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By William P. Matz
President
Masters Touch Mortgage Corp.
Avoid the Pitfalls of Brokering Short Sales
New rules open the door for brokers to take on a new role — negotiator
The Secure and Fair Enforcement for Mortgage Licensing Act may have opened an unexpected
new market for mortgage brokers.
Although the Home Affordable Foreclosure Alternatives (HAFA) program
offers an opportunity to assist purchasers in short sales, this new prospect
may be much larger.
Beginning in 2011, a mortgage-loan-originator endorsement will be
required for all loan activity. In many
states, including California, “loan
origination and servicing” incorporates all lender negotiation, including
loan modifications and short sales.
Although it is unclear where the line
will be drawn, based on past interpretations for loan audits and modifications, once there is any contact with
the lender, an endorsement may be
required. This standard may vary by
state, so be sure to verify the regulations in your area.
Under that standard, a real estate
agent negotiating the short sale cannot deal with the lender. This opens
an opportunity for qualified brokers to perform lender negotiations.
Before embarking on this new role,
however, brokers must understand
the dangers of improperly structured
short sales. These include:
1.• Borrower•liability•to•the•lender; and
2.• Cancellation• of• debt• income• (CODI)•
to•the•borrower.
Avoiding these will likely require assistance, probably either a tax attorney or an attorney and certified public
accountant.
The starting point is normally
to determine whether the state in
which the property is located is an
anti-deficiency state. Does state law
make mortgages nonrecourse after a
foreclosure? Many states have anti-de-
ficiency laws. These operate to bar de-
ficiency judgments after a foreclosure.
As a “voluntary” agreement to pay part
of a deficiency after a foreclosure is not
a deficiency judgment, however, the
borrower may or may not be protected.
This makes the express release critical.
But if a borrower has post-sale liability as a result of a short-sale contract,
CODI may be created if that debt is later
forgiven, even if there would have been
no liability after a foreclosure.
If the loan is recourse, tax treatment
hinges on the fair market value of the
property. Debt up to the fair market
value, not the foreclosure auction price,
is treated as the purchase price of the
property for computing capital gain or
loss. Any debt above the fair market
value that is forgiven in a short sale, or
after a foreclosure, creates CODI.
Brokers should be aware that when
lenders issue Form 1099-C after a foreclosure, they generally do not show a
separate determination of fair market
value apart from the auction price. This
results in overstating any CODI and
should be challenged by borrowers or
their tax preparer when appropriate.
Mortgage brokers can be valuable assets in helping borrowers prove fair market value when it is necessary to do so.
Even if a transaction other wise results
in CODI, several exceptions may reduce
or eliminate the impact. Most notable is
the Mortgage Forgiveness Debt Relief
Act that eliminates CODI for qualifying primary-residence debt. Other exceptions under Internal Revenue Code
Section 108 include bankruptcy, insolvency and a special election allowable
only for business property.
The importance of minimizing CODI
cannot be overstated. CODI is ordinary
income. If there is CODI that results in
the short sale or foreclosure creating a
capital loss, the loss is nondeductible
for a primary residence and effectively
deductible only against capital gains
for investment property. So failure to
structure a short sale correctly may create phantom income.
The above tax discussion covers only
federal tax treatment and is general.
Each state’s treatment must be separately examined. Because tax treatment may have to be determined by
first referencing state anti-deficiency
laws, the treatment is often one that
only a tax attorney can make.
The bottom line in short-sale negotiations is that the borrower is doing
the lender a favor. By avoiding a foreclosure, the lender typically receives 10
percent to 15 percent more. Therefore,
the borrower shouldn’t be placed in a
worse position than if foreclosure occurred. It is even advisable that the
borrower get something for the favor,
like extended free occupancy or cash
— HAFA offers $3,000.
Although HAFA and other short sales
offer a niche market for them, mortgage
brokers should be sure to get solid professional advice on liability and tax issues. For the prepared broker, there is
no reason short-sale agreements with
lenders cannot include compensation
for the negotiator and adviser, just as
for real estate commissions. Ultimately,
it is the short-sale negotiator who determines whether the owner proceeds with
the sale through proper structuring of liability and tax issues. •
DISCLAIMER: The above is for informational
purposes only and does not constitute tax or
legal advice.
William P. Matz is president of Masters Touch
Mortgage Corp. He also is an attorney and
broker practicing in Windsor, Calif. Matz
focuses his law practice on real estate,
finance and taxes. Having also run an active
mortgage business since 1992, he has a
unique perspective on the mortgage crisis.
Reach him at (707) 837-2161, ext. 121.
the state level. Expect more regulatory changes and stringent enforcement in 2011.
« EDUCATION continued from page 30
Market opportunity
Given all the hurdles that potential
homebuyers will face in the coming
year, it may seem counterintuitive that
nonqualifying loan applicants represent a large and important market for
mortgage brokers. With the right kind
of education and customer service
from their mortgage broker, millions of
these applicants can obtain a qualifying credit score.
That education involves explaining
credit-scoring to borrowers and ensur-
ing applicants’ credit files are complete
and accurate. Correcting even one
piece of outdated or misreported infor-
mation in applicants’ credit files can
make the difference.
Building business
There is considerable goodwill generated when a mortgage professional
shows low-credit-score applicants how
taking specific steps, such as correcting file errors, will help them qualify
for a mortgage. This extra level of customer service on the part of a broker
also can be a tremendous source of referral business.
Further, in a re-review of 500 loan
applications declined because of low
credit scores, a study found that 83
percent could have reached their target
score with the help of a credit-monitor-ing program.
This suggests another way that
mortgage brokers can profit. You can
mine previously pulled credit reports
to identify applicants who, although
turned down earlier, have credit scores
within a certain threshold and will
likely benefit from a financial-roadmap
program. Brokers can use data they already paid for and contact highly motivated homebuyers.
Going the extra mile to educate and
assist clients has always been a smart
business strategy. Thanks to credit-scoring tools, it also can make an immediate impact on your bottom line
in 2011. •
