Federal tax relief on forgiven real estate debt is already provided under the Federal Mortgage Forgiveness Debt Relief Act of 2007.

State tax relief for California distressed homowners is now on the way.

The new Measure will waive the tax bill to distressed homeowners on forgiven debt once the California Governor signs it. And sign it he agreed to do when he said on April 9th, ”We want to be helpful in every way we can, so we will sign it.”

Many of these underwater houses are in Sunbelt States like California, Arizona, Nevada, and Florida.

If you’re an under-water homeowner, you have three options:

1.  Ride out the housing storm and wait (at least a decade) to regain your lost equity. 

2.  Get Lender approval to sell your house short (for less than what you owe on it aka Short Sale).

3.  Strategically Default (let your house go into foreclosure even though you can afford your monthly payment, and then deal with the damage to your credit report caused by the foreclosure).

And why haven’t more Lenders voluntarily reduced mortgage principals?

The answer to both of these questions has to do with the high number of mortgage loans that were securitized.

When a mortgage is in a security, it’s owned by groups of investors. Even though a principal write-down of one or more mortgage balances may be in the interest of an entire pool of investors, it may not be in the best interest of certain investor groups that comprise the investment pool.

So it does makes sense on paper for lenders to forgive a portion of a troubled mortgage, but conflicts among investors and between loan servicers and investors who hold the actual note are one of the reasons we don’t see more write-downs occurring.

Securitization is also one of the reasons Obama’s programs fail (and will continue to fail) in mitigating the foreclosure problem. Although new government plans and expanded plans get a lot of celebratory coverage in the news, in reality, they only apply to a small number of non-securitized mortgages.

Moreover, if a homeowner has an over-leveraged house and stays current on his/her monthly payments, the new plan pays lenders to lower the balance of the loan, and the homeowner is eligible for a new loan guaranteed by the FHA.

For 2^nd mortgages, the plan doubles the amount paid to lenders to modify them.

Administration officials say that these changes are expected to help 4 million families, but don’t bet on it. Government plans to date have failed miserably in helping a small number of troubled homeowners, let alone a decent number of them.

The combination of high unemployment and a high number of over-leveraged houses is what’s keeping us mired in this foreclosure hell. Keep an eye on the unemployment number because, if it doesn’t improve, it will heighten the housing crisis.

When homeowners were granted loan modifications that reduced monthly payments, many still walked away from their houses, because reductions in loan balances were out of the question and homeowners weren’t comfortable waiting years to rebuild lost equity.

Things started to shift in the 3^rd quarter of 2009 with Wells Fargo which started using principal reductions with pay option arm loans.

Effective May 2010, Bank of America will follow suit and begin reducing mortgage balances as well.

To qualify for a mortgage principle reduction with Bank of America, you must have missed at least two mortgage payments and owe 20% or more on your mortgage than the current value of your house.

So if your house is worth $100k, and you owe more than $120k, you meet the latter requirement.

California Law may soon conform with Federal Law on this issue once again thanks to the California Senate’s passing of SB 32 (8X) (authored by Lois Wolk, D-Solano) on March 11, 2010.

This Bill exempts homeowners from paying California State Tax on forgiven debt (up to $500,000) that is created from 1) receiving a loan modification, 2) selling a house via short sale, or 3) losing a house to foreclosure.

Usually, the IRS and California Franchise Tax Board consider forgiven debt to be taxable income to you even though you do not receive the forgiven amount in the form of cash from the sale or surrender (as in deed in Lieu) of your house.

As always, seek competent professional counsel on the distressed real estate situation you face.  

There’s intermittent talk in the news about Strategic Defaults, but what is a Strategic Default?

This is when a homeowner with one or more mortgages on a property can afford to make the monthly mortgage payment(s) but chooses not to, because today’s value of the house is less than the total amount owed on the mortgage(s).

Some homeowners view whether or not to strategically default as a business decision. If it takes longer to restore the lost equity than it does to clear a negative event (i.e., a short sale or forecloure) from his/her credit report, choosing the latter over the former gets very tempting. 

Other homeowners strategically default because they disagree with the double standard that exists for banks and homeowners, and they think, “If banks can get bailed out, why can’t I just walk away?”

For a homeowner with more than one mortgage, it may be possible to walk away from the junior lien and end up with a house that is no longer over-leveraged.  

Let me elaborate with what I’ve been noticing: If the amount of the first mortgage is less than or equal to the current fair market value of the house, the howeowner continues to make the monthly payment on the 1st but stops paying the 2nd mortgage.  Rather than begin foreclosure proceedings, the 2nd mortgagee may try to settle with the homeowner for (sometimes significantly) less than what’s owed. If the homeowner settles, s/he is left with just a 1st mortgage in an amount that is less than or equal to the current value of the house. 

Strategic Defaults are wild cards in the housing recovery, because no one has a handle on how many people will strategically walk away and when.

Since 1st Quarter 2009 and up to now, Federal Homeowner Assistance Programs that respond to the bursting of the housing bubble were designed to keep homeowners in their houses via loan modifications.

These Federal Programs failed miserably, because lenders refuse to do loan mods on overleveraged houses and most mortgages are bundled into Mortgage Backed Securities which seriously limit the ability to do loan mods.

The Federal Programs to date have been so consistently ineffective, I stopped blogging on them a year ago and recently removed the section covering them from my Special Report. 

This year, Obama does an about-face with his latest Federal Homeowner Assistance Program scheduled to roll out on 04/05/10.

Instead of encouraging homeowners to remain in their houses, the new Program pays $1,500 to homeowners with overleveraged houses to move out & do a short sale (sell house for less than what’s owed).

Agreeable 1^st and 2^nd lenders will get $1,000 each per short sale.

Two of the callers informed me that their bank dipped into their checking accounts (with no warning) and withdrew sufficient funds to cover past due payments on a mortgage (~ $20k) and a credit card (~ $1,100)!

The third caller informed me that, to his knowledge, he was not even delinquent on his business line of credit (BLOC) when, out of the blue, his bank sent him a vague letter that led me to believe (upon having it read to me via phone) that something similar was about to occur with his checking account funds in an effort to satisfy all or a portion of his BLOC.

People of all socio-economic levels are finding themselves in a cash crunch. As a result, even some prime borrowers are trying to stare down delinquency and default as they try to service their monthly debt obligations in their entirety. 

In light of this, you may want to consider moving your deposit accounts to a financial insitution(s) that is/are separate from the one(s) you borrow from.

Now might also be a good time to read the fine print on all of your deposit and loan agreements, so you know what you could be dealing with if you do fall behind in payments.

Go here to read it:

http://money.cnn.com/2009/03/19/news/economy/Obama_foreclosure_plan/index.htm?source=yahoo_quote

This report also provided a website that distressed homeowners can visit to determine whether or not they qualify for assistance under the Plan. Here it is:

http://makinghomeaffordable.gov/