A client called to say that he just moved out of his home in foreclosure and, on the way out,  he took the following:  Stove, refrigerator, washer and dryer.  Not satisfied with taking just these items, he disconnected and hauled away the exterior air conditioning  and put that big whopper in a storage locker. He had moved all the way across the country, so he really had no use for any of this stuff and it struck me as kind of excessive. His lender thought so too.

The reason for the client’s call to me was that his lender had called demanding  the  a.c.  be returned and threatening to file an insurance claim on his homeowner’s policy if it wasn’t returned. I told him to return the a.c.

Increasingly, lenders  will file claims against an owner’s homeowner’s policy if a home in foreclosure is stripped of fixtures. The lender is an additional insured on the insurance policy and is entitled to payment.  Homeowners need to be careful about this because after the insurance company pays the claim, the insurance company will sue the homeowner for the money it paid out.

Generally, it’s okay to take appliances like washer, dryer, refrigerator or stove. When I arrange “cash for keys” agreements for clients at the end of foreclosures, the lender will usually allow the owner to take these appliances along. But taking a furnace, a.c. unit or kitchen cabinets from a home in foreclosure is crossing the line and should not be done unless you want to be lit up with a lawsuit later.

I sure hope the Mortgage Debt Forgiveness Act (MDFA) is extended soon, so clients can relax their collective minds. It expires in 4 months.  I thought it would have been extended by now.

The MDFA says that if a homeowner is foreclosed upon or short sells his or her primary residence then no tax is due on the 1099 issued afterward.   For foreclosures, the mortgage amount minus the market value of the property is taxable to the owner under the 1099. For short sales, it’s the total mortgage amount minus the amount repaid in the short sale that’s taxable.

The graphic above from the Chicago Tribune shows that the AVERAGE foreclosure case in Cook County taxes 682 days. So, If you started a strategic default one year ago you have almost one more left to go. Meanwhile, the law is about the change and leave you hanging with one foot over a cliff. A big 1099 will be dropped in your lap at the end of the short sale or foreclosure and that will send many over the financial edge.

Short sales will no longer be an attractive option if the MDFA  expires. It’s great to get a release of deficiency in a short sale, but if a lender is shorted $100,000 after a short sale (not unusual) the owner faces a $25,000 tax bill (at an estimated 25% tax rate). That’s rough. Unless a client can claim insolvency and thereby knock out a 1099, a short sale will make no sense in many cases.

One strategy that will become very popular if the MDFA expires is the surrender of a property in a chapter 13 bankruptcy. This is not a new method of avoiding tax on the 1099, but it will take on new importance if the MDFA expires.

If we lose the MDFA, there will be three ways to avoid tax on the 1099:

Surrender house  in a chapter 13. The law allows a homeowner to file a chapter 13 bankruptcy and surrender the underwater house. This means the owner stops making payments on the house and it returns to the lender in a foreclosure.  It doesn’t matter what assets or income the owner has (there are limits on the size of the mortgage).  The owner does not have to pass the means test required in a chapter 7. The owner stops making payments, files the chapter 13 and stays in the home until the end of the foreclosure. The 1099 is wiped out by the chapter 13 and the owner is released from any deficiency judgment. The owner makes a few payments to the bankruptcy trustee for attorney’s fees and other costs and then is discharged from all liability including the 1099. Sweet, right? The negatives: attorney’s fees are about $3500.00 and the owner’s credit is damaged.  If the client has a second mortgage, there is a chance that the second mortgage company might file a claim that the mortgage is unsecured, but that usually does not happen. Very few clients other than real estate investors needed to use this .  That’s because in Illinois, there are few to no deficiency judgments on first mortgage foreclosures and the 1099s after a foreclosure were blocked by the MDFA, so there was no need to file a chapter 13 for the vast majority of primary residence foreclosures. I look for this to become a much-used strategy if the MDFA goes away.

