The 6 phases of a foreclosure

If you or someone you know is facing possible foreclosure, you should know what to expect

Many people have either gone through foreclosure, a process that allows a lender to recover the amount owed on a defaulted loan by selling or taking ownership of the property, or know someone who has.

RealtyTrac released its U.S. Foreclosure Market Report on April 15 for the first quarter of 2010. The report calculates foreclosure filings, including default notices, scheduled auctions and bank repossessions, and showed that 932,234 properties were involved in the first quarter. That was a 7% increase from the last quarter of 2009 and a 16% increase from the first quarter of 2009. An astonishing one in every 138 U.S. housing units received a foreclosure filing during the quarter. If you or a loved one are facing foreclosure, make sure you understand the process. While it varies from state to state, there are normally six phases of a foreclosure.

Phase 1: Payment default
A payment default occurs when a borrower has missed at least one mortgage payment. The lender will send a missed-payment notice indicating that it has not yet received that month’s payment. Typically, mortgage payments are due on the first day of each month, and many lenders offer a grace period until the 15th. After that, the lender may charge a late-payment fee and send the missed payment notice.

After two payments are missed, the lender may send a “demand letter.” This is more serious than a missed-payment notice; however, at this point the lender is probably still willing to work with the borrower to make arrangements for catching up on payments. The borrower would normally have to remit the late payments within 30 days of receiving the letter.

Phase 2: Notice of default (NOD)
A notice of default is sent after 90 days of missed payments. In some states, the notice is placed prominently on the home. At this point, the loan will be handed over to the lender’s foreclosure department in the same county where the property is located. The borrower is informed that the notice will be recorded. The lender will typically give the borrower another 90 days to settle the payments and reinstate the loan. This is referred to as the reinstatement period.

Phase 3: Notice of trustee’s sale
If the loan has not been brought up-to-date within the 90 days after the notice of default, a notice of trustee’s sale will be recorded in the county where the property is located. The lender must also publish a notice in the local newspaper for three weeks indicating that the property will be available at public auction. All owners’ names will be printed in the notice and in the newspaper, along with a legal description of the property, the property address and when and where the sale will take place.

Phase 4: Trustee’s sale
The property is placed for public auction and will be awarded to the highest bidder who meets all of the necessary requirements. The lender, or firm representing the lender, will calculate an opening bid based on the value of the outstanding loan, any liens and unpaid taxes, and any costs associated with the sale. Once the highest bidder has been confirmed and the trustee’s sale is completed, a “trustee’s deed upon sale” will be provided to the winning bidder. The property is then owned by the purchaser, who is entitled to immediate possession.

Phase 5: Real-estate owned (REO)

If the property is not sold during the public auction, the lender will become the owner and will attempt to sell the property on its own, through a broker or with the assistance of an REO asset manager. These properties are often referred to as “bank-owned.” The lender may remove some of the liens and other expenses in an attempt to make the property more attractive.

Phase 6: Eviction
The borrower can often stay in the home until it has been sold either through a public auction or later as an REO property. At this point, an eviction notice is sent demanding that any people vacate the premises immediately. Several days may be provided to allow the occupants sufficient time to remove any personal belongings, and then typically the local sheriff will visit the property and remove the people and any remaining belongings. Belongings may be placed in storage and retrieved later for a fee.

The bottom line
Throughout the foreclosure process, many lenders will attempt to make arrangements for the borrower to get caught up on the loan and avoid a foreclosure. The obvious problem is that when a borrower cannot meet one payment, it becomes increasingly difficult to catch up on multiple payments. If there is a chance that you can catch up on payments — for instance, you just started a new job after a period of unemployment — it is worth speaking with your lender. If a foreclosure is unavoidable, knowing what to expect throughout the process can help prepare you.

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Home Foreclosure and Debt Cancellation

Update Dec. 11, 2008 — The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualify for this relief.

This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion doesn’t apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.

The amount excluded reduces the taxpayer’s cost basis in the home. More details. Further information, including detailed examples, can also be found in Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.

The questions and answers, below, are based on the law prior to the passage of the Mortgage Forgiveness Debt Relief Act of 2007.

1. What is Cancellation of Debt?

If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances. When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is reportable as income because you no longer have an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.

Here’s a very simplified example. You borrow $10,000 and default on the loan after paying back $2,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $8,000, which generally is taxable income to you.

2. Is Cancellation of Debt income always taxable?

Not always. There are some exceptions. The most common situations when cancellation of debt income is not taxable involve:

• Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
• Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you.You are insolvent when your total debts are more than the fair market value of your total assets. Insolvency can be fairly complex to determine and the assistance of a tax professional is recommended if you believe you qualify for this exception.
• Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income. The rules applicable to farmers are complex and the assistance of a tax professional is recommended if you believe you qualify for this exception.
• Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences, as discussed in Question 3 below.

