Monthly Archives: August 2011

Can I rent out my house if it’s in foreclosure?

I’m always surprised that so many owners in foreclosure (including those who  strategically default) decide to move out of the property early in the foreclosure process. I’d say at least half leave the house as soon as they stop making mortgage payments.

In Illinois, foreclosure takes about 16 months (from the first missed payment) and the owner can live in the property and does not have to make payments during the foreclosure. So it makes economic sense to stay in the property as long as possible. But, many say they just want to “move on” or that they literally hate the property and can’t bear to stay there anymore.

Lately, I’ve seen an increase in the number of owners who move out of the property and then rent it out during the foreclosure process.  Is this legal? As our former Alaska governor would say, “You betcha”

There are some legal and tax consequences to renting the property and one should be aware of these before trying this.

  1. Do I have to tell my mortgage company that I am renting the home? No.Can my mortgage company try to take the rent from me? No, not unless you signed an “assignment of rents” which is pretty rare.
  2. How much rent should I charge? Most landlords charge slightly below market rent.  The  rental market is very hot these days. There’s usually no problem finding a tenant.
  3. Should I do a credit check on the tenant? Yes, even though the property is in foreclosure, I would run a credit check on the tenant so that you don’t put Jack the Ripper in the house.
  4. If I rent my house during a foreclosure, doesn’t that convert it to an investment property? Not necessarily. The definition of primary residence is pretty broad as detailed below.
  5. Can I still call the house my primary residence if I rent it? The Mortgage Debt Forgiveness Act says that there is no tax due on the 1099 issued after a foreclosure if the property is your primary residence.  After a foreclosure, the owner gets a 1099 for the difference between the mortgage amount and value of the property.  The definition of primary residence is this: The owner used the property as his or her main residence for any two of the last five years. So, you can rent out the property for a few years and it will still qualify as your primary residence and there will be no tax owed from the 1099.
  6. Should I tell the tenant the property is in foreclosure? Absolutely. You should be fair and honest about it and disclose to the tenant that the property is in foreclosure.
  7. How long can I rent it out? In Cook County, you can rent out a property in foreclosure for about 14 to 16 months. It depends on what county the case is in and how fast the bank’s attorney moves the case along.
  8. What about homeowner’s insurance? You should change tell your agent that you are renting the property and change your insurance accordingly. There are no contents to insure so the premium may go down. If you leave your homeowner’s insurance in effect and don’t tell your agent you are renting it, and later make a claim, it will be denied since you were not occupying the property.
  9. Will the tenant be served with the foreclosure summons? Usually the tenant is not served with the summons. I has happened a few times lately. That’s one reason you should tell the tenant it’s in foreclosure.
  10. How long can I collect rent? You can collect rent until the sheriff’s sale of the property which is at the end of the foreclosure. You don’t own it anymore after the sheriff’s sale.
  11. Will the tenant be kicked out by the sheriff? The foreclosing bank gets an order of possession about 60 days after the sheriff’s sale (the sheriff’s sale  is about  12-14 months into the process). An order of possession can be placed with the sheriff and the tenant could be evicted.
  12. Do I have to pay income tax on the rent I get? Yes.


Short sales: Ask for release early and often

Last week, I emailed the negotiator for a particularly pesky and difficult short sale lender and asked him, not so politely, to release my client.  This was the fourth time I had asked him to release the deficiency (difference between what the lender was to receive and what the lender was actually owed).

The first three times that I asked him for a release, I felt like a cotton candy salesman in the Wrigley Field bleachers. He ignored me every time .

Fed up, I emailed him that “we might as well put a stake in this one unless you are willing to release any and all deficiency.” Finally, he agreed to release the deficiency.

It is possible to get a release of deficiency on the short sale of a first mortgage, and some lenders will just offer this up, which is awesome, but rare. Most short sale lenders ignore the issue and have to be hammered over the head with requests for it.

Most times, you will only get a release of deficiency if you are willing to pay something. This is called a “contribution.” In this case, the negotiator asked for $20,000 contribution from my client. We went back and forth a few times and ended up with a $7000 contribution and a full release of deficiency.  The client was happy with the result.

Too many times, attorneys and agents negotiating a short sale don’t ask for a release of deficiency until it’s way too late. You have to ask for a release early and often and you need to know the exact release language that will be in the short sale approval letter. The release usually reads something like this: “Lender agrees to release owner from any and all liability and any deficiency under the note and mortgage in consideration of the payment of $____.”

I have seen quite a few short sales where the eagerness to collect a commission and/or attorney’s fees was so great  that no one even discussed the issue of a release of deficiency with the seller and no one bother to even as the lender for a release. That is not good, but it happens a lot.

Here are some things to be aware of in getting a release in your short sale:

  • A short sale with release of deficiency is better on the credit of the seller.
  • Most first mortgage holders will not pursue the seller after a short sale. Try explaining that to the seller. Finality is good. Not having to look over your shoulder for 10 years is valuable. What if the  lender dumps all its short sale and foreclosure notes to a debt collector and tries to collect the deficiencies. What then?
  • Unless you are very lucky or a master negotiator, you won’t get a release of deficiency on a second mortgage in a short sale. That begs the question of why you are even doing a short sale with a second mortgage. I am not a fan of short sales involving second mortgages. Illinois needs to pass a law like the California law just passed that erases liability on second mortgages in a short sale. We need that to speed up and encourage short sales.
  • The release of deficiency is put in the short sale approval letter and is not a separate document.