Insolvency. A 1099 after a foreclosure is wiped out if the homeowner is insolvent, meaning that the sum of all debts is greater than the owner’s assets. I find that many clients do qualify as insolvent, which would mean they would not need to file a chapter 13. This is a simple remedy, but it’s all or nothing. You either are or are not insolvent.
Chapter 7. Filing a chapter 7 bankruptcy will knock out the 1099, but homeowners have to pass the means test which requires a relatively low income. Also, there are asset limits that have to be met. Generally, we use chapter 7s only when the owner passes these tests and has a large second mortgage or only a first mortgage and high credit card debt.

Of these three solutions, the chapter 13 surrender will be only  remedy that works for many clients and should at least be considered when constructing a strategy for an underwater property.

All you have to do is look at my facebook page to see how much I participate in online forums. I’m  mainly a lurker and don’t contribute much. It’s probably a character defect, or an overreaction to giving the wrong answer to Sister Margaritas  in fourth grade religion class. Man, that ruler hurt.

I’m barely a contributor and certainly not a flame war type of guy, but now I am banned from an online forum. The ban is not temporary, it’s for life.

Here’s how it happened:

This week I was looking at the statistics for illinoislawnew.net and I saw a bunch of incoming clicks coming from loansafe.org. Loansafe.org is an online discussion forum in which people talk about foreclosure, short sales and underwater real estate. I registered for the site a long time ago and posted one time about a year ago in response to someone asking a foreclosure question. I rarely go to the site, but I do get many hits from this site to my site because users of loansafe.org  post links to things I’ve written about Illinois foreclosures and short sales.

Here is a typical day and the chart below shows people clicking a link to my site from  the loansafe.org site.

Loansafe.org is an active forum. It’s kind of a venting, spill your guts type of affair where people post their personal story about their underwater real estate and everyone else comments on it. Here is a typical example of a post by Miserable In Cook Co. A lot of the “advice” and comments are way off base, but occasionally there is a reasoned, accurate response. You see a lot of comments like “all attorneys are stupid” and “I will never deal with a bank again.”

Anyway, I clicked on a link from Loansafe. org  to this post that I wrote about how collection cases on  second mortgages are a bigger risk than deficiency judgments.  The moderator, some goof named Tom Eason, commented on my post saying.  “That is the site of Tom Sammons, a solo attorney bankruptcy mill.” Then he wrote, “Doesn’t he sound like a typical bankruptcy mill lawyer , LOL.” Tom felt that I was encouraging everyone with an underwater home to file bankruptcy.

Tom is a volunteer moderator who lives in California and hands out advice across the country to everyone and anyone. In fact,  one would think that he had the wisdom of a thousand  Buddha’s from the way he holds forth.

I was not happy to see  this guy trashing me. I responded  back with a post that I was not a bankruptcy mill and that my second mortgage post was accurate. Tom, the moderator, never responded. The site administrator deleted my response and when I logged in I saw this:

If I were a character in my favorite show “Game of Thrones,” the shame and dishonor of a lifetime ban on Loansafe.org would have forced me to join the Nights Watch (a group of rejects who can’t have girlfriends and are forced to protect the kingdom against encroaching monsters). Sometimes I think it might be easier to fight whitewalkers all day than to  practice law. But I live in suburban Palatine, not Winterfell, so I soldiered on.

Now having recovered emotionally from my lifetime ban, I wondered what should you watch for when reading online about underwater real estate?

1.  Beware of the closed ecosystem. Most forums  value healthy discussion. They monitor posts for vulgarity and stop hostile flame wars, but that’s it. Loansafe.org edits out any post that threatens its self-appointed expert status. After I was banned, the moderator of the site went back and tried to clip out all of the links to my site, but she missed a bunch of them.

2. Don’t take advice from out-of- state experts. Real estate is hyper local. I would never give advice to anyone outside of Illinois. Be very careful about taking advice from out-of-state, non-lawyers about your underwater property.  It’s a complicated topic and you want to be sure to get a balanced view on your case.

3. Diaries written by others are cathartic for the writer, but won’t really help you . One thing I have learned by doing phone consultations with Illinois clients on underwater real estate is that every case is different and you need to know a lot of details to give the proper guidance to a client. Reading about someone else’s journey through foreclosure is interesting and all, but it will rarely help solve your problem.

There is still no extension of the Mortgage Debt Forgiveness Act (MDFA) that expires December 31, 2012.

