating, however has a greater impact on the borrowers credit rating than a short sale.
Short Sale: This is an agreement with the lender whereby the lender agrees to accept the net proceeds from the sale of the property negotiated by the borrower as full repayment of the mortgage. The process would begin by the borrower communicating with the lender as to their process for approval of short sales. Sometimes it is difficult to determine who is actually in a position at the lender to authorize and approve a short sale. Start by contacting the “Loss Mitigation Department”. If a broker is aiding the borrower in the process, he/she should obtain a form for authorization to release information signed by the borrower in favor of the broker which would entitle the broker to work directly with the lender during the short sale process. A package would need to be presented to the lender with the following information:
a) A letter describing the financial difficulties of the borrower and why they are no longer able to make payments under the mortgage. This is referred to as a “hardship” letter.
b) A sales contract with a buyer of the property. This contract would need to be contingent on the lender accepting the terms of the sale and payment of the net proceeds (sales price, less the costs of sale, including brokerage commissions and other closing costs) of the sale as payment in full of their mortgage. A preliminary statement of closing costs should be supplied the lender to show the net proceeds of the sale which would go to the lender in full settlement of their debt. The contract should also include the typical sellers disclosure statements, buyer prequalification lender and proof of funds and ability to finance the purchase, a copy of the certified escrow instructions, as well as a preliminary title report.
c) Support that the sales price is for the fair market value of the property. Lenders generally require that the sales price be within 95% of the fair market value. Fair market value should be supported by an appraisal from an independent third party. The lender often requires that they obtain the appraisal from an independent appraiser. The selling broker can also provide sales comps as well as a description to the lender of any factors affecting the property and its fair market value, such as deferred maintenance, and problematic floor plan, etc.
d) Financial information on the borrower showing an inability to service the existing debt. This could include one or more of the following: A completed and signed IRS Form 4506 “Request for copy of Tax Form” giving the lender a right to obtain an official copy of the borrowers tax return, a completed and signed personal financial statement, previous 2 years tax returns, employment paycheck stubs for the past two months, or the past three months bank statements of the borrower.
Advantages to a Short Sale versus a foreclosure are as follows:
1)Impact on Credit Score: The FICO website states : “The common alternatives to foreclosure, such as short sales, and deeds-in-lieu of foreclosure are all “not paid as agreed” accounts, and considered the same by your FICO® score. This is not to say that these may not be better options for you from a financial perspective, just that they will be considered no better or worse for your FICO score.” Even so, lenders when looking at your credit score consider a short sale much less negatively than a foreclosure as it shows that you made the best attempt possible at solving your financial problem.
2) Credit History: Foreclosures will remain on a credit history for 10 years or more. Short sales, however, are typically reported as “paid in full, settled” or “paid as agreed” . This would show up on the borrower’s credit report as a negative mark for seven years. (Cal. Civ. Code § 1785.13.)
3) Future Loan from Fannie Mae for Principal Residence: A borrower will normally be able to get another Fannie Mae loan after only 2 years after a short sale. After a foreclosure, a borrower is ineligible for a Fannie Mae loan for 5 years
4) Future Loan from another mortgage company for conventional financing: On the form 1003 Credit Application required by lenders, a borrower must answer yes to question G in Section VIII of form 1003 that asks “have you had property foreclosed upon or given title or deed in lieu thereof in the last 7 years”, which will affect the borrowers approval probability or the interest rate to be paid. There is no similar question dealing with a short sale.
5) Security Clearances: If a person has a foreclosure and is a police officer, in the military, in the CIA or any other position that requires a security clearance, the clearance will be revoked and employment will be terminated. A short sale on its own does not challenge most security clearances.
6) As noted below, in California a lender who agrees to a short sale is prohibited from pursuing a deficiency judgement.
Disadvantages to a Short Sale versus a foreclosure are as follows::
1) One disadvantage to a borrower relating to a short sale is the very time consuming and complex process of completing a short sale.
