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An Offer I Should Refuse?

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Posted On: 04/29/2009

Q: I refinanced my home two years ago. I owe $450,000 on the first mortgage and $50,000 on the second mortgage. The second is not an equity loan. Both loans are with the same lender. They approved my short sale with a lien release only as long as I net them $290,000. My broker has a buyer and we’re ready to go into escrow, but I don’t know if I should accept the offer because my lender claims that they can and will file a deficiency judgment against me for their loss.

A: Put down the newspaper and call an attorney who specializes in real estate. Now.

To see what’s really happening here, let’s trade places. Now you’re the investor, the party who actually owns the loan. Two years ago you financed a property with $500,000 in loans or you bought those loans. Today the borrower wants to dump the property and asks you to accept $290,000 – that’s a $210,000 loss to you.

You as the loan owner think to yourself: “Hmm, imagine if the value of the property rose to $710,000 in two years. Would the borrower call to offer me any share of the profit? Then why should I give up $210,000 when the value of the property falls?”

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You can see the lender’s logic. Why should the lender take any loss when values are falling if he’s not going to get a dime when property values increase?

If you had “purchase money” financing, the loan or loans used to acquire the property, then in some jurisdictions you might not be liable for any lender claims beyond the sale value of the house. However, when you refinanced the “purchase money” status of your financing vanished.

Now the lender is saying if you sell for $290,000 we’ll sue you for the difference. This is not common, but it can happen. In general terms you can expect the lender to look at all your assets to see if any recovery is possible -- maybe you own other real estate, or a business, or whatever they can get.

If the property was used as a rental then another issue is that the lender’s loss may be regarded as taxable income to you. Under the Mortgage Forgiveness Debt Relief Act of 2007 those who have losses from the sale of a prime residence are not required to pay taxes on principal not repaid to the lender, what can be regarded as a form of “imputed” income. However, the rule does not apply to investment property owners. As the IRS explains, “only canceled debt used to buy, build or improve your principal residence or refinance debt incurred for those purposes qualifies for this exclusion.” See IRS Publication 4681 and speak with a tax professional for specifics.

Before going further there is a question you ought to ask the lender: Is there a sale price below the outstanding mortgage that would be acceptable to the lender and that would not result in a suit against you? If the answer is yes -- and if the price is plausible in your market -- then your attorney can get the details in writing from the lender.

Q: I’m currently renting a house. My landlord has a land contract with the person who owns this house. My lease is up in September and I’ve been advised to get a land contract with my landlord for this property. What should I do?

A: A “land contract” – also known as a “contract for deed," “land installment contract” or "agreement for sale" – is an installment sale. Instead of getting title up front, the potential buyer only gets title when some or all payments have been made. It’s like buying a car on credit -- you don’t get title until the debt is fully paid.

The landlord has a land contract. What we don’t know is whether or not the landlord has also gotten title.

If the landlord does not have full title then he can’t sell what he doesn’t own. You might be able to take over his agreement with the current owner, but you would not be able to modify their arrangement.

Before signing anything with anyone, please contact an attorney, legal clinic, community housing organization or a pro bono legal service.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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