Money Law Blog

Homeowners in DC, VA and MD seeking loan modifications to save the family home may see improvements in the currently messy process if a group of state attorney generals and federal officials are successful in on-going settlement talks with major US banks.

"What we're really trying to do is change a dysfunctional system," Iowa Attorney General Tom Miller, the point man for a 50-state effort, told the Washington Post in a March news article. "We really want to try and change all that."

Homeowners who have asked mortgage lenders (or more specifically, the mortgage servicing department of banks who administer the loans on behalf of bond investors) know very well the many and outrageous modification abuses including:

• Losing homeowner's modification applications and causing them to have to submit the documents numerous times, or giving up altogether.
• Leaving homeowners in the dark for months or years as to the status of the applications.
• "Dual tracking" homeowners so that while the modification is pending the loan is also put on track for a foreclosure catching the homeowner unaware as he or she is awaiting a decision.
• Rejections of the modification application without a statement of the reason(s).
• Fraudulent statements from mortgage servicers misstating the amount owed by employees who swear to, but have not actually checked, the lender's records.
• Employees at the mortgage servicing departments telling homeowners to make a reduced payment pending the modification, then holding the homeowner in default for thousands of dollars later when the modification is denied. It's either pay up all at once or go to foreclosure.

Many of the mortgage modification abuses have been written about in this blog based on the experiences of the clients of our bankruptcy law firm.

The government's initial 27-page proposal provides for some important reforms:

• A time-line for decisions.
• Guidelines for determinations, and possibly mortgage principal reductions.
• A web-based portal for homeowners to track the application in real time.
• A ban on "dual tracking."

Most importantly, the proposal provides for penalties for the mortgage servicers. For this writer, that would be the single most important reform. At present, lenders operate with impunity. There is no law that clearly holds mortgage servicers accountable. Penalties would put teeth into the reforms and, it's hoped, put an end to the abuses.

It feels like another kick in the teeth: You lose a home or rental property in a foreclosure or short sale, get a Form 1099-C from the mortgage company, and now you have to pay income taxes on it, too? Like a lot of things in the law, it depends.

It's a curious, but absolutely-settled principle of tax law, that a debt that is forgiven by a lender becomes taxable income to the borrower. Basically the accounting works like this: When you took out the loan it's not considered income because you have an obligation to pay it back. When, however, that obligation is removed, you become richer by the amount of debt that you will not have to pay, and the tax law says that must be recognized and you must pay income taxes on it.

Unfair, you may say, but it's the law. In late 2007, federal lawmakers decided to give SOME relief to taxpayers losing personal residences and changed the law so that the resulting income could be excluded from income tax, if the forgiveness (also known as "cancellation in indebtedness" and
"cancellation of debt" ("COD") income) meets key requirements:

1. The mortgage debt was for a principal residence (that is, the property was the taxpayer's "home" under the law) and,
2. The mortgage debt was the original loan used to purchase the home, or, if the loan was a refinance of the original loan, the proceeds from the refinance were used to make improvements to that property.

Note that the author of this blog emphasizes the term "some" because there is a lot of misinformation out there, probably propagated by commission-hungry, short-sale realtors, that there is a blanket exclusion from COD income for all primary residence mortgage debt forgiven in short sales (or foreclosures, which, for the tax law, are functionally the same).

Nope, doesn't work that way. If the loan was a refinance or second mortgage where part of the proceeds was used to pay off car loans, credit cards, take vacations, etc., those proceeds will NOT qualify for income tax exclusion under the tax law.

Your tax preparer will need to fill out Form 982 and see if the COD income reported to IRS on the Form 1099-C can be excluded under the exceptions available. Our DC-based tax and bankruptcy law firm has prepared an guide to the tax effects of foreclosures and short sales explaining the issue.

One of the most important exceptions is the "insolvency" exclusion. You can exclude the COD income from taxable income to the extent your net worth calculation shows you are insolvent.

If you use that exclusion, it's a good idea to keep the documents you use to calculate your net worth. Generally, the government has three years to audit your tax return. Values of assets and debt balances can change significantly in the interim and determining them years later will be impossible.

Remember, finally, that a discharge in bankruptcy avoids the tax issue entirely. So, if you're not sure the lender will forgive the debt after the foreclosure, or if you know the debt will be forgiven but are unsure or worry about the tax consequences, you may want to consider that option.

Last Friday, the attorney generals of Arizona and Nevada filed suit against Bank of America alleging state consumer fraud violations for a practice that's come to be known as "dual tracking" -- bank employees are telling homeowners seeking modifications to make a reduced payment while the "modification is pending."

All the while, the lender is still holding the homeowner in breach of the contract and taking payments until such time as it decides to go ahead and foreclosure. It's a slimy tactic. If the homeowner knew they were getting nothing for the deal it would have been better to save the money and short sell or surrender the property in bankruptcy.

This bankruptcy law firm has seen a number of similar cases during the past year with homeowners in Maryland, Virginia and DC. We have written about this abuse against homeowners in another posting on this blog.

Most states, including Maryland, Virginia and DC, have similar consumers laws addressing "unfair and deceptive acts and practices."

Good for you Arizona and Nevada. May this suit go places.

Fannie Mae and Freddie Mac have complete power to address a large part of the national foreclosure problem by demanding that the mortgage servicers and law firms they hire to execute foreclosures do so correctly and fairly.