Why would a lender agree to a short-sale instead of a foreclosure action?
1) The lender could become responsible for many unpaid fees related to the property upon foreclosure, including unpaid HOA fees, property taxes, utilities, etc.
2) The lender avoids the time delays and uncertainty involved in marketing the property after foreclosure. They also avoid such costs of marketing the property as advertising.
3) The lender avoids the extensive costs of the foreclosure process including attorney’s fees, possible delays due to bankruptcy filings, as well as possible deterioration of the property during the period it is owned by the lender after foreclosure.
4) if the property contains hazardous materials, particularly asbestos, lenders are often reluctant to take title to property with such materials as it puts them on the “chain of title” in case liability claims are raised due to the presence of asbestos.
Deficieny Judgment Issues :
The following comments relate to the anti-deficiency statutes in the State of California CCP § 580b thru (d) . A deficiency is the difference between the amount owed and what the lender was able to recover through foreclosure.
1. In California, lenders have two choices in foreclosing on a property. Non-Judicial foreclosures are where the lender forecloses under the rights in their deed of trust and are processed without court intervention, with the requirements for the foreclosure established by state statutes. Under a non-judicial foreclosure, the lender initiating the foreclosure can not later sue for a deficiency judgment, based on what is called the “one-action rule”. Judicial foreclosures are where the lender sues for foreclosure under their rights of sale under the mortgage and pursues the foreclosure through a law suit through the courts. In this situation, the lender may also sue for a deficiency. In California, however, a lender may not pursue a deficiency for loans that qualify as a “Purchase Money Mortgage”.
To qualify as a purchase money mortgage in California, the loan must be obtained at the time of purchase of the borrowers principal residence. This can include a second mortgage obtained at the time of purchase. Although the legal issue as to whether a home equity line of credit used to purchase a home would qualify as a purchase money mortgage has not yet been fully addressed through case law, most attorneys believe that if the loan was only used to purchase the property and additional draws for other purposes were not taken, the home equity line should qualify as a purchase money mortgage. If the initial loan was refinanced, even if no additional proceeds were drawn and the refinance was only a change in interest rate or terms, the new loan would not qualify as a purchase money mortgage and would be recourse. This is a major issue with those borrowers who have recently modified their loans which are in default, because they may have unknowingly converted their purchase money non-recourse loan to a fully recourse loan, and exposed themselves to a potential large deficiency judgment.
If a second mortgage is a purchase money mortgage, and the first mortgage forecloses out the second mortgage, the second mortgage is precluded from pursuing a deficiency judgment as the borrower is protected by California anti-deficiency laws. Under Code Civ Proc, § 580b, the holder of a note secured by a purchase money second trust deed may not recover even though the second trust deed had become worthless by reason of a sale conducted under the senior first deed of trust. Barash v. Wood (1969, Cal App 2d Dist) 3 Cal App 3d 248, 83 Cal Rptr 153, 1969 Cal App LEXIS 1377.
2. If the first and second mortgages are recourse and not purchase money mortgages, and the property is foreclosed on in a non-judicial foreclosure, it is important as to who initiated the foreclosure. If the first forecloses on the property and wipes out the second mortgage, the first mortgage holder can not pursue a deficiency, however the second mortgage holder can pursue a deficiency judgment against the borrower. If the second mortgage holder forecloses on the property and takes over the property, they would not be able to pursue a deficiency judgment. In California, this is known as the “one-action” rule. A lender can not both go through a non-judicial foreclosure ( foreclose on the deed of trust )and then sue to collect a deficiency judgment, however they could choose to go through a judicial foreclosure where they are not simply foreclosing on the deed of trust through a trustees sale, but instead are suing the borrower for title as well as a deficiency judgment. This is not often done as it is much more expensive and time consuming to go through a judicial foreclosure.
