Different Ways to Deal With Your Mortgage Arrears and Other Liabilities

by Stephen Kass on August 22, 2012

This article is written in response to the numerous readers’ questions regarding the ways to save the house when the times get tough and homeowners fall behind on their mortgage obligations.

It is not a secret that the amount of foreclosure sales in the country is at its highest level, and a lot of people are struggling with the monthly mortgage payments.

According to the information provided by foreclosures.com, California based foreclosure information specialists, for all of 2007 almost 1.32 million homeowners nationwide (18.2 for every 1,000 households) faced pre-foreclosure, up 59.65% from 636,957 filings (11.4 per 1,000 households) in 2006.  The same source states that the total outstanding U.S. mortgage debt totals more than $10 trillion.

Most of the borrowers that are having problems with their outstanding mortgage obligations are those who probably should not have been approved for the mortgage in the first place. I have clients coming into my office who were approved for multiple mortgages in the amounts of almost 62 times more then their income was. I believe it was a mistake for the banks to approve people with an income of $8,000.00 a year for mortgages of over $500,000.00. Such mortgages are known as subprime mortgages. Naturally, what is happening right now is what had to happen. People, relying on the increase in real estate prices were buying houses right and left and when real estate market went down, and they were not able to sell their properties, they were stuck with huge mortgages that they will never be able to pay. This is known subprime mortgage crisis.

Another type of person who are getting in problems are those whose income actually was checked and verified and they got mortgages that they can afford paying for, but because of medical issues or loss of income for several months, they fell behind on their mortgage obligations.

For both of these categories of people, there are ways out if they wish to save their houses, especially if the house is their primary residence.

First of all, there are different programs that the Mortgage Banks are offering directly to borrowers. You need to call your Bank directly and try to make a deal. Different variations of programs include: entering into forbearance agreement with the Bank; entering into the deed in lieu of foreclosure; another option is to put the amounts due at the end of the loan; short sales, and other means of rehabilitating your current default situation.

If none of those options work, there is always an option to involve the Court to help to reorganize and stop foreclosure. I am talking about filing for Bankruptcy under Chapter 13 of the Bankruptcy Code. The borrower will propose a Plan of Reorganization and his/her creditors do not even need to approve it, the judge is the only one who approves the plan with a Chapter 13 Trustee’s recommendation. Usually, within the Chapter 13 proceeding, the arrears on the mortgage have to be paid in full, and all unsecured creditors (credit cards, medical bills, etc.) can get as little as a 10% distribution within a 5 year plan.

For those people who do not want to keep the house, there is filing under Chapter 7 of the Bankruptcy Code, which is also called liquidation. In this case, the person will liquidate its liabilities, as well as surrender the house back to the Bank.

Let’s discuss those options in more details:

Forbearance agreement. What it means is that sometimes the Banks instead of hiring an attorney’s office to prepare a foreclosure are willing to work with the client and allow him/ her to pay the back owed mortgage obligations in installments over a period of time. Regular mortgage payments must be current. So, on top of the mortgage payments the client will be paying back owed obligations within some period of time. The amount of time the client is given depends on the amount owed and can vary starting from 6 months to a year. To be able to enter into Forbearance Agreement, the client needs to produce a number of documents to their Bank with which it has to be able to proof its ability to repay the back owed obligations.

Deed in Lieu of Foreclosure. What it means is that as a result of substantial negotiations with the client, the Bank would agree to take back the deed and will become the owner of the house. A part of negotiations can be provisions regarding the fact that the Bank will not go against the client for the past due mortgage payments, as well as potential deficiency judgments. It sounds like a great deal, but unfortunately it does not work out successfully most of the time. Here the trick it to prove to the mortgage company that taking back the house is the fastest and easiest way for the bank, that foreclosure is very costly, and probably the bank will end up buying the house back since the market is slow and no one will be interested in the purchase of this house.

Short sale.  This is another way to minimize losses for both the banks and


clients. In this situation, the Bank sells the home for less than the amount is owed, with the Bank forgiving the difference. The sale releases borrowers from their obligations. For mortgage holders, it can be less costly than foreclosing- and could provide protection against future price drops. For the third parties, who will buy at a short sale it is a great opportunity to buy home at an attractive price. As great as this deal may sound there are a number of pitfalls that the borrowers need to know about: at the end of the day the original borrower might end up with the tax bill, taxing the amount of the forgiven debt obligation. For example the house had a mortgage in the amount of $400,000.00 and was sold to a third party for $200,000.00, at the end of the year the mortgage companies have to report forgiven debt to the IRS and you, as a borrower, will be taxed on $200,000.00 forgiven debt. This is one of the negatives, among other unpleasant moments that can happen if you choose short sale as a way to deal with your financial difficulties.

Other negatives can include a long waiting time for the mortgage companies to respond to the offer; if homeowners may have more than one loan on the property it will significantly slow the process; and also it is hard to make mortgage service companies to agree to the purchase price.

The process of short sale can be a very emotionally draining and long. Practice shows that the deal with the bank may take for up to a year to make it happen. Very often the process is so frustrating for the parties involved, that real-estate agents and home buyers, as well as suffering borrowers are deciding that the process of short sale is not worth the effort.


Chapter 13 or Chapter 7  Bankruptcy

One of  my favorite ways to deal with the financial difficulties is Chapter 13 or Chapter 7 Bankruptcy. I will explain why: first of all, there is no forgiveness of debt income, if you reject your house within Chapter 13 or Chapter 7, meaning if you reject you primary residence or investment properties within the bankruptcy, mortgage companies will not report to the IRS regarding any deficiencies that might be outstanding; another important factor is the fact that because the Bankruptcy court is involved and the process is supervised by the Bankruptcy Trustee, you do not have to personally deal with any of the Banks, it saves tons of money and time; and a final point to take into consideration is the fact that you will be able to take care of not only arrears on the mortgage, but also discharge other outstanding obligations as well, such as credit cars, medical bills and so on.

The Difference between Chapter 7 and Chapter 13 when you are dealing with mortgage arrears:

1.      You need to file Chapter 7 Bankruptcy when you want to reject the property which is your primary residence or investment property. It will allow you to reject the property back to the Bank and not be liable on any outstanding obligations. In order to file for Chapter 7 you obviously need to qualify, there are: income, asset and means test that we use in order to determine whether the person will qualify or not.

2.      You can file for Chapter 13 Bankruptcy when you want to keep some of the properties. You can keep one (your primary residence for example) and reject others (your investment properties, which are “Underwater”). In order to do that you need to prove it with your budget that you are able to get back on track. Your income needs to exceed your expenses for the repayment amount, and it should be enough to pay back your creditors. The rule of repayment is: you will be paying 100% to your secured creditors (mortgage arrears) and as little as 10% to unsecured creditors (credit cards) within a 5 year plan, with this 10% increasing if you have greater ability to repay or substantial equity in your assets.

There should be one more very important thing mentioned in the context of dealing with devalued properties and trying to get out of the subprime mortgage mess. In December, 2007 President Bush had signed “The Mortgage Forgiveness Debt Relief Act of 2007” and pursuant to the Act there is no more forgiveness of debt income when applied to the primary residence. So, if your primary residence is foreclosed on, and the sale price is less than what you owed on the mortgage, Banks will not report the discrepancy as your income for the tax purposes. Please pay attention that this law is not applicable to investment properties.

There are so many factors that one need to take into consideration deciding on the way to approach its financial difficulties that the best advise is to turn to knowledgeable people, preferably attorneys specializing their practice in the arrears of debt reorganization and restructuring.

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