A few years ago, I wrote a post about how a subdivision in Florida called Lehigh Acres  had so many deficiency judgments entered against foreclosed owners that it should be called “deficiency judgment acres.” Unfortunately, the same can now be said for the Chicago area.

Foreclosure cases are way down in Chicago. They have dropped almost 60% over since last year. But, with the slowdown, lenders are now entering deficiency judgments  against homeowners on first mortgages in droves. Deficiency judgments were rare to nonexistent for the last 5 or 6 years (although they were always allowed by law in Illinois).

A deficiency judgment is a personal judgment against the homeowner for the difference between the market value of the property at the end of a foreclosure and the amount owed to the lender. The lender can try to collect the judgment by filing a wage garnishment or taking non-exempt assets from the homeowner. The only remedy for a homeowner is to settle the judgment, or to  file a chapter 7 or chapter 13 bankruptcy.

In the last 5 years, I did not see a single deficiency judgment entered (on a normal residential mortgage). In the last 4 weeks alone I’ve seen these deficiency judgment entered:

Deutsche Bank $58,000.00 – Lake Co. condo.

Nationstar $50,000 – Chicago house

Nationstar $105,000 – Northwest suburban condo

Citimortgage- $25,000 – Northwest suburban house

Now, any time a mortgage company gets personal service on an owner in a foreclosure case (or substitute “abode” service on someone who answers the door) there is a real risk of a deficiency judgment being entered. If the lender is not able to personally serve you with the foreclosure complaint at the beginning of the case, then a deficiency judgment cannot be entered.

Why are so many deficiency judgment being entered? I don’t know the answer to this. For one thing, the volume of foreclosures is way down. Also FNMA and Freddie Mac have said that they intend to pursue strategic defaulters for deficiency judgments. Chancery court judges have clearly reversed course and now routinely enter them when they previously refused to do so.

So what does this mean to Illinois homeowners who have underwater properties?

•  Strategic Default is dead. There used to be little to no risk in stopping payments on a first mortgage in Illinois. The 1099 issued at the end of the foreclosure was wiped out by the Mortgage Debt Forgiveness Act. That expires at the end of this year and I doubt it will be renewed. Also, the risk of deficiency judgment is now so high that it makes no sense to stop paying on a mortgage unless you plan to file bankruptcy.

• Short sales are close to dead too. A favored strategy was to attempt a short sale, because the homeowner could get a release of deficiency from the lender.  But the Mortgage Debt Forgiveness Act is about to expire, meaning the homeowner will have to pay tax on the 1099 after the short sale closes AND if the short sales doesn’t close, the risk of deficiency judgment is way too high to try a short sale.

• Bankruptcy’s the only route. The only sure-fire way to get rid of a deficiency judgment is to file a chapter 7 or chapter 13 bankruptcy. Chapter 7 is cleaner than Chapter 13, but there is an income limit (called the “means test”) that has to be met and an asset limit. I’ve had to file several bankruptcies for clients lately after deficiency judgments were entered. Chapter 13 bankruptcies are less desirable because the creditors have to be repaid, but the income and asset limits are very broad and most people can easily meet them.

As part of the fiscal cliff bill passed early this morning, the Mortgage Debt Forgiveness Act (MDFA) was extended for an additional year through 2013. It expired on 12/31/12.

As long as your short sale closes before the end of 2013, and provided the property was your primary residence, there will be no income tax due on the 1099 that is issued after closing.

The same will apply to properties foreclosed in 2013. If the foreclosure is completed in 2013 (sheriff’s sale held and confirmed by the court), then there will be no tax owed on the difference between the market value of the property and the outstanding mortgage amount. This will only help owners of properties already in foreclosure. Since foreclosure takes so long in Illinois (14-20 months), you will have to carefully examine if beginning a strategic default makes sense now makes sense or not, because the law will likely expire again before the foreclosure is completed. And who knows if it will be extended again.

I just closed a short sale with GMAC Mortgage and it only took 3 months to close from the date of the contract. In the normally slow moving short sale world, that’s blindingly fast. So GMAC is my short sale best friend forever. Closing one of these makes up for the many death march short sales I’ve endured with the likes of Citibank and B of A.

My clients bought their home in Pingree Grove in 2006 and paid $250,000. They listed it for a short sale and got an offer for $150,000.00. GMAC short sales are initiated on the online Equator system and they quickly ordered the broker price opinion (BPO) and asked the buyer to raise the price by $5k. The buyer agreed to this and the short sale was approved in about 45 days. GMAC did not ask for a seller “contribution” despite the fact that the married couple selling were both employed and had good incomes. GMAC shorties also include a waiver of deficiency, so the seller is released from liability on the note (which is one of the main reasons to do a short sale in the first place).

When the buyer applied for his new loan, the property appraised $4,000 under the agreed short sale price after the increase. GMAC agreed to reduce the price back down to the appraised price, which was a minor miracle. Appraisal problems are everywhere now and a week does not pass without a property under-appraising, but that’s a post for another day.

GMAC also agreed to extend the initial short sale approval while the buyer finished his loan approval. For some reason, when lenders approve a short sale they put a very short wick on the time for closing, often less than 30 days. In this market, it takes a buyer a minimum of 30 days to obtain financing, so a short sale extension is often needed. Extending short sale approvals can be a mess. I am working on another short sale and the lender did a new BPO when asked to extend the short sale approval and increased the price $10,000 in mid-stream. That was not fun.

GMAC has a simple, final approval process for closing. The final HUD-1 closing statement is uploaded 48 hours before closing and, in this case, it was approved in about 1 hour. The final approval is fast and easy and not the extended nightmare of say, a Wells Fargo short sale.

So if you have an underwater home with a GMAC mortgage, you might consider a short sale. My unscientific guess is that you have an 85% or better chance of closing your short sale quickly and with a full release.

This video from one of my favorite movies (Monty Python and The Holy Grail) is symbolic of what happened to the new Illinois short sale law as it wound its way through the legislature. You’ve seen it.  King Arthur and the Black Knight get into a sword fight. King Arthur carves up the Black Knight  limb by limb, until nothing remains.  That’s pretty much what happened to this new statute just signed into law last week.

When I first saw that a new short sale law was working its way through the legislature, I hoped that it would help clear out the backlog of near-foreclosures and get the real estate market back on track. Initially, the new law required lenders to respond to a short sale offer in 30 days and it said that all approved short sales in Illinois must include a release of deficiency. California passed a law that prohibited deficiency claims on first and second mortgages not too long ago and I was hoping for a law similar to theirs. But as the law worked its way through the legislature over the past year, the forgiveness of deficiency was amended out of it and the requirement that the lender respond in 30 days was extended to 90 days.

As passed,  the law does one thing:  Requires the lender to respond to a short sale offer in 90 days. That’s it. And there’s no penalty if the lender doesn’t respond. Basically, the new law does nothing and that’s  not good at a time like this when so many homes are way, way underwater.