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Federal Bill Could Help Short Sale Sellers

WASHINGTON – April 2, 2012 – Under U.S. law, a homeowner with an underwater mortgage who goes through a short sale has part of his or her debt forgiven by a bank. The amount forgiven is legally considered income, as if the lender gave the owner a monetary gift by saying, “You no longer have to pay this.”

As a gift, that money is income and taxable by the IRS when the homeowner fills out his yearly income taxes. However, a temporary law effective through Dec. 31, 2012, nixes that amount as homeowner income, making the debt forgiveness tax-free. A short sale in 2012, then, allows a homeowner to walk away free of debt.

As it stands now, that rule expires next year, and underwater homeowners who go through a short sale could be taxed on the amount forgiven.

However, a bipartisan bill introduced late last week by U.S. Senators Debbie Stabenow (D-MI) and Dean Heller (R-NV) – the Mortgage Relief Act – would extend that rule past Dec. 31 if approved by both the House and Senate and signed by President Obama. Senators Robert Menendez (D-NJ), Sherrod Brown (D-OH) and Jeff Merkley (D-OR) cosponsored the legislation.

  “It is bad enough that so many families are faced with mortgages that now exceed the value of their home,” says Stabenow. “But to add insult to injury, without this bill, the IRS would once again require these families to pay hundreds or thousands of dollars in additional income tax when they sell or refinance their home. That’s just wrong.”

  Stabenow championed the original Mortgage Relief Act of 2007 designed to fix the problem that now expires at the end of 2012. Stabenow and Heller’s new bill will extend this tax protection for underwater homeowners through 2015.

  Approximately, 20 to 25 percent of American homeowners are currently underwater on their mortgages.

© 2012 Florida Realtors®

Short Sales and Slow Payments Can Ruin Your Credit Score

How to Wreck Your Credit Score  by Karen Blumenthal
Tuesday, May 24, 2011  


  

Don't underestimate the harm that even one missed mortgage payment can do to your credit score -- especially if you had good credit to begin with. 

The severe consequences underscore that you shouldn't shrug off even an accidentally missed payment. Instead, you should pay it and call the lender right away, begging for forgiveness before it mars your credit record. 

In an unusually specific commentary to lenders, Fair Isaac (NYSE: FICO - News), the creator of the FICO score, recently spelled out the severe consequences to the credit scores of borrowers who are 30 days late on their mortgages -- as well as the long-term impact of failing to repay the whole mortgage. 

It isn't a pretty picture.

Being 30 days late on a house payment -- even if it is an accident -- can knock 100 points off a pristine 780 credit score, moving you from qualifying for the very best interest rates to the edge of subprime territory.

The actual numerical drop is less severe if your starting credit score is 720 or 680, but the impact is greater, since your new score is likely to sink to a level where new credit is hard to get and very expensive.

The FICO score ranges from a low of 300 to 850, with scores of about 750 or higher generally qualifying for the best loan terms.

The details provide a warning for anyone whose home is way underwater and is tempted to simply walk away, or considering a "short sale." That is when the sale price is less than the amount you owe and the borrower doesn't make up the difference. More than 350,000 homes have been sold this way since 2008, according to the Office of the Comptroller of the Currency.

FICO officials usually dodge questions about the specific impact of actions on scores. But Joanne Gaskin, director of FICO mortgage markets, compiled the data partly to counter incorrect information, such as recommendations that people stop paying their mortgages so they can negotiate with a lender, she says.

FICO says a foreclosure or short sale where the size of the unpaid balance is reported are equally devastating to a good or excellent credit score, reducing it by as much as 150 points, to the high 500s or low 600s. A rarer "deed in lieu of foreclosure" -- in which the borrower voluntarily transfers ownership of the home to the lender -- may have less impact on an excellent score.

Recovering your original score takes about seven years. That also is how long the information stays on your credit report, where insurers and potential employers can see it. Returning to a mediocre 680 score may take only three years.

Here are some other lessons from the data:

• Your past behavior counts, but your current behavior matters more.

Credit scores are intended to measure the risk that you won't repay a current or future debt. So your careful payments over many years translate into a higher starting score.

But your score takes the biggest hit of all when you are 30 days late on a payment, falling 70 to 100 points in the FICO example. It drops less when you are 90 days late and if you default. The reason? The first missed payment "captures a good deal of the risk of the consumer," Ms. Gaskin says.

• The best way to rebuild a damaged credit score, ironically, is to use credit.

Avoiding borrowing altogether means "you've frozen your credit history in a negative state," says Maxine Sweet, vice president of public education for credit bureau Experian. You will be better off using a credit card judiciously and paying it off promptly, adding good-behavior points to your record.

• A rotten score hurts more than you think.

A person with a 620 score would pay almost 12% interest on a four-year $25,000 car loan, compared with less than 5% for someone with a 780 score -- a difference of almost $4,000 over the life of the loan. On a 30-year fixed-rate $250,000 mortgage, a person with a 620 score might qualify for a 6% rate, but probably wouldn't be able to get mortgage insurance, which is required if your down payment less than 20%. A person with excellent credit might land a rate less than 5% and pay about $3,000 a year less.

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Canceled Debt from Short Sales May Result in More Income Tax

WASHINGTON – March 7, 2011 – One can only imagine all the high-fives and fist-bumps that erupt once a can’t-make-ends-meet borrower finally, finally talks a lender into forgiving $3,000 in credit card debt.

Now let’s picture that same person months later handing over a little piece of paper called a 1099-C to a tax preparer.

