‘There is so much misinformation out there … the law is constantly evolving.’
Home values are going up, and many struggling homeowners are gaining equity in their property. But nearly 14 million U.S. homeowners remain underwater – with mortgages worth more than their homes.
More than 27 percent of U.S. homeowners with a mortgage, and nearly 20 percent in Orange County, had negative equity in their homes at the end of 2012, according to a report by Zillow.com.
Many homeowners face foreclosure or are having a difficult time making their payments and are considering options such as a short sale, filing for bankruptcy protection or just handing the bank the house keys and walking away from their debt.
The choices can be confusing.
“There is so much misinformation out there,” said Doug Bickham, a real estate lawyer in Lake Forest. “The law is constantly evolving and even Realtors don’t understand all the fine distinctions in the law.”
The Register asked Bickham, managing attorney at Rasmussen Law Firm, and Bob Hunt, broker at Keller Williams OC Coastal Realty and a longtime member of the California Association of Realtors’ board of directors, to explain the most common misconceptions held by underwater homeowners, or those trying to help them.
Here’s what they said.
Myth: The new California Homeowner Bill of Rights keeps a lender from foreclosing on a home regardless of whether the borrower is pursuing a loan modification or a short sale.
Reality: The Homeowner Bill of Rights, which went into effect in California on Jan. 1, is supposed to restrict lenders from “dual tracking” – that is, repossessing a home while a homeowner is awaiting a decision on a home loan modification application
But a short sale is a different situation, Hunt said. By the time the law kicks in on a short sale, it may be too late.
When a borrower sends in a complete loan modification application, the foreclosure process should instantly stop. If the lender rejects the application, the borrower has a 30-day period to appeal the decision. The home cannot be foreclosed during that time, either.
In a short sale, however, the foreclosure process is halted only after all the lien holders on a home agree to the short sale and the prospective buyer gets financing. All of that can take months. The bottom line: “A foreclosure could easily occur during the attempt to bring about a short sale,” Hunt said.
That means someone facing foreclosure and considering a short sale should act sooner rather than later.
Myth: A “deed-in-lieu” of foreclosure – in which the lender agrees to take back the keys and lets you walk away – is better than spending the time trying to do a short sale, especially because with a deed-in-lieu, you now potentially can get a few months of free rent.
Reality: Mortgage giants Fannie Mae and Freddie Mac recently came out with new guidelines for a deed-in-lieu of foreclosure. Now homeowners with hardships can turn over the house keys and erase their debt – even if they are still current on their payments. Some struggling borrowers who relinquish their homes can live in them for up to three months without having to make mortgage payments.
But even with the new rules, lenders rarely do deed-in-lieu transactions in California, Bickham said.
A primary reason is that California allows non-judicial foreclosures, meaning the property is foreclosed through a trustee’s sale rather than the relatively lengthy judicial foreclosure process required in other states.
In addition, he said, lenders only approve deed-in-lieu transactions if there is a single loan on the property or multiple loans with the same lender, which also greatly limits their usefulness.
“In the vast majority of cases, it’s usually not the most advantageous foreclosure-prevention option for a homeowner, assuming a lender will even agree to a deed-in-lieu,” Bickham said.
It’s better to do a short sale, he said, especially if there is more than one loan.
That’s because striking a deal with a first, purchase-money lien holder does not automatically get the homeowner off the hook when it comes to second or other junior loans.
By contrast, in a short sale, all lenders must sign off, and California law requires them to forgive any remaining balances after the sale. “They (homeowners) are going to get the legal protections on all of the loans, not just one of the loans,” Bickham said. And, because short sales can typically take three to four months, homeowners will also get a few months of free rent, as well.
Also, in a deed-in-lieu agreement, a lender can require additional cash contributions be made by the homeowner, which are illegal in a short sale.
Myth: A bankruptcy prevents a foreclosure.
Reality: “People always seem to think a bankruptcy is going to solve all their house-debt problems,” Bickham said.
However, a Chapter 7 bankruptcy – the most typical bankruptcy protection filed by individuals – will at best delay, but not prevent, a foreclosure. Banks will typically just wait out the bankruptcy case, then immediately proceed with the foreclosure upon discharge. Or, occasionally, the banks will petition the court to release the property even during the bankruptcy if it has no equity so they can proceed with foreclosure, Bickham said. If the home has enough equity, it will be sold as part of the bankruptcy case, with the proceeds going to creditors.
What a bankruptcy will do is convert all “recourse” loans – where a borrower has personal responsibility for repayment – into “non-recourse” loans, where lenders cannot sue a borrower to get repayment, Bickham said. That’s because a Chapter 7 bankruptcy will discharge the borrower’s personal responsibility for the debt even though it will not release the liens on the property for the loans.
So while the bankruptcy does not eliminate secured home loans and a homeowner can still be foreclosed on, all home loans, including second mortgages and home equity lines of credit, will become non-recourse, and lenders cannot sue the homeowners for any balance owed.
Myth: Doing a short sale will require money from homeowners.
Reality: “There’s literally zero out-of-pocket costs to the homeowner to do a short sale and, in fact, they can often get cash back to help with moving expenses,” Bickham said. “In a short sale, essentially, the seller’s lenders step into the shoes of the seller. Most of the closing costs on the seller’s side are picked up by the seller’s lenders.”
That includes agent commissions, escrow fees, title insurance fees, taxes and even homeowner association transfer fees. They’ll only cover so much, though, and the buyer will have to assume the rest. Many programs are available now where lenders will actually give cash back to homeowners who agree to a short sale, as well.
Short sale buyers should be prepared to kick in an additional 3 percent above the price of the home to cover any costs that the seller’s lender declines to pay, Bickham said. But buyers can typically purchase a short sale property for 5 to 10 percent below full fair market value even with the additional costs, he said.
Myth: A foreclosure absolves a homeowner of delinquent homeowner association dues.
Reality: “People often think that if a property is foreclosed or it was given back to the lender as a deed-in-lieu, the homeowner will be absolved of all back dues they owe the association. But HOA dues are actually a homeowner’s personal obligation,” Bickham said. “Even after a bank forecloses on a home, the HOA can still sue the homeowner to collect on any unpaid back dues.”
In a short sale, however, the delinquent HOA dues will often be fully paid off or settled as part of the short sale negotiations, he said, since all lien holders, including the HOA, must agree to release their liens for the short sale to successfully close.