Dennis' Mortgage Blog

Bailing Out Millionaires

The House of Representatives today passed by a huge margin (386-27) the “Mortgage Forgiveness Debt Relief bill (H.R. 3648) which if passed by the Senate and signed by President Bush would remove the tax penalty on homeowners when the principal amount of their mortgage is reduced due to loan modifications, short sales, or deeds in lieu. Of great interest is the limit in debt reduction allowed under the bill: $2 million! Yes multi-millionaires that could afford to purchase multi-million dollar estates in Nicholas Cage’s neighborhood in Newport Beach, or Oprah’s in Montecito, or Tiger’s in Isleworth but walk away from their mortgages can avoid a tax penalty of three-quarters of a million dollars thanks to Congress.

Recalling my School House Rock on How A Bill Becomes A Law (and Mr. Nimmons’ U.S. History classes!), I know this House Resolution must now go through committee in the Senate and then be voted on and approved by the Senate, any revisions back to the House and Joint Committee and then voted on again by both the House and Senate and then sent to the White House for signature or veto—that said bailouts up to $2 million is a very high starting point for any negotiations.

The premise of this bill is one I would be in favor of, the premise but not the current language. With the current language, the removal of the tax liability consideration in determining whether to keep a property or not creates a detrimental environment for lenders—particularly because of the lack of limits on the tax relief forgiveness. I am going to make a wild assumption that an individual who is in a position to have potentially $2 million in debt relief on a single property is a person of wealth and either very astute financially or pays someone to be financially astute for him or her. As such they are in a position to take advantage of this proposed Debt Relief bill.

The premise is to provide some relief to a family already facing financial difficulties, perhaps catastrophe, by preventing the I.R.S. from piling on while they are down. A family is in a position where they can no longer manage their home and must sell it—try to do what they feel is right rather than going through foreclosure; the proposed bill would end the financial hardship when the property sells. I understand the intent of some sort of relief like this would be to assist families facing financial hardship and sale or loss of their home who do not have the resources to “ride it out”, who are in the position because of job loss, job transfer, health factors or other singular life events. Instead as the bill is written it is open for abuse and what I would consider undeserved relief.

In the high foreclosure market in Southern California in the early 1990s when the state saw job losses of almost 20% from the severe reduction in defense and aerospace employers in the state, I and most of my fellow mortgage originators, had many clients who took advantage of the economic downturn to purchase a new home, and “upleg”, before their current residence sold. They took advantage of what were then new mortgage products allowing 5% down and purchased their new, bigger home, and then after they moved in either let their old home (often condos) go into foreclosure, or put on the market at reduced price and gave the lender a choice of short-sale or foreclosure. There was little concern for the derogatory reporting on their credit record because they already had the home they would be spending the next several years in. The industry saw this happen fairly often, I personally might have had up to twenty clients that I know of who took this route to get into their new home and out of their old one. Under the bill headed to the Senate these individuals, who faced no financial hardship, would be exempt from any tax relief for their taking advantage of the market and their lender.

Were I on the House Ways and Means Committee which originated this bill, I would have required the following modifications to get my vote:

1) Limit the amount of the Debt Relief that would be excluded from taxes, say $100,000

2) If the Debt Relief is on mortgage(s) that were used for cash out refinancing then there is no tax exemption

3) The Debt Relief must be on mortgages that are “seasoned”, i.e. have to have been in place for say 18 months or more

4) If a the borrower purchases any property within 24 months of the date of the loss that triggers the Debt Relief exemption then the exemption is lifted and the forgiveness is once again a taxable event

Essentially this bill should be for families that are not wealthy, did not purchase a property speculating they could flip it and make thousands (or tens of thousands), have an honest financial hardship and must sell their home. As it is now the bill could encourage more short-sales and foreclosures which could have very detrimental results in some regions for other homeowners trying to refinance or sell their homes without a loss. As well without the changes many lenders will face even more losses, which will result in even stricter qualifying guidelines and higher rates for all.

I am hopeful the Senators crafting their version of the Mortgage Forgiveness Debt Relief bill will insert some caps and limits so the provisions benefit those family most in need of escape from further financial hardship.

Dennis

 Friday, October 05, 2007