3. If a mortgage satisfies the conditions of a purchase money mortgage under these statutes at the time the mortgage is made, then if the property is later converted to an investment property and rented out, the status of the mortgage as a purchase money mortgage is not changed.
4. SB 931 Bill Passed by the California State Senate on August 23rd 2010 which provides Short Sale Deficiency Protection for First Mortgages in a short sale transaction effective for transactions after January 1, 2011. The legislative counsel’s summary of the bill follows:
“This bill would prohibit a deficiency judgment under a note secured by a first deed of trust or first mortgage for a dwelling of not more than 4 units in any case in which the (owner) sells the dwelling for less than the remaining amount of the indebtedness due at the time of sale with the written consent of the holder of the first deed of trust or first mortgage. The bill would provide that written consent of the holder of the first deed of trust or first mortgage to that sale shall obligate that holder to accept the sale proceeds as full payment and to fully discharge the remaining amount of the indebtedness on the first deed of trust or first mortgage. “
Existing law prevents a lender who has made a purchase money mortgage ( a loan used to purchase a home , not a refinance ), from pursuing a deficiency judgment after foreclosure. In a short sale, however, some attorneys have been concerned that this protection may not extend to a seller in a short sale where the lender does not expressly relieve the seller from a potential deficiency judgment even if the loan was a purchase money mortgage. This law eliminated this ambiguity in the law. This law would also apply not only just for purchase money mortgages, but for “hard money loans” which are first mortgage loans not used to originally purchase the home, such as a refinance.
Many attorneys still believe, however, that if a second mortgage was also a purchase money mortgage used to initially purchase the home, that the second loan would also still be non-recourse after a short sale, but there has not been definitive case law confirming this.
In July, 2011, SB 458 was passed. SB 458 extends the protections of SB 931 (2010), to ensure that any lender that agrees to a short sale must accept the agreed upon short sale payment as payment in full of the outstanding balance of all loans.
Under previous law (SB 931 of 2010), if a first mortgage holder accepted an agreed-upon short sale payment as full payment for the outstanding balance of the loan, they could not pursue a deficiency judgment, but unfortunately, the rule did not apply to junior lien holders. SB 458 extended the protections of SB 931 to junior liens.
Many have welcomed this law thinking that it eliminates the problem of property owners having exposure to deficiency judgments for junior liens after a short sale or will prevent the junior lender from negotiating an additional settlement amount other than just the sale proceeds in order to agree to a short sale .
While it is true that under SB 458 if a junior lien holder agrees to a short sale that they waive any future deficiency judgment, there is nothing in the law that compels the lien holder to agree to the short sale. Although the law states that the ” holder of a note shall not require the trustor, mortgagor, or maker of the note to pay any additional compensation, aside from the proceeds of the sale, in exchange for the written consent to the sale “, this does not mean that the junior lender must agree to the short sale if they believe that they would benefit by letting the first lender foreclose and then pursue a deficiency judgment.
There is also nothing in the law that prohibits a borrower from “voluntarily” offering a monetary contribution to a lender in hopes of obtaining a short sale. A lender is also permitted under the new law to negotiate for a contribution from someone other than the borrower, such as other lenders, agents, relatives, and the like.
This law has not changed much of the negotiation process between home owners and their lenders.
5. In states other than California, which have specific deficiency judgment protections by law for short sales, in obtaining a release from the lien of a second lender in a short sale, even if the loan is a purchase money mortgage, it is imperative that a full release from both the mortgage lien as well as the promissory note is obtained, otherwise the lender may pursue a deficiency judgment since the lender did not go through foreclosure. Releasing the lien on the property is not enough since the property just serves as security for the promissory note. You must get a full release on the note as well. Often times a second mortgagee will negotiate with the borrower as to what they will require to be paid, either from the sale proceeds ( as allowed by the first mortgagee) or from the seller contribution, but this may be just for obtaining their release of the lien, and you need to make sure they will also give a full release of the promissory note, otherwise they could pursue a deficiency judgment after the short sale is closed.
