It’s no secret the real estate bubble has burst. But the local Hispanic community, in particular, is feeling the impact.
As home values have declined, so has work for real estate agents and brokers, loan brokers, contractors, construction workers, and those who depend on them such as insurance brokers, cleaners, maintenance workers, and others. Many of the same persons are also homeowners or real estate investors who find themselves in a pinch.
Since 2005, our law firm has seen a surge in the number of persons it is seeing with financial problems related to the downturn in this part of the local economy.
The following article is designed to answer frequently asked questions regarding options to address this problem.
Work is drying up, business is off, my tenants have left. Now my income is down. I am having trouble paying my mortgage. What will happen?
First of all, it is important that you be aware that you signed a contract with your lender for your house. Under that contract, you promised to pay back the loan with interest. Your financial problem probably is not your fault, but unfortunately that is not a legal defense to the lender’s right to enforce the loan. The loan is a debt. As such, the lender has a legal right to sue and make you pay back the loan in full.
How does the lender enforce his loan?
When you bought the house, you took out the loan through a “promissory note” and you also gave the house as collateral to the lender through a “deed of trust.” You also promised to make regular payments and if you failed to do so, you gave the lender the right to sell the house to pay the loan through an auction sale process known as “foreclosure.” Sale of the house through foreclosure is an eventuality if you fail to make payments on the loan.
I am going crazy with worry about when the sale will take place. When will the lender foreclose?
In Virginia, before the current downturn, lenders used to routinely set a date for the foreclosure sale by the third month of missed payments. Now, probably because of the volume of defaults, lenders are taking six to nine months. However, it’s not a good idea to wait to seek solutions.
How does the foreclosure process work?
After the first missed payments, the lender will notify you that you are late. After that, the lender may declare an “acceleration” of the loan, so that the whole loan becomes due. If you send a monthly payment at this point, the lender will send it back to you stating that it is insufficient to pay off the whole balance of the loan. In the final step the lender will set a date, time, and place, for the foreclosure sale.
What are the steps in foreclosure?
Under the usual deed of trust in Virginia, the lender will advertise the foreclosure auction sale of the house twice in a major newspaper in the county where the house is located over about three week’s time. That is the basic legal requirement. The lender may send a notice to the homeowner, but if he does not, or you do not see it, it will not bar his legal right to sell the house. At the auction, the lender will take bids from the public and make an offer himself if there are no takers.
I am getting a lot of letters from the lender. What does the foreclosure notice look like?
The important language to look for in a notice of foreclosure is a specific date, time (down to the very minute), and a location for the auction in front of the courthouse for the county in which the property is located.
I have attempted, but been unable to sell the house for what I owe. What happens if the house goes to foreclosure and it sells for less than the loan?
If the proceeds of the sale are insufficient to pay back the loan, the lender can sue you personally for the balance, also known as the “deficiency” on the loan.
What is the effect of a foreclosure to my credit rating?
A foreclosure does serious damage to your credit, more than a bankruptcy. It will hurt your chances to get a loan in the future to buy another home.
What do I do to avoid foreclosure?
Following are the major options. The feasibility will vary with the time you have before foreclosure, the amount of equity in your house, and your current financial situation:
1) Sale before foreclosure.
- Pro: This is the best option. You pay off the debt in full and preserve your credit.
- Con: You have to have enough time before foreclosure, and you have to have enough equity in your property to reduce the price for a quick sale and still fully pay off the mortgage (as well as paying the costs of sale and real estate agent’s commissions).
2) Refinance. This can be effective, if the only problem is monthly payments that are too large.
- Pro: Reduces monthly payment so you can meet the mortgage obligations.
- Con: The value of the house must be high enough to serve as collateral to cover the new loan in full. If you bought during the 2005-2006 peak of the market and put little or no money down, the value probably has dropped, so this is not likely. Furthermore, if you have missed payments, your credit score has dropped making obtaining a new loan more difficult.
3) “Short sale.” In a “short sale,” the lender agrees to take less than the full balance owed on the mortgage and permit a sale to close by releasing his lien.
- Pro: You sell the property and avoid foreclosure.
- Con: You need the agreement of the lender or lenders, if you propose to pay them less than what is owed. Lender cooperation is absolutely voluntary. The lender cannot be forced. Each of the lenders is different, and none are easy to work with to obtain this agreement. You will need to provide financial information on yourself showing inability to pay off the loan in full from personal assets, and probably a showing from the realtors that you cannot get a higher price.
Furthermore, some lenders cannot agree to a short sale, even if they want to because the loan has been sold to investors as bonds with strict rules about what can be done with problem loans. They are forced to proceed to foreclosure.
If the lender does not “waive the deficiency,” and continues to hold you personally responsible for the loan, you must still personally repay the lender the deficiency, possibly over time, with or without interest, depending. For example, if the sale is short by $50,000, you must pay that back to the lender.
If the lender does waive the deficiency and “writes off” the loan, he will report the cancelled deficiency to the IRS and state tax agency, so that you must report that as taxable income and may have to pay income tax on that amount. For example, if the sale is short by $50,000 and the lender waives that deficiency, you will have taxable income in the amount of $50,000 for that year. If your tax bracket is 25%, you may have to pay $12,500 in additional tax at year’s end to the IRS (and whatever state tax is due). (See Table 1-2 and Example 2, page 5, IRS Publication 544, “Sales and Other Dispositions of Assets.” Note that, for tax purposes, a “short sale” is treated the same as a foreclosure.)
