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   ARTICLE   |   From Scotsman Guide Residential Edition   |   December 2009

Options for Borrowers in Loan Distress

Consider 10 alternatives when helping to advise troubled homeowners

Millions of homeowners in loan distress are swamping mortgage brokers and other advisers, asking questions and pleading for solutions. Unfortunately, urgency causes many homeowners to make decisions before they're aware of all their options. The fact that few advisers, including attorneys, have a broad-enough background to advise adequately about all categories of borrower options compounds the problem.

There's no substitute for competent, professional advice that helps borrowers make fully informed decisions, however. In most cases, it's best if a team of advisers collaborates to evaluate options because one adviser is rarely capable of considering all alternatives. Also, the tax implications of each solution can be extensive and must be considered.

Loan distress typically takes one of two forms:

  1. Valuation distress, which occurs when borrowers owe more than their home is worth.
  2. Payment distress, which occurs when payments become unmanageable, typically because of increasing payments or financial woes such as a job loss or health emergency.

Some borrowers experience both types of distress at the same time. Mortgage brokers working with distressed homeowners should ensure they have a team competent of evaluating all options or limit their advice to those areas in which they are competent.

Only with comprehensive advice can distressed borrowers make fully informed decisions about their best course of action.

Here are 10 primary solutions for distressed homeowners:

  1. Sale of the home. This may be advisable when borrowers have equity and payment distress and when no alternative allows continued ownership. In tight markets, homeowners may consider a lease option to an otherwise-well-qualified buyer who can't close immediately.
  2. Refinancing. When owners still have some equity and sufficient, provable income, this option can help relieve payment distress.
  3. Reverse mortgages and sales of options or future appreciation. These represent good choices for some homeowners ages 62 and older. Age restrictions and equity requirements exist. These programs can pay off all or part of a mortgage and/or provide monthly income.
  4. Loan modifications. This option received a boost from the U.S. Department of the Treasury's Home Affordable Modification Program (HAMP) and various changes to state foreclosure laws. Trained brokers may be able to help clients make preliminary determinations of HAMP eligibility. The program's payment-reduction-estimate calculator can be found online at sctsm.in/HAMPcalc.
  5. Short refinances. These differ from loan modifications and occur when the existing lender writes down the current loan to an amount that allows a normal refinance. Removed principal can be forgiven or converted to an unsecured debt. 
  6. Bankruptcy. This represents the best solution for some borrowers. A proposed change to bankruptcy laws would give judges authority to impose loan modifications on primary residences, something they can already do for rental-home loans.
  7. Short sales. This well-known option involves selling a property for less than the loans against it. The typically long wait for lender approval, however, often causes buyers to withdraw their purchase offers. Short sales can reduce the negative impact to distressed borrowers' credit. Lenders may require short-sellers to repay some or all of the shortage. Short sales require an attorney. Because of the liability and tax issues present, short sales should never be done based solely on the advice of a real estate agent.
  8. Deeds in lieu of foreclosure. These may be an option if borrowers are leaving the house for other reasons. Lenders, however, are reluctant to accept such deeds if there is any doubt about intervening liens. A deed in lieu normally is treated as a foreclosure in terms of its effect to borrowers' credit scores.
  9. Foreclosures. This default option offers some protections. Advisers must be fully conversant in any statutory anti-deficiency protections. Although only available in a minority of states, these can prevent borrowers from having any liability beyond loss of the property in foreclosure. From the time of borrowers' last payment, it generally will be at least three to four months before lenders start foreclosure, a process with timeframes that vary widely by state. Borrowers in foreclosure should set aside at least a month's worth of rent each month to fund a rental when they leave, and many borrowers can negotiate a move-out payment -- often called "cash for keys" -- when foreclosure is complete.
  10. Litigation. This can be a solution when other avenues prove inadequate or when significant lender errors or misconduct are discovered. Brokers can assist attorneys by reviewing the origination file and foreclosure documents for defects that can delay or even defeat the foreclosure.

Once borrowers' situations are evaluated professionally, some options will be eliminated. Borrowers and their advisers must compare the remaining options accurately to determine the best fit based on the borrowers' personal and financial plans. The final choice may be some combination of the aforementioned options.

Brokers can be valuable members of borrowers' advisory team. Know, however, that many states restrict charging advance fees for foreclosure assistance. Brokers who don't work in the distressed-loan area should at least maintain general knowledge and develop referral relationships with advisers who can help.


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