For short sales closed prior to the effective dates of California laws SB 931 and SB 458, if a full release from the promissory note was not able to be obtained, or if the lender insisted on including language in their short sale approval letter that they can pursue a deficiency in accordance with law, unfortunately there is no case law currently on point in California as to whether a lender may pursue a deficiency judgment on a purchase money mortgage after a short sale. This is because the anti-deficiency statutes in California specifically relate to a foreclosure sale and do not mention short sales. Most attorneys that I have spoken to believe that lenders would have a difficult time prevailing in a lawsuit pursuing a deficiency after a short sale for a loan that was a purchase money mortgage. They believe that a court would have a hard time allowing a lender to contractually work around the anti-deficiency statutes when there is no consideration given by the seller. This is a very complex area of law and a competent real estate attorney should always be consulted when facing this issue.
Tax Issues:
Debt Forgiveness – Federal and California Tax Issues
For most states, other than California as explained below, if you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances. When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is normally reportable as income because you no longer have an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.The amount of debt forgiven must be reported on Form 982 and this form must be attached to your tax return
The federal Further Consolidated Appropriations Act, 2020, signed by the president on December 20, 2019, extends the Qualified Principal Residence Indebtedness (QPRI) exclusion through the year 2020. This exclusion allows some taxpayers who’ve had mortgage debt forgiven—like after a foreclosure, loan modification, short sale, or deed in lieu of foreclosure—to exclude the canceled amount from their income for federal tax purposes. For California, enerally speaking, nonrecourse debt forgiveness does not result in a tax liability from Cancellation of Debt Income (CODI). However, a portion of recourse debt forgiven in 2014 may result in CODI, and therefore may be taxable. See https://www.ftb.ca.gov/file/personal/income-types/mortgage-forgiveness-debt-relief.html
If the debt forgiven is not for your personal residence, the forgiven debt may qualify under the insolvency exclusion. Normally, you are not required to include forgiven debts in income to the extent that you are insolvent. You are insolvent when your total liabilities exceed your total assets. The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real property business indebtedness. If you believe you qualify for any of these exceptions, see the instructions for Form 982. Publication 4681 discusses each of these exceptions and includes examples.
California Short Sales: Section 580e of the California Code of Civil Procedure also addresses mortgages. This section was added in 2010 and it prohibits a deficiency judgment on specific agreed to “short sales” (allowing the defaulter to sell the house at below cost, and the lender accepting the proceeds as payment in full). In 2011, section 580e was amended to expand its provisions in order to mitigate the impact of the ongoing foreclosure crisis and to encourage the approval of short sales as an alternative to foreclosure. This relates only to principal residences.
According to an IRS Information Letter dated September 19, 2013, the IRS has determined under the 2011 changes to the California Code of Civil Procedure Section 580e, that California taxpayers who sell their principal residences in a short sale for less than what is owed on the home are relieved of incurring cancellation of indebtedness income, if the lender agrees to the short sale as full consideration of the mortgage debt, and there will be no cancellation of indebtedness income.
The IRS’s letter answered the question regarding whether a homeowner would have taxable cancellation of indebtedness (COD) income when the lender approved a short sale considering California’s Code of Civil Procedure (CCP) section 580e. The letter finds California’s anti-deficiency provision under section 580e of the CCP which generally prohibits a lender who holds a deed of trust from either claiming a deficiency or obtaining a deficiency judgment from the homeowner after agreeing to a short sale, treats the homeowner’s obligation as a nonrecourse obligation for tax purposes.
This means in California, upon a lender’s acceptance of the short sale any CCP 580e qualifying cancellation of indebtedness income is nontaxable nonrecourse debt. CCP 580e does not apply to all short sales. In addition to other restrictions this law states it does not apply if the trustor or mortgagor is a corporation, limited liability company, limited partnership, or political subdivision of the state.
