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New Home, Lost Home

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Posted On: 02/11/2009

Q: I bought a new home, but I'm losing my current home to foreclosure. The first home won't sell or rent because mortgage payments for the first and second loans are too high. What can happen to me when I finally lose the first house?

A: Just a guess, but I bet you bought the second home before September. Here's why: On September 19th HUD established tough new regulations to prevent what are called "buy and bail" transactions for FHA borrowers, lending standards which have now been picked up by many private-sector lenders as well.

Basically the idea is to prevent owners from buying a replacement property and allowing the first property be foreclosed. The new standard says that owners cannot buy a replacement property and keep the old one as a rental unless they pass several tests:

First the sellers must have 25 percent equity in the first home, or ...

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Second, they are moving "to an area not within reasonable and locally recognized commuting distance." In this case sellers can rent the current property but they can only finance the replacement home if they have a one-year lease on the first house plus a security deposit or the first month's rent. Please speak with local lenders for specifics.

In your situation the first house has both a first and second mortgage. Rent will not cover your monthly costs. Not renting or selling the house at a loss means the inevitable result is that you will be foreclosed. What happens next depends on several factors:

Was the first home a principal residence or an investment property? If the home was an investment then you may be taxed on any amount not repaid to the lender.

Where is the property located? The rules vary by state, but since you have a second mortgage and not just purchase-money financing it's likely that one or both of your lenders will have the right to seek a deficiency judgment and go after your other assets, including the new home. However, this might not happen if the home is foreclosed without the lender going to court. For the specifics in your area speak with a local real-estate attorney.

Lastly, your credit for the next few years is shot.

Is there an alternative to foreclosure? It might be cheaper to rent the property at a loss and hope that the market comes back. Or, sell the property with a lease purchase agreement. Speak with local real estate brokers before missing a payment on the first home.

Q: A local real-estate broker recently sent around a newsletter saying that a growing percentage of local sales involved distressed properties. What is really meant by the term "distressed" property?

A: Distressed properties come in two flavors, those that are actually distressed and those that are not.

A "distressed" home has traditionally been seen as a property with physical problems - something important and expensive is leaking, rusted, rotting, bent, warped, out-of-date, in need of repair or otherwise in shambles.

But the real definition of a "distressed" property these days is a little different: What is often meant is not that there are any physical problems with a home but instead that the owner is having financial difficulties. The result is that in many cases "distressed" properties are actually fine in a physical sense but available at discount because the owner or lender needs to sell. Such homes, on a selective basis, can be good buys in the marketplace because they're simply properties in normal condition owned by folks who have encountered tough times.

To a great extent it's the supply of financially distressed homes that is holding down home values nationwide. Until the inventory of distressed, foreclosed and REO properties (real estate owned by lenders) is reduced, home values will be depressed.

Q: How long can a negative item appear on a credit report?

A: There are several exceptions, but in general terms most negative items get wiped off in seven years, bankruptcies in 10 years.

In a practical sense, lenders have traditionally been concerned with recent credit activity - say late payments made during the past two or three years.

Several months before refinancing or entering the real estate marketplace get your truly free credit report at AnnualCreditReport.com, a site self-described as "a centralized service for consumers to request free annual credit reports. It was created by the three nationwide consumer credit-reporting companies - Equifax, Experian and TransUnion."

Check for outdated items and factual errors. Contact the credit-reporting agency to request changes and if you see a problem explain the issue and provide proof of payment or resolution.

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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