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 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, Calif. “The law is constantly evolving, and even realtors don’t understand all the fine distinctions in the law.”
The Orange County 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: 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, said Bickham, lenders only approve deed-in-lieu transactions if there is a single loan on the property or multiple loans with the same lender, which 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.
Also, in a deed-in-lieu agreement, a lender can require that 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.
But 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 three 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 five to ten percent below full fair market value even with the additional costs, he said.
MYTH: A foreclosure absolves a homeowner of delinquent homeowners 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.