The tax preparer must break the bad news: Most times, canceled debt is treated like income. And $3,000 of forgiven credit card debt must be reported as income on state and federal income tax returns.

“Sort of what you did is you switched creditors,” said George W. Smith IV, a certified public accountant and partner at George W. Smith & Co. in Southfield, Mich.

“I had one guy storm out of here saying, ‘I’m not going to report it,’” Smith said.

If you don’t report it, you can expect the Internal Revenue Service to come calling.

“The IRS gets a copy of that 1099,” said Jim Van Grevenhof, senior tax analyst for the tax and accounting business of Thomson Reuters. “They’re going to be looking for that on your tax return. And if you don’t deal with that, they’re going to ask why.”

A Form 1099-C is issued when a debt of $600 or more is forgiven or canceled. According to the IRS, the number of 1099-C forms filed with the federal government by creditors and debt collectors grew from fewer than 1 million forms in 2003 to more than 1.987 million in 2008. Some estimates project 2.8 million 1099-C forms will be sent out in 2011 for the 2010 tax year, according to CreditCards.com.

What’s unsettling, of course, is that people who couldn’t afford to pay their debt now owe thousands in taxes.

“It’s very unlikely they have several thousand dollars sitting in the bank that they can use to make an unexpected tax payment,” said Ben Woolsey, director of marketing and consumer research for CreditCards.com.

They’re going to need to borrow money – or enter into installment payment plans with the IRS.

“We’ve seen this issue more frequently in the past several years, both with credit card debt and home mortgages,” said Marshall Hunt, certified public accountant and director of the tax-assistance program of the Accounting Aid Society in Detroit. If you’d need to add $50,000 in canceled debt to your income, you could be looking at another $15,000 owed on a tax bill.

All canceled or forgiven debt, though, is not treated the same.

For example, if student loan debt is canceled as part of a forgiveness program for working in a particular field, such as health care in an underserved community, the debt that is forgiven is tax-free. The same is true for public service loan forgiveness programs, said Mark Kantrowitz, publisher of Fastweb.com and author of “Secrets to Winning a Scholarship.”

But the forgiveness of the remaining student loan balance after 25 years in an income-based repayment program is taxable.

Given the complex rules, you should provide the 1099-C to the tax preparer.

There is a special provision that allows up to $2 million of canceled debt on a mortgage to be excluded from income. This applies only to a principal residence – not a second home. And the exclusion applies only if a foreclosure or short sale takes place from 2007 through 2012.

The canceled debt must have been incurred to buy, build or improve your main home.

Consider this example from Van Grevenhof: Say a couple paid $500,000 for their home. But the house’s value tumbled to $350,000 after the collapse of the housing market. Their mortgage was for $450,000. One person lost a job and the couple couldn’t afford the monthly mortgage. They handed the deed to the bank and walked away.

The bank sold the house for $350,000. The house sold at a $150,000 loss, and the couple had $100,000 in canceled debt.

The loss is not deductible. But that $100,000 in income now is covered by the “Principal Indebtedness Exclusion.” So this foreclosure does not drive up their tax bill.

Who faces the most headaches?

Watch out if you tapped into the equity of the house to make an investment in a sure bet, but later lost your shirt and walked away from that debt.

“You had a buddy who said ‘I’ve got a great deal for you’ – and you put it in a Ponzi scheme,” Smith said.

You could end up with an extra $50,000 showing up as income on your tax return.

And if you faced foreclosure on your vacation property, you would have to report that forgiven debt and would owe taxes on it.

“All of a sudden, I’m saying ‘Guess what? Here’s your tax problem,’ “ Smith said.

What you should know

If you had debt forgiven, here’s what you need to know at tax time:

• A 1099-C is sent to the borrower and the IRS if a creditor or debt collector agrees to forgive $600 or more in debt.

• You would want to look at Box 2 of Form 1099-C for the amount to be reported as “other income” on Form 1040.

• Make sure to dig deep into your mail to find all Form 1099-Cs that you would receive from a federal government agency, credit union or bank.

• Complex rules exist for mortgages and some student loan debt. You need to know rules about when forgiven or canceled debt can be excluded from income. For example, a special exclusion exists for health care professionals who have student loans forgiven and they work in underserved communities.

• Other exclusions apply, too. For example, cancellation of debt income that occurs during bankruptcy proceedings is excluded from income, as is cancellation of debt income to the extent of the borrower’s insolvency immediately before the debt forgiveness event occurs. Also, there is no cancellation of debt income if the mortgage was nonrecourse or seller financed.

 © 2011 Detroit Free Press, Susan Tompor. Distributed by McClatchy-Tribune Information Services.

Real Estate's Shadow Inventory

Where is the shadow inventory?
WASHINGTON – Sept. 20, 2010 – For the last year, the real estate industry has been talking about shadow inventory and the coming flood of distressed properties. Where are they?

Here’s what’s happening, according to a recent paper by Alan Mallach, a senior fellow the Brookings Institution:

• Some delinquencies have been resolved through loan modifications or people working out the problems on their own.

• Banks are getting better at managing short sales.

• Investors are aggressively buying up properties, sometimes in bulk, directly from the banks or at courthouse auctions so they don’t hit the market.

The likeliest outcome, Mallach predicts, is a steady flow of foreclosures over a long timeframe that will prevent another crash in home prices – but it will probably lead to low or no appreciation in home prices for a while.

Source: The Wall Street Journal, Nick Timiaros (09/16/2010)