* Follow me on Twitter: http://www.twitter.com/mclaughlinchris

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Modified mortgages still defaulting

Tens of thousands of homeowners who were hoping for lower payments are discovering that lenders roll late fees, back taxes or other costs into the principal, sometimes turning a difficult payment into an impossible one.  That’s one reason many reworked mortgages are sliding back into default.  Monthly payments, on loans modified from Jan. 1, 2008, through March 31, 2009, increased on 27% and were left unchanged on an additional 27.5% according to a recent report by banking regulators.  Many modified mortgages fall delinquent — 25% to 40%, depending on the type of mortgage.  It’s too early to know if this pattern will continue under the Obama administration’s $75 billion initiative to get lenders to reduce monthly payments for homeowners struggling to make their mortgages.  A total of 360,165 mortgage modifications are now in a three-month trial period under the government’s plan announced in March.  But the initiative focuses on reducing interest rates rather than cutting principal.  “Payments have [either] gone up [or] the payment relief can last for the first few years and then go up (again),” says Alan White, assistant professor of law at the Valparaiso University School of Law in Valparaiso, Ind.

FDIC details mortgage payment reductions

Yesterday I mentioned an “urging” by the Federal Deposit Insurance Corporation (FDIC) directed at its loss-share partner institutions to consider temporary mortgage payment reductions for unemployed borrowers.  A spokesman for the FDIC offered further clarification: “Servicers may provide the borrower with at least six months of payment relief…The term [of] forbearance may vary based on the borrower’s circumstance.”  The program reaches out to both the unemployed and the underemployed, and applies to borrowers who suffer a reduction in household income due to decreased hours, loss of job, or a qualifying pay cut.  Acquirers of failed insured institutions who agree to a loss-share arrangement must abide by the FDIC Mortgage Loan Modification program for any assets purchased from the failed bank. The program provides loan modifications by reducing the borrower’s monthly housing debt to income ration (DTI ratio) to no more than 31%.  “The FDIC has a loss share monitoring program responsible for surveillance and compliance monitoring of the assets covered in the shared-loss agreement,” the spokesperson said. “In this oversight capacity the FDIC will review loss share servicers forbearance policies and ensure compliance with the shared-loss agreement.”

GAO looks at alternatives to Fannie Mae and Freddie Mac

The Government Accountability Office (GAO) is scrutinizing some of the proposed alternatives to Fannie Mae and Freddie Mac, now both in conservatorship.  The alternatives include reconstituting the GSEs as for-profit corporations with government sponsorship and additional restrictions.  According to the GAO, this option would effectively add controls to minimize risk in the system; eliminate or reduce the GSEs’ mortgage portfolios; establish executive compensation limits; and completely convert the GSEs from shareholder-owned corporations to lender-owned firms.  This model is not entirely without risk, however, as investors might be unwilling to invest capital in reconstituted enterprises unless the Treasury Department assumed responsibility for losses incurred during their conservatorship, GAO said.  “Continuing the enterprises as GSEs could present significant safety and soundness concerns as well as systemic risks to the financial system,” GAO said in the report. “In particular, the potential that the enterprises would enjoy explicit federal guarantees of their financial obligations, rather than the implied guarantees of the past, might serve as incentives for them to engage in risky business practices to meet profitability objectives.”

Sales up in August

The Commerce Department said total retail sales rose 2.7% last month, compared with July’s revised decline of 0.2%.  Sales excluding autos and auto parts rose 1.1%, compared to a 0.6% decrease in July, suggesting that the Cash for Clunkers Program is largely responsible for the bounce.  Economists surveyed by Briefing.com had predicted August sales would increase by 2%, and had expected a gain of 0.4% in August sales, excluding auto purchases.  Some of the other biggest sales winners were gasoline stations, whose sales rose 5.1%, as well as clothing and department stores, which each rose 2.4%.  “We expected a big jump in autos, obviously, but we got decent increases elsewhere when we expected only modest gains,” said Adam York, analyst at Wells Fargo Securities.  But furniture store sales slipped by 1.6%, and building/garden equipment fell by 1.2%.  York said it was “tough to say” whether the broad gains will hold in future months, though September auto sales will certainly reverse without the Clunkers benefit.

Oh, really, Mr. Geithner?

U.S. Treasury Secretary Timothy Geithner says President Barack Obama can return the U.S. budget situation to a sustainable one without breaking his pledge to not raise taxes on Americans making less than $250,000.  “It’s his (Obama’s) commitment and he’s very committed to that.”  Geithner also said the government would work to unwind its investments in financial institutions and other companies as quickly as possible, but it would likely take longer to sell off its major stakes in General Motors and Chrysler.  “We’re not going to keep a penny in the financial system or in the U.S. economy longer than we think is absolutely necessary,” Geithner said.  Asked if the government would be out of the auto business by next year, Geithner said, “I think it’s going to take longer than that just to be honest and realistic.”  Errr…speaking of “honest and realistic”…no new taxes?  Really, Mr. Geithner?

Now on to our real estate education section…

Short Sales & State Taxes

By now most people realize short sales, deed-in-lieu of foreclosures and other “debt forgiveness” programs may generate federal tax if not properly structured; however, far fewer people consider the potential consequences related to state taxes.

While federal guidelines exempt homeowners from federal taxes through 2012, most states waived taxes for 2008 but are increasingly reluctant to implement the policy for 2009 and beyond. For example, California, one of the hardest hit areas of the nation in terms of real estate declines and foreclosures, has not yet signed a bill into effect for 2009 leaving homeowners uncertain of their financial future.

Because the state tax hit for debt forgiveness is potentially large, the question is more than merely academic despite the fact that most mortgage loans are non-recourse (ie, the lender cannot go after other assets) and therefore less likely to result in taxable income. However, even if the primary mortgage is a non-recourse loan, home equity lines of credit, refinancing and other debt is typically recourse debt subject to income taxation at both the state and (usually) federal level. Furthermore, the temporary waiver does only applies to primary residential properties – not investment or vacation homes creating greater confusion for homeowners and short sale investors alike.  Note: many investors may avoid federal income taxes by declaring insolvency – see our prior blog posts about this topic.

Savvy short sale investors are probably wondering if all states are equally regressive in their reluctance to assist troubled homeowners; fortunately the response is a resounding “no”.  In fact, seven states (or nine depending on how you view it…more on that in a minute) have zero state income taxes which makes it quite simple to avoid potential tax ramification since the federal waiver remains in effect for several more years.

Wondering which states manage to escape personal income taxes? Here’s the list…

• Alaska
• Florida
• Nevada
• South Dakota
• Texas
• Washington
• Wyoming
• New Hampshire and Tennessee only tax dividend and interest income which is unlikely to impact short sale investments owned by individuals.

On the flip side, for those short sale investors curious about which states have the highest state income tax rates you might be surprised to learn California has been removed from the top spot; Hawaii displaced California with a new maximum rate of 11 percent. California comes in at a close second at nearly 10 percent while New York makes a strong showing at nearly 9 percent (excluding local taxes which push New York residents into the top spot with a combined 12.62%).

See you at the top!
Chris McLaughlin

http://www.shortsalesriches.com

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