Whether you will be charged with tax, depends on whether your situation fits under the exceptions or exclusions, including a surrender of the property while in bankruptcy, or while insolvent. (See discussion on page 21, and example on page 22, IRS Publication 908, “Bankruptcy Tax Guide.”)
NOTE: If the tax is not paid in full, the outstanding tax will not only accrue interest, but also substantial penalties, which grow very quickly and large over time. A tax lien issued by IRS to enforce unpaid taxes is fatal to obtaining new credit (as well as impacting visas and/or citizenship applications). The possible income tax consequence of a “short sale” where the debt is forgiven should be explained to sellers by realtors and other promoters of this transaction.
4) “Deed in Lieu of Foreclosure.” Similar to a short sale, the borrower conveys the house to the lender in return for stopping enforcement of the loan.
- Pro: Avoids foreclosure.
- Con: The lender may or may not forgive the deficiency. (The other consequences are stated above in “short sale.”)
5) Surrender of the property in Chapter 7 bankruptcy. In bankruptcy, a debtor is discharged of most debts, including personal liability on mortgages. Chapter 7 bankruptcy is a “liquidation” of the debtor’s property. Basically, he turns over his assets — subject to exemptions in the law for basic property he needs to live — in return for the discharge of his debts.
In regard to his house, in Chapter 7, the debtor gives it up to an attorney (called a “trustee“), appointed by the court to sell his property for the benefit of the creditors, or surrenders the collateral to the lender, while being freed of the underlying debt.
In addition, the debtor may be able to keep the house, if the property has no equity and does not interest the trustee, and the debtor can raise the money to pay the lender the arrearage quickly plus pay the monthly payments going forward.
6) Stop a foreclosure through Chapter 13 bankruptcy and either “cure the default,” or gain additional time to sell the house. In Chapter 13 bankruptcy, the debtor also discharges debt. The difference is that the debtor pays into the court through a plan of reorganization he proposes, and approved by the court, funded by his earnings or sale of assets.
This type of bankruptcy provides great flexibility to the debtor to keep property that is not protected in Chapter 7 or to hold on to valuable property he wants to keep. The plan provides for repayment of the arrears for the house he wishes to keep, payments going forward, and full or partial repayment on other depending on other factors.
What is the “automatic stay” feature of bankruptcy?
This is one of bankruptcy’s most important and powerful legal features. From the moment a case is filed with the bankruptcy court (and cases are now filed electronically making filing virtually instantaneous), a court order — the “automatic stay” — goes into effect halting all creditor enforcement action. Everything must stop including telephone calls, letters, lawsuits, and foreclosures. A case can be filed up to minutes before a foreclosure auction sale is set to begin.
What are the other pros and cons of bankruptcy?
- Effective in doing away with your debts permanently and making them legally unenforceable against you.
- Provides you with flexibility in dealing with property you wish to keep or surrender.
- The “automatic stay” feature is powerful in shielding you from creditor harassment.
- The bankruptcy is on your credit report for ten years. However, the practical reality is that lenders will lend again to you knowing that you are debt-free and cannot re-file a Chapter 7 for eight years. Furthermore, the impact is much less than that from foreclosure or tax liens.
What explanation do I need to give to the court?
None, generally. You do not need to justify or explain the bankruptcy filing to the court. An explanation is only necessary if you are accused of fraud, that is, that you took the loan out with the intention, from the beginning, of not paying it back, or if you induce the lender to give you money based on false financial information.
If I surrender, when do I have to move out of the house?
Once the bankruptcy case is filed, the automatic stay goes into effect stopping all creditor action. To take back the house, the lender must file a “lift stay” motion asking the court for permission to take its collateral back. It usually takes about 30-45 days for the lender to get this permission from the court. Then the lender must re-start the foreclosure, which will take no less than another three weeks. Finally, after the sale is done, and you are still inside the property, the lender must file in state court an order to evict. This will take another 30 days or so. In summary, it will take about three months after the bankruptcy filing before you must leave or be evicted.
I am scared. Can I be thrown out of the house without warning?
No. In Virginia, the occupant of a dwelling cannot be physically removed without court process. Once sold, the new owner cannot use self-help to remove belongings or change the locks of a residential building. He must serve a summons on the occupant to come to court and go before a judge to explain before an order can be issued by the judge for eviction.
Will all my debts be discharged?
Most will be discharged, but some are not, depending on whether Chapter 7 or 13 is filed. For example, generally you will not be discharged of real estate property taxes accrued while you were the owner of the house, and will have to pay them. This is one reason you should not keep a house you cannot afford longer than is necessary. You will need to discuss your personal circumstances and types of debts with an experienced bankruptcy lawyer.
Will I have to give up all my property?
No. The law will not permit leaving the debtor destitute. The law provides that some property will be held exempt. Most bankruptcy cases, when planned, are “no asset” cases, in which the debtors have claimed an exemption in everything they own. Thus, there are no assets to distribute to your creditors.
How should I select a professional to help me?
Use care in selecting an advisor. Unfortunately, there are persons in the community who hold themselves out as professionals when they are not licensed, educated or trained, or experienced. Only attorneys licensed in the state or court in which they practice are authorized to give legal advice. Following are important questions to ask:
- If I file bankruptcy, will you be signing the filing? As an attorney? As a bankruptcy preparer? (Note: If they are a preparer, they cannot give you legal advice.)
- Do you have a license to practice law? In which state are you licensed?
- Are you admitted to the court in which I would have to file?
- What percentage of your practice is devoted to financial distress cases?
- Will you personally represent me at the creditor’s meeting?