Now there are two bills pending to extend it.

The MDFA says that if a homeowner’s primary residence is foreclosed or short sold, then the 1099 issued afterward is not taxable.  Normally, a homeowner would owe tax on the difference between the mortgage balance and the value of the property.

The Democrats have introduced  HR 4202 that proposes a 2 year extension of the MDFA through the end of 2014. Republicans are pushing HR 4336 that suggests a 1 year extension through December 2013. Both bills are stalled in the House Ways and Means Committee.

I think that The MDFA will be extended at the last minute.

It will not be pretty if the MDFA expires. Some homeowners will still avoid tax on the 1099 by claiming insolvency, but few will meet the tough definition of insolvency.

Here is what to do if the MDFA does expire.

(Thanks again to Chris D. for staying on top of this.)

Last week, a client in foreclosure arrived home from a long day at work and found this notice slapped on her front door:

Vacant Posting Notice

This property has been determined to be vacant. This information will be reported to the mortgage servicer responsible for maintaining the property. The mortgage servicer intends to protect the property from deterioration. The property may have its locks replaced and/or plumbing systems winterized in the next few days. If this property is NOT VACANT please call BAC Field Services immediately.

She was pretty alarmed by this and thought that her lender, Bank of America, might try to change the locks and take back possession of the house.  Of course, in Illinois, possession is not given back to the lender until about 60 days after the sheriff’s sale. The sheriff’s sale isn’t until the end of the foreclosure ( about 10-12 months after it starts), so it takes a long time for the lender to get possession.

My client was about 3 months into the foreclosure,  she had a short sale contract signed and the closing date was fast approaching.

I called BAC Field Services and told them the property was occupied and if they contacted my client again she would file a construction eviction case against them. Since this was B of A, I also sent them a direct message on twitter to @BofA_help. As a side note,  B of A twitter help account is very helpful. They respond almost immediately and really try to help you with any foreclosure or short sale related matters. If the B of A short sale department was as good as @BofA_help, then doing a short sale with B of A wouldn’t be the god-awful cluster that it is. But that’s a post for another day.

These vacancy posting notices are ridiculous. I understand that the lender wants to monitor and take care of obviously vacant foreclosures, but they have no right to bother and annoy owners still in possession of the property. The notices imply that the lender has the right to possession, when they don’t have that right.  The notices confuse owners who are already under stress due to a short sale or foreclosure

In one case, BAC Field services entered the property after it was sold to a new buyer.  Welcome to the neighborhood, here’s your complimentary lock change and winterization! Oops, sorry wrong house.

If you get a vacancy posting notice, just call the phone number and tell them the property is still occupied. Tear off the sticker and toss it where it belongs.

What is Buy and Bail?
 Buy and Bail is a version of strategic default. The owner of a severely underwater house or condo buys a new house.  After they close on the new house, they either try to short sell the old home or stop making payments on it and strategically default on the old house.

What is the advantage of Buy and Bail?
 If a homeowner sells a home in a short sale or stops paying and loses the home to foreclosure in a strategic default, the owner will be unable to buy a new house for between 2 and 5 years.  The hit to the owner’s credit will stop them from qualifying for a new mortgage. Buy and Bail allows you to own your new house at today’s low prices and avoid renting.

Is Buy and Bail illegal or unethical or both?
 Go ahead and google “Buy and Bail” and you will see many blog posts that say it is fraud to buy a new house with the intention of dumping the old one. I disagree with that. It is loan fraud to lie on a loan application. But most loan applications just ask for your financial data and don’t require any statement concerning your current home. I have seen mortgage lenders ask the buyer for a statement explaining why they are buying a new house in the same area as their current home. Most clients explain that they have a growing family and want to take advantage of the low prices to buy a bigger house. As long as you qualify for the new loan and don’t misstate  anything on the application, there is no fraud involved in my opinion. It is total loan fraud to do a fake lease on your current property. Don’t do that, please. The rental income probably won’t help you qualify for the loan anyway (see below). I will leave the discussion of whether Buy and Bail is unethical to greater minds than mine. That is up to you to decide. Blog comments on Buy and Bail  range from “everyone who does it should be shot” to “the banks caused all this and they deserve it.”

