FORECLOSURES AND SHORT-SALE
 
 “If ya don’t pay, ya don’t stay” goes the old saying in the mortgage business...and many
In The state of FL are not paying, and therefore not staying. Foreclosure filings have
Approximately tripled from 2007 to 2008 in The state of FL. And filings this year will likely
be Higher than last year. (An interesting byproduct of this is that The FL state courts and
Judges are clogged with foreclosures, creating delays in all other types of suits).
This situation is not going unnoticed by the media. Recently, national news publications
Reported that Cape Coral/Ft. Myers has the highest foreclosure rate in the entire USA,
With one in every 86 homes in foreclosure. Indeed, most local real estate attorneys,
Including yours truly, have been inundated with foreclosure, short sale and deed in lieu
Questions from borrowers. This is understandable, since there are many tax and legal
Consequences to foreclosure, so borrowers in this position should always seek
Professional legal and tax help. Unfortunately, though, there are usually few “loopholes”
Or legal “technicalities” available to get a foreclosure suit thrown out. This is not
Hollywood.
But a borrower’s big question is usually, “can the lender ‘come after’ me for everything I
Own?” That concerns deficiency judgments, and will be covered in this article. But don’t
Forget the IRS. It has far more power than any lender.
 
FORECLOSURE BASICS AND PROCEDURE
 
Remember that lenders don’t want to have to foreclose. They are not in the business of
Owning property. They are in the business of lending money and they want that money
Back, not the property. But foreclose they will if they don’t get paid back. (And of course, A borrower’s credit report is hit hard by a foreclosure). How do lenders foreclose?
Florida is a judicial foreclosure only state. In other words, the lender must file a lawsuit
Against the borrower in the circuit court in which the property is located. (Some states,
Notably Georgia, California, Texas, and New York, allow non judicial foreclosure in some Instances). Foreclosure is started by the lender sending the borrower a demand letter to the borrower to pay once the borrower falls behind in payments. Usually the borrower has 30 days to cure the default. Some lenders may work with the borrower by giving the borrower more time to pay, or even reducing the monthly payment. Some lenders, though, will never return calls. The options can vary greatly from lender to lender. If the borrower can’t work it out with the lender, or if the borrower doesn’t want to work it out, the lender will eventually foreclose. The lender files a foreclosure Complaint in the circuit court in which the property is located. That is the “suit.” The lender will also record a “lis pendens” in the public records of the county in which the property is located, which tells the world that the property is in foreclosure. The lis pendens cuts off the rights of any lien holder or other party who records its lien or document after the date of recording of the lis pendens. The lis pendens is a very powerful litigation tool. It “ties up” the property so that the seller cannot sell it until the lis pendens is released. The lender must join any junior lien holders (i.e., holders of HELOC’s or second mortgages) in the foreclosure action. Otherwise, their interests will not be “foreclosed”, or wiped out. The lender must try to get personal service of process of the summons and complaint on the borrower and all other defendants. Note that it must get personal service of process on the borrower in order to eventually be granted a deficiency judgment. More on that later.
If the lender can’t get personal service of process after diligent effort, it can do service of
process by publication, by filing a Notice of Action in a local newspaper, once a week for
four consecutive weeks.
If the borrower is personally served, the borrower must file with the court its Answer and
Affirmative Defenses within 20 days of being served the foreclosure Complaint. He or
she must admit or deny the allegations contained in the complaint, and state why the
foreclosure should not be granted. But in today’s environment, most borrowers have little
to no legitimate defense. (Remember: “If ya don’t pay, ya don’t stay.”) If the borrower
does not file an Answer within the 20 days, he or she will be defaulted, which means he
or she essentially loses the case. Also, if the borrower is defaulted, he or she will not
receive in the mail any subsequent information from the court on the case. The lender
will then file a Motion for Summary Judgment, which says, in essence, “the borrower has
not paid, the material facts are not in dispute, and we are entitled to a Final Summary
Judgment of Foreclosure as a matter of law.”
The Motion for Summary Judgment usually asks the court to reserve jurisdiction to
award a deficiency judgment. The lender sets the hearing on the Motion for Summary
Judgment, and sends a notice of the hearing date, time, and place to all parties who
have filed an Answer. At the hearing, the judge will usually grant the Motion for
Summary Judgment, unless he or she believes that some material facts are in dispute,
in which case the judge sets the matter for a non jury trial (no right to a jury trial). The
judge signs the Final Summary Judgment of Foreclosure, stating the amount owed
including attorney’s fees, and setting the property for foreclosure sale. The judge will
reserve jurisdiction on a deficiency judgment. The foreclosure sale will be held within 20
to 35 days after the Final Summary Judgment of Foreclosure is signed. A Notice of Sale
must be published once a week for two consecutive weeks in the county in which the
property is located. The Notice of Sale states the property to be sold and the time and
place. The property is then sold at the sale to the highest bidder for cash. In this
market, the highest bidder is usually the lender. The lender ordinarily bids the amount of
his final judgment, plus a nominal amount, such as $100.00. The lender gets a credit for
the amount due under the final judgment. Immediately after the sale, the clerk of court
will issue and file a Certificate of Sale, which states who the winning bidder is. The
borrower has a right of redemption and may stop the foreclosure sale at any time before
the filing of the Certificate of Sale by paying off the amount contained in the Final
Summary Judgment of Foreclosure. Objections to the sale must be made within 10
days from the date of issuance of the Cert. of Sale. If there are no objections and 10
days have elapsed, the clerk issues the Certificate of Title to the winning bidder, and
disburses the sale proceeds as per the Final Summary Judgment of Foreclosure. The
Certificate of Title acts like a deed, and it conveys title to the winning bidder.
The new owner is entitled to immediate possession of the property. If the borrower or
tenants are still in the premises, the new owner is entitled to a writ of possession, usually
without having to file a new eviction suit.
 