California conforms to the relevant portions of the federal tax law governing the forgiveness of nonrecourse and recourse debt, so if the lender agrees to the short sale as full consideration of the mortgage debt, for tax purposes, the loan will be nonrecourse thus, there is no cancellation of indebtedness income for California tax purposes.
The above information is provided for educational purposes only and is not intended to be definitive legal advice. The specific facts of a case can have significant impact . Anyone going through a short sale or foreclosure should obtain legal counsel from a licensed real estate attorney.
Investing in Foreclosure Properties:
Some people spend a great deal of time seeking out properties that are in the foreclosure process. These are known as pre-foreclosure properties. The first source of information in seeking out these properties is to review local papers that publish notices of default or notices of sale. There are other services for a fee and pre-foreclosure data services which research the public records for properties for which a notice of default or a notice of sale have been recorded. Direct contact with the delinquent borrower may provide an opportunity to present an offer to purchase the property at a distressed price below market rates. If the borrower is not able to cure the delinquency during the 3 months subsequent to the initial recording of the notice of default, they may be willing to discuss a sale of the property in order to at least salvage some of the equity that they have in the property. Keep in mind the fact that most of these properties have a large amount of deferred maintenance issues since the borrower has probably not had the resources to properly maintain the home. California, however, has laws protecting property owners during the foreclosure process which prevents someone from taking unfair advantage of a homeowner with a property in foreclosure, as can be seen from this excerpt from California Civil Code 1695.13, .14, and .8 taken from http://caselaw.lp.findlaw.com/cacodes/civ/1695-1695.17.html :
“1695.13. It is unlawful for any person to initiate, enter into, negotiate, or consummate any transaction involving residential real property in foreclosure, as defined in Section 1695.1, if such person, by the terms of such transaction, takes unconscionable advantage of the property owner in foreclosure.
1695.14. (a) In any transaction involving residential real property in foreclosure, as defined in Section 1695.1, which is in violation of Section 1695.13 is voidable and the transaction may be rescinded by the property owner within two years of the date of the recordation of the conveyance of the residential real property in foreclosure. (b) Such rescission shall be effected by giving written notice as provided in Section 1691 to the equity purchaser and his successor in interest…”
“1695.8. Any equity purchaser who violates any subdivision of Section 1695.6 or who engages in any practice which would operate as a fraud or deceit upon an equity seller shall, upon conviction, be punished by a fine of not more than twenty-five thousand dollars ($25,000), by imprisonment in the county jail for not more than one year, or in the state prison, or by both that fine and imprisonment for each violation.”
The key in the above, is what it means to “take unconscionable advantage” of a homeowner in the foreclosure process. This does not mean that a top price needs to be paid, but it does mean that a significantly below market price, when taking all issues affecting value (such as location, interior lay-out, square footage, age of the home, condition of the home, views, etc.), negotiated with a homeowner in the foreclosure process, may expose the new buyer to not only rescission of the sale for a two year period following the sale, but also to possible criminal prosecution.
The most important piece of information when investing in foreclosed property is to know the property’s market value, taking into consideration its current physical condition. It is usually a good practice to engage the services of a real estate broker when negotiating on a property in foreclosure. They can prepare a comparative market analysis (CMA) on the property, which takes into account both previous sales of comparable properties as well as other comparable properties currently listed as available for sale, and can provide support to the buyer that the price paid was a reasonable one, from both the buyers and sellers stand point.
Lists of foreclosure properties that are available for sale by the lender after they have acquired the property through foreclosure may be obtained from the following resources:
Fannie Mae Foreclosed Properties
Freddie Mac Foreclosed Properties
Other Governmental Agencies with Foreclosed Properties
Banks and Other Financial Institutions
These properties are normally marketed through real estate brokers and agents and are usually listed on the local multiple listing service ( MLS ). Some of these properties may have had major repairs completed, but are often in a state of disrepair.