3. I lost my home through foreclosure. Are there tax consequences?

There are two possible consequences you must consider:

• Taxable cancellation of debt income.(Note: As stated above, cancellation of debt income is not taxable in the case of non-recourse loans.)
• A reportable gain from the disposition of the home (because foreclosures are treated like sales for tax purposes).(Note: Often some or all of the gain from the sale of a personal residence qualifies for exclusion from income.)
Use the following steps to compute the income to be reported from a foreclosure:

Step 1 – Figuring Cancellation of Debt Income (Note: For non-recourse loans, skip this section. You have no income from cancellation of debt.)
1. Enter the total amount of the debt immediately prior to the foreclosure.___________
2. Enter the fair market value of the property from Form 1099-C, box 7. ___________
3. Subtract line 2 from line 1.If less than zero, enter zero.___________
The amount on line 3 will generally equal the amount shown in box 2 of Form 1099-C. This amount is taxable unless you meet one of the exceptions in question 2. Enter it on line 21, Other Income, of your Form 1040.

Step 2 – Figuring Gain from Foreclosure

4. Enter the fair market value of the property foreclosed. For non-recourse loans, enter the amount of the debt immediately prior to the foreclosure ________
5. Enter your adjusted basis in the property.(Usually your purchase price plus the cost of any major improvements.) ____________
6. Subtract line 5 from line 4. If less than zero, enter zero.
The amount on line 6 is your gain from the foreclosure of your home. If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income. If you do not qualify for this exclusion, or your gain exceeds $250,000 ($500,000 for married couples filing a joint return), report the taxable amount on Schedule D, Capital Gains and Losses.

4. I lost money on the foreclosure of my home. Can I claim a loss on my tax return?

No. Losses from the sale or foreclosure of personal property are not deductible.

5. Can you provide examples?

A borrower bought a home in August 2005 and lived in it until it was taken through foreclosure in September 2007. The original purchase price was $170,000, the home is worth $200,000 at foreclosure, and the mortgage debt canceled at foreclosure is $220,000. At the time of the foreclosure, the borrower is insolvent, with liabilities (mortgage, credit cards, car loans and other debts) totaling $250,000 and assets totaling $230,000.

The borrower figures income from the foreclosure as follows:

Use the following steps to compute the income to be reported from a foreclosure:

Step 1 – Figuring Cancellation of Debt Income (Note: For non-recourse loans, skip this section. You have no income from cancellation of debt.)
1. Enter the total amount of the debt immediately prior to the foreclosure.___$220,000__
2. Enter the fair market value of the property from Form 1099-C, box 7. ___$200,000__
3. Subtract line 2 from line 1.If less than zero, enter zero.___$20,000__
The amount on line 3 will generally equal the amount shown in box 2 of Form 1099-C. This amount is taxable unless you meet one of the exceptions in question 2. Enter it on line 21, Other Income, of your Form 1040.
Step 2 – Figuring Gain from Foreclosure
4. Enter the fair market value of the property foreclosed. For non-recourse loans, enter the amount of the debt immediately prior to the foreclosure. __$200,000__
5. Enter your adjusted basis in the property.(Usually your purchase price plus the cost of any major improvements.) ___$170,000__
6. Subtract line 5 from line 4.If less than zero, enter zero.___$30,000__

The amount on line 6 is your gain from the foreclosure of your home. If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income. If you do not qualify for this exclusion, or your gain exceeds $250,000 ($500,000 for married couples filing a joint return), report the taxable amount on Schedule D, Capital Gains and Losses.

In this situation, the borrower has a tax-free home-sale gain of $30,000 ($200,000 minus $170,000), because they owned and lived in their home as a principal residence for at least two years. Ordinarily, the borrower would also have taxable debt-forgiveness income of $20,000 ($220,000 minus $200,000). But since the borrower’s liabilities exceed assets by $20,000 ($250,000 minus $230,000) there is no tax on the canceled debt.

Other examples can be found in IRS Publication 544, Sales and Other Dispositions of Assets, under the section “Foreclosures and Repossessions”.

6. I don’t agree with the information on the Form 1099-C. What should I do?
Contact the lender. The lender should issue a corrected form if the information is determined to be incorrect. Retain all records related to the purchase of your home and all related debt.

7. I received a notice from the IRS on this. What should I do?
The IRS urges borrowers with questions to call the phone number shown on the notice. The IRS also urges borrowers who wind up owing additional tax and are unable to pay it in full to use the installment agreement form, normally included with the notice, to request a payment agreement with the agency.

8. Where else can I go to get tax help?
If you are having difficulty resolving a tax problem (such as one involving an IRS bill, letter or notice) through normal IRS channels, the Taxpayer Advocate Service may be able to help. For more information, you can also call the TAS toll-free case intake line at 1-877-777-4778, TTY/TDD 1-800-829-4059.
In some cases, you may qualify for free or low-cost assistance from a Low Income Taxpayer Clinic (LITC). LITCs are independent organizations that represent low income taxpayers in tax disputes with the IRS. Find information on an LITCs in your area.