  
DEFICIENCY JUDGMENTS
 
A “deficiency” arises when the fair market value of the property is less than the loan
balance plus the attorney’s fees and costs incurred in the foreclosure action. If that is
the case, the lender can seek a “deficiency judgment” against the borrower. This is the
 “going after” that so many borrowers are so afraid of. Generally, in its Motion for
Summary Judgment of Foreclosure, the lender will ask the court to reserve jurisdiction
for a deficiency judgment. The lender then has 10 months from the date of entry of the
Final Summary Judgment of Foreclosure to file its Motion for Deficiency Judgment. If
the lender does file this Motion, the court will then conduct an evidentiary hearing to
determine the amount of the deficiency judgment against the borrower. The court will
calculate the deficiency as illustrated in the following example:
Outstanding loan balance: $300,000.00
Plus Attorney’s fees and costs: $ 5,000.00
Total: $305,000.00
Minus fair market value of property at foreclosure sale date: $250,000.00
Deficiency judgment amount: $ 55,000.00
Of course, if the fair market value of the property exceeds the outstanding loan balance
plus attorney’s fees and costs, then there is no deficiency and the lender would not be
entitled to a deficiency judgment. (Remember: The lender must have gotten personal
service of process upon the borrower in the foreclosure action in order to obtain a
deficiency judgment). Interestingly enough, though, at present, most lenders in Lee
County are not pursuing their rights to a deficiency judgment, due to the time and effort
involved. But that may change. No one knows what the lenders will do in the future. We
only know what they can do under the Florida law. And they can pursue a deficiency
judgment if the property is worth less than the loan balance plus court costs and
attorney’s fees. If the lender does get a deficiency judgment, they can enforce that
judgment and try to collect upon that judgment like any other judgment. Note that
Florida is a rather debtor friendly state, though, so collecting on a debt here can be
tough.
 
 
                  SHORT-SALE.
 
