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Upside Down Home Sellers Owe More Than They Get

Posted on February 13 By MLP Blog

Jeffrey Taylor and his wife bought their dream home in Purcellville for $538,000 last August. Now they have to sell it because they are getting divorced and neither one can afford the mortgage alone.

The most they could get for it was $430,000. After paying all the real estate commissions and taxes, they will still owe the bank $118,000.

"Five months later, I lose $100,000," said Taylor, a high school teacher. "I don't think I can take $100,000 into the stock market and lose it faster."

Such a scenario, known as a short sale, was unthinkable during the real estate boom of recent years. In the course of five months, a person could buy and sell a property and walk away with tens of thousands of dollars. Now, instead of receiving large checks at the settlement table, many sellers are writing them.

"It was unheard of three years ago," said Kevin Connelly, a mortgage banker for Pinnacle Financial in Vienna, Virginia. "Everyone was doubling their money, and suddenly the tide has turned."

The Mortgage Bankers Association does not keep track of the number of short sales, but real estate agents, settlement attorneys and some lenders said they are happening more frequently, especially in areas where prices appreciated rapidly, such as the Virginia exurbs. "Oh my God. Have we seen it? We're closing probably three or four a month like that," said Sherry Wilson, a real estate agent with Re/Max Leaders in Purcellville.

The people most vulnerable are those who bought their homes within the past two or three years and now want to sell, either because of a life change or a financial problem. Prices in some places are notably lower than they were at the peak of the market, and the costs of selling can eat up even more money.

The last time large numbers of sellers found themselves "upside down" on their mortgages, or owing more than their houses were worth, was in the early 1990s, when the recession dragged property values down in many parts of the country. Several real estate agents and settlement attorneys say they are bracing for worse this time around because prices rose at an unprecedented rate and people eager to get into the market took out nontraditional loans to pay the inflated prices.

Thus, there are many homeowners with mortgages that allowed them to put little or no money down or to pay only interest in order to keep their monthly payments low. Others have adjustable-rate mortgages with low introductory teaser rates that have increased. Because they have little or no equity, such homeowners can't refinance. If they can't refinance, they have to ask the banks to modify their loans.

If that doesn't work, they have to sell their homes at a loss or let the banks foreclose on them. Given the choice, most real estate agents and financial advisers say selling is the way to go because foreclosure ruins a person's credit for years.

For Tara Snow, selling a one-bedroom condo in the District's Kalorama neighborhood will be the end of an ordeal. Paying her mortgage was not a problem because she had a traditional loan, but a job relocation forced her to sell as quickly as possible. She bought the condo in June 2004 for $390,000. She put it on the market in November for $430,000. She eventually got $375,000.

When she goes to the closing in two weeks, she will have to write a check for about $15,000. She plans to pay it outright.

"The weight of the world is off my shoulders," she said. "Now I am able to move and relocate my life fully."

For Randy Morrow, however, the fallout from a bad investment will haunt him for years.

Morrow, a real estate agent for Keller Williams Realty in Arlington, Virginia, bought a one-bedroom condo in February 2006 for $280,000. He intended to fix it up and sell it. But the repairs he needed to make were more extensive than he thought they would be.

For almost a year, Morrow paid the nearly $4,000-a-month mortgage on the Arlington house he lives in and $2,300 for the condo.

"The market at the time wasn't showing that it was going to get a lot stronger, so I decided it was best to take a loss and get out from under it," he said.

He sold the condo for $265,000. After paying a 3 percent commission to the buyer's agent, a loan prepayment penalty of $8,000 and other closing costs, he ended up owing the bank $33,000, which he did not have. He managed to persuade the bank to let him make monthly payments of $1,000.

Real estate agents point out another harsh reality in today's market: You don't even have to sell your property for less than you paid for it to end up upside down on your mortgage.

Kimberly Pexton and her husband bought a house in Fairfax County for $687,000 in June 2004. After deciding to separate, they agreed to sell it for $700,000. They had a mortgage that allowed them to choose how much they paid each month, adding the unpaid amount to their debt. Two days before the closing, scheduled for Friday, they discovered that they had a prepayment penalty of 2 percent of the price of the home. They will have to take about $28,000 to the table.

"It's the closing costs and commissions and all the other things you end up having to pay that tilts the scale," she said.

So far, lenders have been slow to come up with options to help sellers. "In the beginning, you couldn't even talk to them. Now the banks are talking," said Wilson, the Purcellville real estate agent.

Still, many banks are not willing to set up payment plans. Instead, they will force sellers to tap into other assets, such as retirement savings or cars. And if the lenders do forgive the debt, the Internal Revenue Service will consider it taxable income. On Wednesday, Reps. Robert E. Andrews (D-New Jersey) and Ron Lewis (R-Kentucky) introduced a bill that would make such a forgiven debt non-taxable.

"Who would you rather have coming after you, the lender or the IRS?" said Jerry Boutcher, chief executive of Monarch Title, a settlement company in McLean. "It's very complicated, and the consequences to the seller are very grave."

One of those consequences could be blemished credit. Taylor is willing to take that hit.

Even if he and his wife had not decided to divorce, they were not happy with their mortgage. They were not paying down the loan at all because it was an interest-only loan.

With an annual salary of $70,000, he does not have enough money for his share of the amount he and his wife will end up owing the bank. So he has asked the bank to forgive the debt, despite the tax implications. If the bank chooses to demand a check, he said he would take out another loan to cover it.

"This has destroyed me," he said.

Doug Duncan, chief economist at the Mortgage Bankers Association, said lenders don't have a uniform way of treating such a situation. "You try to restructure the loan with the borrower to encourage them to stay with the property," he said.

When that does not work, the lender usually tries to avoid foreclosure because it is expensive. That's when the negotiations begin. The usual recommendation is that the seller contact the lender as soon as possible to work out a plan.

Dorothy Hall, another agent with Re/Max Leaders in Purcellville, said that in the short sales she has handled recently, she has had to present the lender with the buyer's offer and prove that the seller cannot get any more than that.

"Sometimes they will come back and say, ‘This is the lowest we are willing to accept on the payoff of this loan'," she said. "If that's the case, we have to go back to the purchaser and ask if they will pay more for it. Sometimes they will take it because they feel it's worth it. Other times, they will walk away."

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