Find out how much of a deal you can get when you make an offer on a home, as well as the latest on foreclosures and some safe housing markets.

There’s no question that it’s a buyers’ market, with prices continuing to dip in the majority of U.S. metropolitan areas. But how much leverage does that give you in negotiations? That varies widely, depending on where you live, who’s selling and what type of home you’re buying. In this month’s Buying Advice, we look at what some buyers are asking for — and what they’re actually getting at the bargaining table.

We’ll also examine the discounts at which foreclosures are trading, and pinpoint five of the safest markets for homebuyers. (Hint: Two of them are in Texas.)

Buying strategy: Should you ask for the moon?
With sales sluggish, it’s tempting to make a lowball offer. But are buyers actually getting huge discounts off asking prices?

One of his clients who was looking to spend $200,000 on a home put in an offer of $190,000 on a property priced $40,000 higher — a large home with new flooring and paint. He didn’t expect much. But the gamble paid off when the sellers, heirs to an estate, took the deal after watching the property languish on the multiple listing service (MLS) for more than 30 days, even after a price reduction.

“They just wanted it to move,” “The best advice is, if you like the house, make an offer. It doesn’t hurt to try.”

Of course, just how low you go should depend on sales activity, inventory and prices in your area.

“You need to back up that offer,” she says. However, if comps come back at $150,000 for similar houses in that neighborhood, it can’t hurt to try $140,000, especially if sales are sluggish.

“A few years ago, agents wouldn’t have returned your call,” he says. But today, of course, it’s a different story.

There are exceptions: In many areas, affordable homes and condos are moving briskly as investors and other cash buyers swoop in to snag bargains.

In these niches, there can often be multiple offers on properties, and a buyer may be better off bidding his highest and best offer initially, agents say.

Likewise, homebuilders often won’t budge on asking prices for new homes because doing so would set a lower price for the rest of the development. But many will make up the difference in concessions, such as seller-paid closing costs, free granite countertops, sod and just about anything else a buyer’s heart desires.

Indeed, in some cases, builders are offering things before they are even asked. Welch recalls one couple he represented who asked a new-home salesperson if it was possible to build a pool in that community.

Just minutes after the pair walked out the door to look at another property, Welch got a text from the agent offering to throw in a pool and a fence with the home they looked at, for the same price they were quoted.

The same approach can work with sellers of existing homes, too, Edwards says. If they won’t budge on price, you could ask them to cover closing costs or pay a discount point on the loan to bring down your rate.

Distressed deals
Foreclosure sales accounted for a slightly smaller percentage of home sales last year — 26% of all transactions versus 29% in 2009, according to data firm RealtyTrac.

Even though foreclosures made up a smaller percentage of overall sales, the prices for these properties continued to slide, weighing heavily on the properties around them.

In the fourth quarter of last year, foreclosure sales traded for 28% below the average price for traditional listings, compared with a 27% discount in 2009 and 22% in 2008.

A total of 149,303 foreclosure sales were recorded in the fourth quarter of 2010, down 22% from the previous quarter and down 45% from the fourth quarter of 2009.

RealtyTrac execs blame the slowdown on the expiration of the first-time homebuyers tax credit and some de facto moratoriums on repossessions as banks re-examined their processes after last year’s foreclosure documentation controversy.

The biggest foreclosure discounts — 35% or more off the average transaction price — could be found in 10 states: Ohio, Kentucky, Tennessee, California, Pennsylvania, Illinois, New Jersey, Michigan, Georgia and Wisconsin.

So, where is stability to be found?
We’ve gotten lots of questions here at MSN from people wanting to know which markets are the safest for prospective homebuyers — those with the least immediate risk and most upside potential over the next several years.

We asked the folks at Local Market Monitor to give us their predictions for five of the top havens for buyers — places with a population of more than 200,000 where the immediate outlook is calm and modestly optimistic over the next two years.

Those looking for stability should do their homework, says Carolyn Beggs, LMM’s chief operating officer.

“Homebuyers should look at data on employment, job growth, job-sector concentrations and income growth … to get an indication of (a market’s) health.”

The latest sales snapshot
Existing-home sales in the U.S. climbed 5.3% in January from the same time a year ago, according to the National Association of Realtors — the third monthly sales increase. However, the median home price dipped 3.7% to $158,800 from January 2010. Who’s buying? One in four sales went to bargain-hungry investors, and 32% of all sales were all-cash deals.

Remember: Your questions are welcome. We’d love to answer them in future installments of this column. So please submit them in the comments section below or on MSN Real Estate’s Facebook page, or e-mail them to refdback@microsoft.com. Please keep in mind that short questions with the broadest range of interest have the highest chance of being answered.