Do I have to qualify for both mortgages?
 Yes, you pretty much have to have a high enough income that you qualify for the old mortgage and the new mortgage. Take your gross monthly income times 28% and your mortgage payments on both places cannot be more than that amount. You have to have a pretty good income to qualify. Many people apply for an FHA loan, which is only 3.5% down as the new mortgage. You can get an FHA mortgage as long as the mortgage on your old home is not FHA. They only allow one at a time. Some get Homepath financing, which requires only 3% down, has no PMI and is offered on the sales of many FNMA foreclosures.

Will my mortgage lender let me count rent I receive as income?
 Probably not. Fannie Mae and Freddie Mac cracked down on Buy and Bail a few years ago and they only allow rental payments to be considered as income if you have 30% down or more in your “old” house. Most people have little to no equity in their current house, so they can’t count the rental income.

Will my new mortgage lender call my loan due if I stop paying on my old house?
 No, the two loans are totally independent of each other. If you decide to Buy and Bail your credit will drop to the low to mid 500s and will stay there for several years. This explains how quickly credit recovers after a foreclosure or short sale.

Will my old mortgage lender try to take my new house from me? 

Buy and Bail is really a strategic default. This post explains the risks in a strategic default and the same applies to Buy and Bail. If you have a second mortgage, it is not wise to Buy and Bail because the second mortgage company likely will try to sue you separately from the foreclosure.

I recently ran across a new Cook County case and, while the case is interesting, I hesitate to even bring it up because everyone will think that it’s open season now for deficiency judgments in Illinois.

Trust me, it’s not. Deficiency judgments are still nonexistent to rare in Illinois.

The case is Metrobank v. Cannatello, 2012 Ill App 1st 110529. Here’s what happened: Cannatello borrowed almost $200k for a multi-family property in the south side of Chicago from Chicago Community Bank (Metrobank took over Chicago Community Bank along the way). A foreclosure was filed against him and the lender asked for a deficiency judgment of about $50k after the sheriff’s sale.

When the foreclosure started, a member of Mr. Cannatello’s family was served with the summons at his house. He lived elsewhere, not in the property being foreclosed. This is called “abobe” or “substitute” service. Any person over age 13 who answers the door at the defendant’s house can be served on the theory that  the person receving the summons will tell the defendant (and hopefully will not just throw it in the garbage). This applies to all civil cases, not just foreclosures.

To make a long story short, the court said that it was allowable to enter a deficiency judgment after abode service and that personal service on the defendant was not necessary. This is not really a surprising result.

What does this case mean? The case just makes it clear that a deficiency judgment can be entered if a member of your family accepts the summons.

Are lenders starting to get deficiency judgments? No. They are still very rare. This was a loan on a multi-family investment property from a small bank. I have said before that mortgages given by small, local lenders hold a much higher rise of deficiency judgments than your garden variety single-family home mortgage from Wells Fargo or Chase.
Should I answer the door if I am being served with a summons in a foreclosure? That is up to you.  The lender cannot get a deficiency judgment unless there is personal service (the summons is handed to you) or substitute service (summons is give to someone over age 13 at your house).  Deficiency judgments are still extremely rare, so if you are served with the summons it’s not the end of the world because it’s unlikely that a deficiency will ever be entered. But people are touchy about this and, to be honest, it seems like most of them do dodge service. I have talked to people during the period when the process server is trying to serve them and they are, shall be say, a tad jumpy about it, because it’s an unfamiliar situation, and they feel like quasi-criminals because someone is pursuing them. Some accept the summons because they literally can’t take the pressure for the two weeks that the process server attempts service.

(Note: The MDFA expired at the end of 2013. This is an old post that and it was not extended through 2014-sorry folks. TS)

It looks like there is a proposal in the 2013 budget package to extend the Mortgage Debt Forgiveness Act (MDFA) through 2014.

The MDFA is an important law that allows homeowners to avoid being taxed on foreclosures and short sales for their primary residences. It was supposed to expire at the end of 2012.

This is not passed yet, but at least it’s in the works

*Thanks to sharp-eyed Chris D.  for pointing this out.