At this foreclosure defense law firm, we see a large number of the same abuses discussed at the December 1, 2010, Senate Banking Committee hearing in our Maryland, Virginia and DC cases.

Among the worst abuses, the practice of putting homeowners in a dual-track:

Mortgage servicers (the bank departments administering loans from whom homeowners get all correspondence and bills on behalf of the mortgage holders) maintain discussions with homeowners about a modification while at the same they have directed attorneys to take steps toward a foreclosure. This is not disclosed to the loan modification applicant.

It's quite a surprise to homeowners who think they are negotiating a resolution when they get notice that the house has been sold and they need to move out! Had the homeowner known he could have taken steps such as initiating formal legal process to protect himself. This deceit happens all the time. I have written about how lenders abuse homeowner seeking modification in this blog and I warn everyone with whom I meet. This is how the Freddie Mac official responds, according to a Washington Post article on the hearing:

Meanwhile, Bisenius defended the dual-track approach to mortgage modification and foreclosure embraced by many of its servicers: Attempt to modify a loan to make it more affordable, but also prepare to foreclose if that is not possible.

"While we believe that borrowers who already are under significant stress arising from their financial situations should not be subjected to needless confusion, we also believe that unnecessary delays in an already lengthy foreclosure process would be counterproductive," Bisenius said.

He noted that foreclosures usually last well over a year, and sometimes close to two. "The dual-track process allows for a delicate balance between the need to minimize losses and protect communities while protecting borrower interests. Lengthy foreclosure delays impose substantial losses on Freddie Mac and taxpayers - by some estimates, $30 to 40 per day and $10,000 to $15,000 per year for every defaulted loan," Bisenius said. "These costs do not include additional losses resulting from depreciation in the value of the property."

That's hardly the case in the Washington, DC area. All foreclosures in Maryland, Virginia and DC are non-judicial -- that is, nothing is presented by the lender to a judge before the foreclosure is initiated to prove the lender's right to foreclose such as a valid note, deed of trust, or the existence of an arrearage. (In Maryland, foreclosures are "docketed" with the court, but nothing is presented to the court except an accounting afterwards for "ratification" of the foreclosure.)

Under Virginia law, a foreclosure can proceed in as little as three weeks. Maryland foreclosures can proceed quickly, but average about six months. DC foreclosures average a couple of months from start to finish.

Other servicer abuses complained about at the hearing, and which we see in this law office:

• Employees of mortgage servicers telling homeowners to stop paying or make a reduced payment to get a modification, without disclosing to them that there is NO legally enforceable agreement to forbear, and that the lender will still hold them default and eventually move the case to foreclosure. I have written about the dangers of lenders telling homeowners NOT to pay before in this blog.


• While the servicer continues to accept reduced payments, they pile on late fees and default charges which the servicer, at foreclosure, collects at 100%, generally right off the top of the foreclosure proceeds.

Most galling is the fact that Fannie Mae and Freddie Mac were also bailed out by the taxpayers, and salaries for employees at both firms are generally above the norm even for the Washington, DC area.

Homeowners and advocates can only hope lawmakers will force Fannie and Freddie to treat the public fairly.

Fannie Mae and Freddie Mac, government-backed businesses who together own or guarantee about half of the outstanding mortgages in the country, were in Washington, DC last week defending themselves before a Senate committee looking into abusive - and in some cases illegal - foreclosure practices that have come to light in recent months.

The excuses voiced by the company's top officials would be out-and-out laughable, if the consequences of the attitudes they demonstrate weren't so tragic. The arguments Fannie and Freddie made indicate just how clueless they are to what is actually going on but is well-known by homeowners with mortgage problems and the advocates who defend them. Here's an excerpt from a Washington Post article which drew from testimony prepared for the Wednesday, December 1, 2010, hearing :

Speaking to the Senate Banking Committee at a hearing on the national foreclosure debacle, Fannie and Freddie executives emphasized that they are not responsible for managing payments by borrowers on home loans or foreclosing on homeowners when they default.

These tasks, executives say, are the responsibility of mortgage servicers and law firms with which the companies contract.

"I want to underscore that Fannie Mae does not service loans. We rely on the loan servicing divisions of major banks and other financial institutions as the primary front-line operators and points of contact with the borrowers," said Terence Edwards, executive vice president for credit portfolio management at Fannie Mae. "We pay servicers significant fees during the life of a loan to work with borrowers. Servicers are required under our servicing contracts to help borrowers in trouble, not just collect payments."

Donald Bisenius, executive vice president of the single family credit guarantee business at Freddie Mac, made the same point. "Freddie Mac provides guidelines for the origination and servicing of our loans, and contracts with sellers and servicers to carry out these operations."

Reading this, I almost fell out of my chair. I was dumbstruck. As an attorney at a law firm devoted to helping Maryland, Virginia, and DC homeowners with mortgage troubles, I could not believe they would proffer this defense, and certainly not with a straight face.

In my own law practice, if I make an error of law, I cannot blame my paralegals - the employees and contractors I hired personally, whom I control, and for whom I am absolutely responsible. (A friend of mine at the Office of US Trustee and I joke about this as the "respondeat inferior" defense - a play upon the legal doctrine of "respondeat superior" where an employer is liable for the actions of his employees.)

If I tried this argument in court, I would not be surprised to see a judge to roll his eyes.