A Mortgage History Lesson & Foreclosure Tax Repercussions

The current mortgage environment has drawn many comparisons with the 1930's, when the government stepped in. It is generally agreed that without those fundamental changes, the Great Depression could have been much worse than it was. In the early part of the last century, most home loans were a 5-yr ARM with a balloon payment. Keeping that in mind, here's a brief summary:

In 1932, the National Association of Real Estate Boards proposed (and Congress created) the Federal Home Loan Bank System, modeled after the Federal Reserve System. Twelve regional banks were created, and a Federal Home Loan Bank Board, like the Federal Reserve board, was set up to oversee them. The Appraisal Institute was also founded in 1932 by the appraisal industry. Bankruptcy and eviction laws were modified and in 1933, Congress created the Home Owners Loan Corporation to help borrowers move from 5-yr balloon loans to 15-year amortizing mortgages.

In 1934, Congress created the Federal Housing Administration (FHA) to insure mortgages and the Federal Deposit Insurance Corporation (FDIC), intended to prevent runs on banks from depleting resources for home mortgages. Lastly, in 1938, Congress created the Federal National Mortgage Association (FNMA or Fanny Mae). Some argue that it is very early in this current business cycle; however it is easy to see the amount of government intervention juxtaposed with today's market, especially at the Federal level.

A plan is nearing fruition on a plan to freeze some subprime rates, but that won't help those already foreclosed upon. As most originators know, in many states (including California), most mortgages that are used to purchase a residence are nonrecourse, but mortgages from refinancing a previous mortgage are usually recourse, based on the note. So, can the lender come after the borrower for the difference? If the loan (Deed of Trust) is a purchase money loan secured by a house that is the borrower's principal residence, the answer is generally "no."

California's anti-deficiency laws [California Code of Civil Procedure Section 580(b)-(d)] protect homeowners by preventing lenders from doing any more than taking back the property. These anti-deficiency laws were enacted during the Depression to give homeowners a fresh start, without a deficiency judgment hanging over their heads. However, the code section is fairly specific. The loan had to be for the purchase of the property and the borrower has to occupy it as his or her principal residence: (No non-owner or vacation homes.) The lender can choose to file a judicial foreclosure against the borrower. For loans involving a refinance or line of credit (technically not purchase money loans) a lender could go after the borrower for the difference.

Regarding tax consequences, here are some sites that may be of help for you:
Questions and Answers on Home Foreclosure and Debt Cancellation -- IRS http://www.irs.gov/newsroom/article/0,,id=174034,00.html

Interest/Dividends/Other Types of Income: 1099 Information Returns (All Other) -- IRS http://www.irs.gov/faqs/faq4-4.html

Foreclosures and Repossessions -- IRS http://www.irs.gov/publications/p544/ch01.html#d0e914
Tax Consequences of a "Short Sale" of Real Estate vs. Foreclosure - CPA's website http://www.realestateinvestingtax.com/shortsale.shtml

Blog worth checking on-- http://dirtlaw.typepad.com/blog/2007/02/preforeclosure.html

In recent weeks jumbo loans have worsened relative to conforming prices, almost back to where they were when they were "bad" a few months ago, and currently have a difference of roughly 1%. So, as usual, headline-grabbing Treasury yields are improving, yet mortgages are plodding along. Conforming rates have improved slightly, jumbo prices hardly at all, while Treasury rates are down. If asked why, the primary reasons are:

Continued fear of delinquencies and foreclosures with mortgages (something not present with Treasury securities)

Investors nervous about declining property values in many markets (not a factor with Treasury securities)

The fear of early pay-offs on current mortgages if rates continue to move down (also not a factor with Treasuries).

The investor perceptions of mortgage companies and FNMA & FHLMC (their stocks are down 50% in recent months) are not helping either.

News today that "The Bush administration and major financial institutions are close to agreeing on a plan that would temporarily freeze interest rates on certain troubled subprime home loans, according to people familiar with the negotiations," is helping us somewhat. In fact, financial stocks are up significantly today. But the 10-yr bond continues to dance around 4% and mortgage prices are roughly unchanged.

Oil has dropped into the $89/barrel range for the first time in over a month. The economic news this morning was mixed. Personal Income was +.2 Personal Consumption was +.2%, with no revisions, but the price deflator moved up year-over-year. Unfortunately rates had crept up overnight, given the potential rally in the stock market.

Besides announcing $1.4 billion in HELOC-related write-downs, Wells Fargo engaged in further product changes. Effective today, for all of their nonconforming Verification of Assets loans, the maximum debt-to-income ratio requirement will decrease from 45% to 38%, and non-self-employed borrowers now have reduced eligibility for Limited Doc/VOA. At least one of the borrowers on the loan application must have their income derive from self-employment to be eligible for Limited Doc/VOA documentation option.

Speaking of Wells Fargo, they are absorbing $1.4 billion in losses on home equity loans that borrowers have stopped repaying. Well Fargo's troubled home equity loans, totaling $11.9 billion, represent about 14 percent of the bank's total home equity portfolio of $83.4 billion. The bank has said most of the delinquent loans originated from mortgage brokers or other lenders on the wholesale market. Wells Fargo is now steering clear of virtually all home equity loans made outside its own offices.

FNMA announced changes to their Alt-A program, effective March 1, 2008. (Remember that most, if not all, investors will probably follow suit.) "In light of the continuing deterioration of market conditions," FNMA will no longer purchase No Income/No Assets (NINA) documentation loans, or No Ratio (No Income/Verified Assets [NIVA]) documentation-type loans. Beginning then, FNMA will only purchase Stated Income/Verified Assets (SIVA) and Stated Income/Stated Asset (SISA) loans, with the following eligibility adjustments: for cash-out refinance loans, the maximum LTV/CLTV is reduced to 75% for all except 1-unit primary residence, the minimum FICO score is increased to 660 regardless of LTV/CLTV, and for 3- to 4-unit properties, the minimum FICO score is increased to 700.

Chase, effective today, is changing their risk-based price adjustments for Agency fixed rate products. Needless to say, they are not for the better. This is in reaction to FNMA and FHLMC's loan level pricing adjustments based on LTV and FICO scores. In addition, JP Morgan Chase will be cutting 91 jobs at a Southern California Mortgage Operations Center.

Freddie Mac is offering $6 billion of preferred stock, saying that the capital will be used for their base requirements. Freddie also cut their dividend by 50%.

Quote of the Day: "This time, like all times, is a good one if we but know what to do with it." ~ Ralph Waldo Emerson

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