Misinformation From Fannie and Freddie On Walking Away

San Francisco Chronicle is reporting Fannie warns homeowners who walk away.

The country's two largest sources of mortgage money have a blunt warning for anyone thinking about joining the growing "walkaway" trend, where homeowners stop making payments and months later send the house keys back to their lender: You will feel the pain.

On March 31, Fannie Mae (FNM) sent out new guidelines to lenders intended for walkaways and other foreclosure situations. Fannie will now prohibit foreclosed borrowers from getting another mortgage through the giant investor for five years, unless there are "documented extenuating circumstances." In those cases, the mortgage prohibition is for three years.

Freddie Mac (FRE), Fannie's rival, counts foreclosures as major credit blots for seven years, and a senior official said the company is now aggressively pursuing some walkaway borrowers "to preserve our deficiency rights" where permitted under state law.

My Comment: Walk away borrowers in non-recourse states do not have a problem on the original loan with Fannie's threat "to preserve our deficiency rights". Where permitted by state law is key. California is a non-recourse state.

Furthermore even if a state is a recourse state, that does not imply that every loan in that state is a recourse loan. Consider this answer from Bryan Whipple, Attorney at Law Re: Non Recourse Loan, Recourse State Florida

(1) Just because a state permits recourse loans doesn't mean it forbids non-recourse loans! In general, parties to loan transactions are allowed to agree on whatever terms they are able to negotiate. It's a freedom-to-contract principle.

(2) However, just because a document is stamped "Non-Recourse" doesn't necessarily make it such. A stamp on a document may be part of its terms, or it may be legally meaningless. To be sure the loan is truly non-recourse, I would suggest reading the entire document pretty carefully.

It pays to consult an attorney. Continuing with the article...

The walkaway trend is particularly noteworthy in former housing boom markets - including California, Florida and Nevada - where many homeowners find themselves upside down on their loans, owing tens of thousands more than the current market value of their houses. If they invested little or nothing in down payments, some owners reason, continuing to make payments - even if they can afford to - may be throwing good money after bad.

My Comment: The walk away trend is highest in the bubble areas. Not surprisingly, those are the areas with the largest numbers of walk-aways and those are areas where walk aways make the most sense.

Robin Stout Migala, consumer outreach manager for Freddie Mac, said in an interview that "there are so many bad reasons for walking away" from a home loan. Not only are borrowers' credit standings wrecked - forcing them into excessively high interest rates on any credit they can manage to obtain. But they also face other potential problems, including federal income tax liabilities.

Federal legislation enacted last year allows homeowners who negotiate loan modifications with lenders and have portions of their principal debt eliminated to escape income tax liability for the amount forgiven. Walkaway borrowers, by contrast, have nothing forgiven, and the IRS may demand income taxes on the balance they never paid, according to Migala.

My Comment: In my opinion Robin Stout Migala is spreading misinformation. I leave it to the reader to decide if this is on purpose or though ignorance.

Migala is misrepresenting the Mortgage Forgiveness Debt Relief Act. There is a provision allowing tax free debt forgiveness, even in recourse states, for reasons of insolvency. Note the following question and answer from the IRS.

If part of the forgiven debt doesn't qualify for exclusion from income under this provision, is it possible that it may qualify for exclusion under a different provision?

Yes. The forgiven debt may qualify under the "insolvency" exclusion. Normally, a taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is insolvent. A taxpayer is insolvent when his or her total liabilities exceed his or her total assets. The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real property business indebtedness. If you believe you qualify for any of these exceptions, see the instructions for Form 982.

Inquiring minds may also wish to read Mortgage Workouts, Now Tax-Free for Many Homeowners; Claim Relief on Newly-Revised IRS Form.

The article continues ....

For borrowers who faced genuine financial hardships leading to foreclosure, underwriters are likely to be more sympathetic a few years down the road. But if you walk away, here's the deal: Don't expect to get a new home loan - certainly not one with favorable terms - for five to seven years.

That's no matter what some promoter promised you online.

My Comment: Robin Stout Migala is talking his book. That book is to get you to keep paying your mortgage whether it makes any sense or not. Threats of "preserving deficiency rights" may be hollow.

Anyone who is deep in the hole on a mortgage should do what is in their best interest. That may mean a work out, it may mean bankruptcy, it may mean walking away. Walking away is not the right solution for everyone, and it does have consequences. On that I agree with Migala. However, the picture Migala presented is far from accurate.

I happen to believe the folks at You Walk Away are providing a valuable service at a reasonable price. They have turned down clients attempting to "game the system". There are times walking away makes sense and times it does not.

I have talked about walking away on many occasions. Here is a recap:

• 60 Minutes Legitimizes Walking Away
• The Business of Walking Away
• Businesses Advised To Walk Away
• Moral Obligations Of Walking Away

In the end, everyone has to decide this issue for himself. However, the one thing that makes absolutely no sense is to struggle for years as a debt slave, attempting to hang on, tapping out credit cars or heaven forbid IRAs, then only to lose the house anyway.

Fannie and Freddie are attempting to stigmatize walking away. Worse yet, they are doing it by spreading misinformation. There is one thing I want to be clear on: I am not promoting walking away for walking away's sake. I am promoting people do what is in their best interest. That may or may not be walking away. Sadly, I suspect walking away makes sense far too often.

Corporations are doing what is in their best interest even if they have to spread misinformation to do it. Why shouldn't people do what is in their best interest and tell businesses where to go? I am sick of seeing people being turned into debt slaves. If walking away makes sense, then by all means do it.

