So my real estate dealings led me to have two almost identical conversations with two distressed property homeowners this week, and made me realize how little some homeowners know about the foreclosure/short sale/deed in lieu of process here in New York State, and in Sullivan County in particular. So I am going to explain the process, and the different options one has to relieve themselves of a distressed property.
It had appeared to me that the second home/weekend market here in Sullivan County had largely escaped the foreclosure glut that swept through the country. My thinking was that if one is well enough off to have a second home, then chances are they will be able to keep paying a (probably) smaller upstate mortgage as well as their primary one–or the rent on their city apartment. And that was the reason for the lack of traditional second home foreclosure inventory hitting our market. And for the most part I still think that is true. However as the years have gone by, and those that bought at the height are now facing the specter of untold more years before they are above water, seller fatigue of a different nature is setting in.
People’s situations change, and they need to sell. But many have unsellable homes. The number to break even with the bank just doesn’t make sense. It is like an albatross that holds people from moving forward with their lives and forces them to make tough decisions.
Many of these people (like the two I spoke with) are good conscience-driven hard working people. Paying your debts is something that has been instilled in them from youth. So for some, the decision is agonizing. What direction to take? Well, they call their banks and explain the situation–again an action that has been inoculated from an early age. Do what is right by the person you owe.
Well this is where I give my distressed property owners a firm talking too. The bank is not your friend. In fact that guilt and pain you feel at not meeting your obligations is a bit less your fault and a bit more the banks fault then you think. These are the same banks that eagerly doled out sub-prime mortgages in the first place, effectively flooding the market and adding buyers which had no business being there, which in turn drove the prices up. Add that to the banks evil step sister, the securities trader, and suddenly when you plunked down your hard earned money for that dream house, you were being swindled–cheated. You were charged thirty or forty percent more for a product then what it was worth. It really is that black and white.
And banks have not changed. Your apologetic hat-in-hand call may seem like it is met with some sympathy and some alternatives to foreclosure, however let’s make one thing clear. The bank is out for the bank. You are a number–a loan number on an e-file somewhere. Your credit, livelihood and well-being are not a major concern for them.
They offer you a deed in lieu of foreclosure. It sounds like the perfect plan. You hand the deed over to the bank, and walk away scot free. However the exact opposite is true. A deed in lieu of is almost just as bad as a regular foreclosure, with none of the advantages. A deed in lieu contract will be written by the bank and will most certainly favor them. The stipulations will be that you must complete the deed transfer within 90 days and leave the premises. The hit to your credit will be slightly less than a foreclosure, but only slightly–around 200 points. And Fannie (and most other lenders) will not lend to you for at least four years.
But a deed in lieu can be even nastier than that. New York is a one action state, meaning a bank can either come after you for the debt owed, or foreclose. They are not allowed to do both. However if you voluntarily give the deed over, they are allowed to come after you for the difference. Now if they plan to do that, they must disclose it, but often it is buried in legal mumbo jumbo in the contract, and if you don’t hire an attorney, you can get hit with a big surprise. Most big banks do not do this, however it is something to be vigilant of if you are planning a deed in lieu of.
The other nasty surprise is the tax repercussions. The government sees the debt forgiveness balance as income. Therefore you will be taxed on this as income. The Debt Relief Act was extended at the 11th hour through 2013, which allows up to one million dollars (two million if married) of debt forgiveness not to be taxable. However this is only on a home that was your primary home. Any rental/ vacation/ second home property is not covered by this act. Even if you were to move out and rent a house, and then do a deed in lieu, you could get hit with a big tax bill. Again this is something that the bank will not tell you.
And finally the last major reason why I would not recommend a deed in lieu of is that you have no control over what the bank does with the property once you hand the deed over. They will hire a management company that will come in and winterize the house and turn off all the power, and then it will sit, while the clogs of big bank business churn, and perhaps six months later it will pop up on the market. By then the mice have set up shop and the moisture and the cold and all the bad things that happen to an empty house will have crept in. Now the offers are thirty or forty percent what you paid for it.
Short sales on the other hand–done correctly–keep you the seller in control from start to finish. Getting a good broker who knows his or her way around the short sale process is crucial, but with the right people in place, A short sale is leaps and bounds above a deed in lieu of foreclosure.
Like I said you are in control, you pick your agent, you pick your attorney, and they do all the work for you–and the bank pays them! The bank never owns the property, so you are never beholden to them. You sell the property, and all the bank does is agree to forgive the balance. Now there are some hoops, but again your agent and attorney will do most of the jumping for you. The hit to your credit is roughly half that of a deed in lieu of foreclosure.
The tax stuff is the same, however it is likely that you will get a higher price for your home than you would with a deed in lieu of, so that would save you money if you weren’t covered by the Debt Relief Act.
So I believe after this long winded post, I can sum up it up this way. Do not be the bank’s friend. They don’t want to be your friend.