GPSOLO July/August 2010
How to Handle Foreclosures
By Jonathan G. Stein
The foreclosure crisis is bad and getting worse. According to one estimate, more than 40 million Americans will be affected by this crisis by the time it is all over—and that is a conservative estimate. Early indications were that this would be a short-term problem, and I had initially predicted that it would be over by early 2009. But as we proceed through 2010, we know that the problem is only getting worse. The first wave of foreclosures affected people with subprime mortgages, a term that is now common. The next wave hit people who took out “B” mortgages. The coming wave is going to affect small business owners on commercial property, as well as people with prime mortgages. So, how can you assist your clients?
The first step in any foreclosure case or potential foreclose case is to evaluate the client’s needs. Not every client who comes to you needs to have the property foreclosed on. Similarly, not every client is a candidate for a loan modification or similar remedy offered by loan servicers. (We have stopped referring to these folks as banks or lenders simply because it is impossible to know who owns a mortgage and who is just servicing a mortgage. Toyota would never fix a Honda car under warranty, but Wells Fargo will service a loan by Bank of America and vice versa.)
Upon initial contact with the client, you need to evaluate the client’s financial situation. This means asking some very detailed, pointed questions. Always start with the basics: What is the client’s monthly income? What is the yearly income? What is the balance owed on the first mortgage and each subsequent mortgage? What is the monthly payment for each mortgage? What other debt does the client have? For residential property, a client can typically afford a house that is three times his or her annual income, or stated differently, a mortgage payment that is one-third of the client’s monthly income. The easiest way to figure out whether the client can afford the house is to take annual income, multiply by three, and compare that to the client’s current home value. If the current home value is higher than this number, then the client should consider not keeping the house.
- Example 1: The client makes $60,000 per year. The house is currently worth $210,000. The client cannot afford this house.
- Example 2: The client makes $80,000 per year. The house is currently worth $235,000. The client can afford this house.
If the client can afford the house, you should explore a loan modification. A modification can be anything from a decrease in interest rate to a change in the principal or an extension of the term of the loan. Sometimes you will get all three, sometimes one. But if the client can afford the house and wants to keep it, you should explore this option with the client.If the client cannot afford the home, then hard decisions need to be made. First, you must figure out if you are in a recourse state (where the borrower is responsible for a deficiency balance after the sale) or a non-recourse state. Determining this may not be as easy as it first sounds—many states are a combination of the two. For example, in California, a purchase-money mortgage (a mortgage used to buy a piece of property) is non-recourse, but a non-purchase-money mortgage or cash-out mortgage (where a mortgage is taken out and the borrower gets cash to make improvements or pay off bills) is recourse. When you combine this fact with California’s one-action rule, which, at its most simple, limits a lender to either selling the house or suing the borrower, it is sometimes difficult to tell if the client faces any personal liability under a mortgage that he or she cannot afford. This must therefore be your first determination.
If the client has no liability in a foreclosure, then your job is more as a counselor than an attorney. You need to sit the client down and explain the realities of life. These realities start with this: losing a home to foreclosure is not the end of the world. In fact, since about 2007, it is quite common. There is no stigma attached to losing a home or making a business decision to give up a home. Many people, especially baby boomers, have a difficult time with this concept and believe they should do everything to keep their home. However, a client who cannot afford his home at its current value should not enter into protracted litigation that does nothing but make money for the attorneys. Thus, your job is to counsel the client on how to make the process easier and how to rebuild the client’s credit. This can be something as simple as moving out now so that the client starts over sooner rather than later, or waiting for the cash-for-keys offer from the bank so that the client has money to pay first- and last-month’s rent or a security deposit.
If the client has liability and cannot afford the home, you need to explore several options. The first is short sale, in which the lender agrees to accept less than the pay-off amount and the borrower sells the property to a third party. Although the incentive to servicers to approve short sales are not high, lenders are willing to consider short sales. In fact, in a lower-value home, a client may be able to short sell the house to an investor who will let the client rent back the property for less money than the client’s current mortgage payment. This becomes a win-win situation. A good real estate broker can help evaluate the home and the likelihood of getting an offer for fair market value. You can then walk the client through the short-sale process, help obtain the necessary documents, and serve as a liaison between homeowner, real estate broker, and lender.
You will also be in a position to negotiate away, or attempt to negotiate away, the client’s liability for any amount not covered. Most servicers are willing to take a lower lump sum with the short sale to erase the debt not covered in the short sale. You can be a vital part in negotiating this for the client.
If the client does not qualify for a short sale or does not wish to go in that direction, you should consider a bankruptcy filing. My experience is that most people who cannot afford their home also have other debt. If you are not an experienced bankruptcy attorney yourself, refer your client to a lawyer who is. An experienced bankruptcy attorney can advise clients on whether a Chapter 13 or 7 is best for them. In some cases, the client may file a Chapter 13 and then convert it to a Chapter 7.
You could also advise the client to walk away and wait. Some lenders, especially on recourse second and third mortgages (usually called home equity loans or lines of credit because they are taken out after the property has been purchased) are not filing suit. Of course, you need to adequately advise the client of the risks and the statute of limitations. However, it is becoming more and more common that servicers are not pursuing people who walk away, and your client may be better off to take a wait-and-see approach—especially when other debts are very low.
Some clients need litigation assistance. This is not an area that you should enter into without experience or experienced co-counsel. Judges see many of these lawsuits and many bad lawsuits, so you start behind the proverbial eight-ball. Suffice it to say, your best bet is working with someone who has experience in litigating these cases.
Finally, if there is a foreclosure, you need to make sure it is done properly. There are many technical requirements, especially for a non-judicial foreclosure. Was the sale noticed properly? Are the required documents attached to a sale notice? After the foreclosure, is title transferred properly? Does the client have any liability for utilities or homeowner association dues that may cause a foreclosing party to delay in recording the sale? These are very technical issues that require a strict reading of your state’s code.
The key to helping clients through the foreclosure process is making sure you assemble a good team. A CPA or tax attorney can provide insight on tax issues, including tax liability that can change from one year to the next. A real estate agent can obtain property values for you and evaluate a home’s “saleability.” By putting together a team, you will be able to provide a valued service to your clients.
Jonathan G. Stein operates a solo practice in Elk Grove, California; he may be reached at firstname.lastname@example.org.