There are alternatives to foreclosure, such as a deed in lieu of foreclosure or a short
sale. A “deed in lieu of foreclosure” is where the borrower “gives back” the property to
the lender by signing and delivering to the lender a simple deed, via either a quitclaim
deed or a warranty deed. Such a transfer may occur prior to or while the foreclosure
lawsuit is pending. Deed in lieu benefits to a lender is that it avoids the costs, delays and
risk of a full foreclosure. Deed in lieu benefits to a borrower are that it prevents a
foreclosure appearing on his or her credit report, and it may help avoid a deficiency
judgment (if the lender accepts the deed in lieu as a full satisfaction of the mortgage,
which most of them are not).
But if there are any junior lien holders (i.e., a HELOC, a second mortgage, HOA or
condo liens), then the lender will not accept a deed in lieu, since a deed in lieu does not
wipe out those lien holders, whereas a foreclosure does. And frustratingly, some
lenders simply won’t respond to a request for a deed in lieu for whatever bureaucratic
reason.
A “short sale” is where the lender accepts less than the full amount due for a payoff and
satisfaction of the loan. A short sale is requested when the borrower is “upside down”
and the loan balance exceeds the fair market value of the property. Note, however, that
a lender is not required to agree to a short sale, just like it is not required to accept a
deed in lieu. But short sales have exploded over the last year. When the whole
mortgage meltdown started, many lenders would not agree to them. But some are
coming around now. Short sales can also be frustrating, though, because a lender
generally will not even discuss a short sale unless the borrower is in default, or the
lender either won’t respond to a short sale request, or takes forever to respond, or some
lenders will verbally agree to something, only to renege at the last minute, or some
lenders require the borrower to fill out a lengthy “work out” package, wherein they
request detailed financial information that the borrower may not want to give. Note too,
that lenders will likely beat you up on your sales commission. When short sales do go
through, they can be beneficial: The borrower sells the property, and he or she avoids a
foreclosure suit and the risk of a deficiency judgment. But the borrower’s credit will still
take a hit. And Uncle Sam will still want his “cancellation of debt” tax money. (More on
that below). Finally, if you do a short sale, it is suggested that you use the new FAR
forms entitled “Short Sale Addendum to Purchase and Sale Contract” and “Short Sale
Addendum to Listing Agreement.” These are good, though not perfect, forms.
 
…AND WHAT ABOUT THE IRS?
 
Of course, there are only two things certain in life. Don’t think foreclosures and its
alternatives are exceptions to these certainties. But everyone’s financial and tax
situation is different. Advise your client to seek the advice of a CPA if they are facing a
foreclosure. Generally, the IRS treats “cancellation of debt”, whether via a foreclosure,
deed in lieu, or short sale, as income, to be taxed at the borrower’s tax rate. The lender
is supposed to send the borrower a 1099, and the borrower is supposed to report to the
IRS the de facto “income” that the borrower received from the foreclosure, deed in lieu,
or short sale. How the IRS treats this cancellation of debt “income” can be illustrated by
the following example.
Loan balance and attorney’s fees at foreclosure or short sale: $305,000.00
Minus fair market value of property at foreclosure or short sale: $250,000.00
Cancellation of debt “income”: $ 55,000.00
However, the borrower won’t be taxed on this income if: The borrower discharges the
debt through bankruptcy, or if the borrower is defined by the IRS as “insolvent” at the
time of the cancellation of debt, or, effective December 2007, if the loan was on a
primary residence, and the loan was taken out to “buy, build, or substantially improve” a
primary residence. The last exception phases out after 2009. See IRS publications 982
and 544 for more information. They are available at www.IRS.gov. Or, the borrower
may be able to show some losses to offset the cancellation of debt income. Again,
advise your client to see his or her CPA. Note that even if the borrower is not upside
down on the loan, (and therefore has equity), and if the property goes to foreclosure or
there is a deed in lieu, the IRS will tax the difference between the fair market value of the
foreclosed property and the borrower’s adjusted basis in the property as income, even
though it is phantom income. That’s because, as the IRS says, “the foreclosure or
repossession is treated as a SALE or exchange from which the borrower may realize
gain or loss. This is true even if the borrower voluntarily returns the property to the
lender.” (IRS pub. 544).
Example:
Fair market value of property at foreclosure sale date: $250,000.00
Minus borrower’s adjusted basis: $225,000.00
Taxable “Gain”: $ 25,000.00
 (Adjusted basis is the original purchase price plus any major improvements)
Of course, if the property was a primary residence, the $250,000/$500,000 tax free
exclusion still applies, or if the property was not a primary residence but was held for
more than a year, the long term capital gains rate of 15% would apply. Again, advise
your client to see his or her CPA.
 
CHEER UP!
 
How we got to this mortgage mess has been well documented by others, so I will not get
into that. What I will say is: “Cheer up, this is beautiful Florida.” We all want to live
here. Everything is cyclical. Things will turn around. And when things do turn around,
we will still be standing, and many of the fraudsters and crooks will have gone
somewhere else.