Loan Modifications, Short Sales, and Deeds in Lieu

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Loan Modifications

One alternative to foreclosure is a loan modification. A loan modification is a permanent change in one or more of the terms of a borrower’s mortgage loan, with the goal of making the loan more affordable. A loan modification can allow the borrower to keep their home.

There are several steps a lender may take to lower a borrower’s monthly mortgage payment. These can include lowering the interest rate, extending the term of the loan, or waiving late fees and other expenses. In addition, loan modifications often allow a loan to be reinstated after a default by rolling the past due amount into the principal of the loan thereby bringing the loan current. This can be a huge benefit for borrowers that have gotten behind and owe a large past due amount, but who otherwise could keep making their monthly payments.

In some circumstances, a reduction of the borrower’s principal loan balance may be possible. One situation where this may happen is when the borrower is “underwater” on the home, meaning the home is worth less than the amount owed on it. In that case, the lender has an incentive to lower the principal amount to reach an affordable modification. This is because the primary alternative – foreclosure – would not result in enough proceeds to cover the amount of the loan.

There are several different options available to borrowers with respect to loan modifications. Probably the most well-known program is the federal government’s Making Home Affordable (MHA) Program, which includes the Home Affordable Modification Program (HAMP). HAMP is a loan modification program designed to lower borrower’s monthly mortgage payments to 31% of their monthly gross income. There are certain eligibility requirements that borrowers must meet in order to qualify for the program. HAMP also includes a Principal Reduction Alternative (PRA) that is designed to help homeowners whose homes are worth significantly less than they owe by encouraging lenders and servicers to reduce these borrowers’ principal balances.

In addition to HAMP, many lenders have their own “in-house” loan modification programs for borrower’s who are ineligible for the HAMP program.

Michigan also provides homeowners with loan modification assistance, through programs such as the Helping Michigan’s Hardest-Hit Homeowners program. This program is run through the Michigan State Housing Development Authority (MSHDA) and has received federal funds to help Michigan homeowners who are at high risk of default or foreclosure.

Short Sales

Some homeowners facing foreclosure determine that they just can’t afford to stay in their home. For borrowers who plan to give up their home, but still want to avoid foreclosure, a short sale provides a viable option.

A short sale occurs when you get permission from the lender to sell your house for an amount that will not cover the amount due on your mortgage, and the lender agrees to accept the lesser amount to discharge the mortgage. In other words, the sale price of the home falls “short” of the amount you owe the lender.

In Michigan and many other states, lenders can sue homeowners after a foreclosure for any deficiency. A deficiency is the difference between the proceeds from a foreclosure sale and the actual amount owed on the loan. For example, if you owe $200,000 on your mortgage and the lender sells the property at a foreclosure sale for $150,000, you may be liable to the bank for the difference, or deficiency, of $50,000. A deficiency judgment is based on the promissory note underlying the mortgage, which is a personal promise to pay back the full loan amount.

One major advantage of a short sale, as opposed to foreclosure, is that lenders will often agree to waive their right to sue for a deficiency. It is very important for borrowers considering a short sale to determine whether or not their lender is waving any deficiency. You should talk with a knowledgeable attorney if you are unsure or have questions.

Another benefit of a short sale is that you can avoid having a foreclosure on your credit record. While a short sale may still have a negative impact on your credit, it generally will hurt your credit less than a foreclosure or bankruptcy.

One drawback is that you will need a bona fide offer from a buyer before you can find out whether the lender will even consider a short sale. This means you could go through the time and expense of marketing your property and finding a buyer, only to find out that the lender will not even go along with the sale.

If you have a second or third mortgage on the property, those lenders must also agree to the short sale. This is often difficult since these subordinate lenders probably won’t get anything from the sale.

Another consideration is tax consequences. Generally, any deficiency that is waived by the lender will result in taxable income. This is often an unwelcome surprise to homeowners that go through with a short sale. Fortunately, the Mortgage Forgiveness Debt Relief Act of 2007 provides relief to homeowners in this situation through the end of 2013.

Deed in Lieu of Foreclosure

With a deed in lieu of foreclosure, you give your home back to the lender in return for the lender cancelling the loan. A deed in lieu is somewhat similar to a short sale except you are basically selling the home to the lender instead of a third party buyer.

Like in a short sale, it is very important to determine whether the lender is agreeing to waive any deficiency. The same tax considerations apply to a deed in lieu.

Before a lender will accept a deed in lieu, it will probably require the borrower to put their home on the market for a period of time (typically 3 months). This is because lenders would rather have you sell your home than for them to have to sell it themselves.

There are several benefits to a deed in lieu. First, unlike a short sale, you may not have to go through the trouble of selling your house yourself. A deed in lieu also looks better on your credit report than a foreclosure or bankruptcy.

Like other alternatives, there are also disadvantages. It is difficult to get a deed in lieu if you have a second or third mortgage on the property. Additionally, it has become increasingly difficult to get lenders to agree to a deed in lieu given the state of the real estate market. Most lenders want cash instead of real estate, because they do not want to deal with maintaining and marketing the property. Many banks have a backlog of hundreds or thousands of bank-owned properties and they don’t want more.

If you are facing foreclosure or have questions about a loan modification, short sale, or deed in lieu, call us today to speak with one of our attorneys. Time is often of the essence in these matters so don’t delay in seeking legal assistance.