Fannie and Freddie's big threat seems to be if you walk away they will require a big down payment, higher FICO score, and ability and willingness to pay the loan back.

Had Wall Street, banks, homebuilders, the Fed, Congress, GSEs, etc., shown any sense of responsibility in the first place, this never would have happened. Yes, consumers were greedy too, but who bears the lion's share of the blame? Now consumers, especially innocent bystanders, are bearing the brunt of a sinking US$, of low interest rates on CDs, of bailouts of banks, etc.

To hell with em.

If walking away makes sense to you, then by all means do it, just consult your tax advisor first.

Comments

[baycommuter]

I work for the Chronicle. This goes well beyond fair use. The Chronicle does have a copyright on the material. I'm not going to call up the Hearst lawyers this time, but the next time I might.

[jimmy46]

YOU'RE NUTS!!!

Just because a Cal mortgage is non recourse doesn't mean than
FNM or FRE ARE REQUIRED to extend a future loan to a person, LOL

It means they can't go to court and seek a judgment on the old
loan.

Sounds like you did something stupid and are angry about it.

[QED]

People be careful! It seems to me that Michael has misread the text he quotes relating to tax relief and Migala/Fannie Mae may well be right. If you read the IRS comment in the link to the Mortgage Forgiveness Debt Relief Act then it seems that "forgiven" does not include walking away where recourse is possible and has not been "forgiven or cancelled". Further, any tax relief, if the debt was indeed forgiven or cancelled, applies only in limited circumstances. The IRS link states the following:

"Does the Mortgage Forgiveness Debt Relief Act of 2007 apply to all forgiven or cancelled debts?

No, the Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes.

What about refinanced homes?

Debt used to refinance your home qualifies for this exclusion, but only up to the extent that the principal balance of the old mortgage, immediately before the refinancing, would have qualified.

Does this provision apply for the 2007 tax year only?
It applies to qualified debt forgiven in 2007, 2008 or 2009."

Walking away may thererefore not only taint your credit rating and affect your future chances on a mortgage. There may also be a further income tax sting in the tail if you walk away when there is recourse for the (remaining) debt and the lender has not agreed to cancel it. For refinanced debt (before 2007) you have to be even more careful. See your tax adviser and lawyer before making things worse.

[I shouldknow]

The most important part of the “walking away is good” theory is that it doesn’t take into consideration moral and ethical standards that say “if you borrow money, for any reason or endeavor, you are morally and ethically obligated to repay that debt. Suppose you borrow money from your family to buys stocks and the stocks go in the tank. Michael Shedlock believes that “it’s OK to walk away” from that debt. Suppose you borrow money from a bank and purchase a boat and the boat sinks and, unfortunately, it is drastically underinsured. Michael Shedlock believes that “it’s OK to walk away” from that debt. Suppose you call your stock broker and make a substantial stock purchase and the stock collapses during the same day. Michael Shedlock believes that “it’s OK to walk away” from that debt, it’s OK to say that you made a mistake and you’re not going to pay for those stocks, sorry. Most stock brokers have experienced that situation at least once. It’s a slimy, despicable way of doing business and it shows the total decay of morals and ethics for a great number of people.

I’ve made my share of bad bets, bad purchases, and bad investments, but I’ve always honored my obligations. I didn’t screw anyone due to my mistake.


On the other hand, Michael Shedlock and many people like him believes that “it’s OK to walk away” from your debts and obligations; morality and ethics play no part in their daily activities. So sad.

[seth caplan]

To Whom It May Concern- below is an email i sent to the Kenneth Harney a columnist who wrote an article quoting the mis information regarding walk aways.



I thoroughly enjoyed your article that I read in yesterdays Los Angeles Times Real Estate Section; however I have a few questions regarding a few parts of the article titled WARNING: WALKING AWAY WILL BE COSTLY. My question is in regards to the part in the article that deals with LOAN MODIFICATIONS AND HAVING NO TAX ON THE AMOUNT FORGIVEN vs. WALKAWAYS, BY CONTRAST, HAVE NOTHING FORGIVEN AND THE IRS MAY DEMAND INCOME TAXES………….ACCORDING TO MIGALA

My understand of the recent law changes allowing for non payment for tax on mortgage debt relief is as follows- if the debt that is forgiven is acquisition indebtedness or a refinance loan, as long as the amount forgiven is not on a refinance loan taking cash out (regardless of owner occupancy vs. non owner etc etc) then there is no tax. Only if the loan is a refi and there is cash taken out and then there is non payment of any part of the cash out then the tax payer will be responsible for tax on debt relief.

In your article you make the assumption that a loan modification is either an actual loan modification of the monthly terms or possible a loan modification allowing for a short pay/sale- thus no tax on debt relief. However if none of the previous takes place then the borrower that gets foreclosed/walks away will be taxed- with no mention of purchase money, cash out, recourse non recourse etc etc.



Does my misunderstanding make sense? I feel that I have a very deep understanding of the aforementioned issues but your article brings up possible issues and scenarios I did not consider as relevant.

i believe that the mis info on the above mentioned issues is done on purpose to try and further confuse borrowers into continuing to pay regardless of there situations.

Can you possible shed more light on my above confusion? Are you available to talk by phone about the above? Can you put me in contact with Mrs. Migala from Freddie Mac?



Thank you in advance for your help,

Seth Caplan