Information on Foreclosures vs. Short Sale for Rental Properties…
Some Questions & Answers
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Q1
Can you provide information on foreclosure vs. short sale for rental properties we own and cannot get the loan modified to rent?
A1
You have asked a question which would require thousands of words to adequately answer because there are several separate primary issues involved and each potentially involves a number of secondary issues. Primary issues include impact on credit record, income tax consequences, and, depending on the state and other factors, the possibility of deficiency judgments from lawsuits against you by the lenders.
I will briefly discuss some of the issues, but for a complete understanding of all the issues using adequate facts related to your particular situation and for your particular state, I strongly advise you to consult with a competent real estate attorney of your state and with a CPA or other competent tax advisor.
Credit Record
Lenders will almost certainly report both foreclosures and short sales to the credit bureaus. In calculating credit scores, every negative on a credit report is assessed by three factors: how recently the negative event occurred; the severity of the negative (how late is the payment); and the frequency of negatives (how many times you’ve been reported delinquent on credit obligations).
A recent bankruptcy does the most damage to your score. If lenders report all of your mortgages as in default, the damage to your credit score would be akin to declaring bankruptcy on all accounts.
Although a short sale, where the lender agrees to take less than owed on the mortgage, will drop your credit score as much as will a foreclosure, there is one advantage to it when a principal residence is involved. This is that you may be eligible to buy a home with an institutional loan backed by Fannie Mae or Freddie Mac more quickly than you would if it went into foreclosure. Borrowers can be considered for loans after 24 months following a short sale if the sale was caused by extenuating circumstances outside of a borrowers’ control, or after 48 months if it was the result of financial mismanagement by the borrower.
The manner in which title to properties are held could affect the impact on your credit score.
Income Tax
The Mortgage Forgiveness Debt Relief Act of 2007 and the recently passed Emergency Economic Stabilization Act, provides for exclusion of up to $2 million of income ($1 million if married filing separately) from debt that’s discharged through mortgage restructuring, or that’s forgiven in connection with foreclosure, for the years 2007 through 2012. The exclusion must be connected with a decline in the home’s value or the taxpayer’s financial condition, and only applies to a principal residence, not investment properties.
There may be other provisions in the law that can help. For example, some or all of that debt may not be taxable if one is insolvent when the debt is cancelled.
Again, the manner in which title to a property is held could affect income tax consequences.
Deficiency Judgment
Depending on the state, there may be the possibility of lenders filing lawsuits and obtaining deficiency judgments following foreclosures. There may also be the same possibility for short sales, so it is important that there be an anti-deficiency clause in the short sale agreement. Since lenders generally net more from short sales compared to foreclosures, they are usually willing to agree to no deficiency action. A few states may prohibit deficiency judgments by statute (modified by court cases). For example, Arizona prohibits deficiency judgments for purchase money loans on one- or two-family homes on no more than 2 acres. For Arizona, the law applies to either one’s personal residence or for rental units.
Again, the manner in which title to properties are held could affect deficiency judgment risks.
Other Options
Some states may provide for other options, so, again you need to seek advice from competent professionals. Competent real estate agents who do significant short sale work may be able to provide information about any state benefits.
Depending upon the specific financial numbers related to particular properties, a lender might also be open to accepting a deed in lieu of foreclosure. This will also have potential income tax consequences and may affect your credit record, but it can be the best solution when possible.
Conclusion
As seen from my very brief discussions of a few of the possible issues, it is important that you make decisions based on your particular situation and on the laws of your state. Given the complexity of the subject, do not attempt to deal with this situation on your own.
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Q2
The tenant that signed the lease (WA state) has a girl friend that will be moving in in a month. Should we have her sign the lease and run a check on her also? What are the benefits and the downside?
A2
The basic rule is that every adult (18+ and emancipated minors) who will reside in a unit should have been checked using every screening method used for any applicant – i.e., identity verification, credit report, eviction record search, criminal record search, and inquiry of previous landlords. This applies to both original applicants and those added at a later date. Every adult applicant should be required to sign the lease, both original occupants and those added later.
Identity verification is a primary screening mechanism, as it is of no value to end up with great reports on an identity thief. Also, a credit report alone is not sufficient, as a convicted drug dealer who is successful in his business and would continue in his business while residing in your rental unit can have an excellent credit record and pass all other screening checks.
Screening every potential occupant reduces the chance of ending up with a very bad tenant if/when the only screened one skips, dies, or files for bankruptcy. Requiring every adult occupant to sign the lease provides additional people to go after if there are later problems, as each lease signatory should be jointly and severally liable for the terms of the lease, including for unpaid rent and damages. Also, having adequately screened each lease signatory provides information that can be useful if/when occupants skip.
Screening every occupant and requiring each one to sign the lease has many upsides. I know of no downside. There are likely landlords who purposely do not have all occupants sign the lease because they mistakenly think it will be easier to evict the non-signing occupants if ever necessary. However, such is not the case because they will have to be removed via eviction if they choose to not voluntarily leave when the lease expires or has been terminated for cause by the landlord, just as will the occupants who signed the lease. The cost of screening should not be a reason to avoid it, as most states allow landlords to charge for processing of applications, including screening and, even when in a state that restricts how much can be charged, the cost is relatively negligible. The time and money for adequate screening are both a lot less than the cost of a trashed unit.
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Q3
My tenant painted the exterior wall without my permission. She wants me to pay for the cost, but on rental agreement she signed indicated that tenants shall not paint, wallpaper, add or change, etc. without owner’s prior written consent. What is the best way to refuse her? Please advise.
A3
Assuming that the lease clause you mention is adequately stated, you should not need to even consider reimbursement for the painting. In fact, if the painting is unacceptable to you – due to color chosen, quality of workmanship, or other reason – you could probably require that the tenant pay you for the cost of correcting the work or even returning the wall to its previous condition. Depending on a number of factors you might even be able to terminate her lease if you wished. However, even if you did not provide written permission, anything you had said related to the matter that may have implied permission, even your prior knowledge of intent to perform the work and not actively protesting the work could negate your right to take such actions against her. In deciding how far to push their rights, particularly when the Landlord has not been significantly damaged, Landlords must always consider that judges do not always worry about legal technicalities. That is, the judge may consider oral notice without your protest to be acceptable in spite of the lease’s requirement of written permission.
Assuming that you did not in anyway orally agree, either explicitly or by implication, that she would be reimbursed, you can simply give her a written notice that she has violated the terms of the lease and that you will not be reimbursing her for the painting. If the work is unsatisfactory and you want to attempt to charge her for the cost of correcting it, you could include that information in the same notice.