Good and Bad News for Short Sales and Loan Modifications

The appropriations bill, which is a $600 billion bipartisan spending bill signed off by the President last week includes a provision allowing homeowners to exclude forgiven mortgage debt (the remaining mortgage loan balance when a borrower’s principal residence is sold in a “short sale” to avoid foreclosure) from their gross income when filing 2015 tax returns. The forgiven mortgage debt exemption is expected to save homeowners about $3.3 billion for the tax year 2015. The president signed off on a similar bill last year on December 19 that retroactively extended 55 tax provisions, including the one that provides tax relief for forgiven mortgage debt.

On the downside, trying to get a short sale or loan modification accepted going forward will be a much harder proposition than over the past several years. Lenders are in a much better financial position than at any time since the mortgage meltdown to play hardball with borrowers, and to absorb foreclosures. Lenders approved short sales and allowed for loan modifications out of their own best interest, not the borrowers. It won’t be impossible, but as a generality, lenders will not be motivated to take a financial loss on a loan. The numbers and borrower’s distressed financial position will have to be extreme.

Property values are up and there are fewer underwater loans (see chart). Inventory is still tight, and there are fewer distressed sales. Question: Why should a lender accept substantially less for the payoff of the principle of a loan, when a properly marketed foreclosed property will get market value? They won’t…

Also even if a short sale is approved, lenders are more aggressive and requiring borrowers to either apply assets, or accept an unsecured loan to cover a percentage of the deficiency.