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Bank of America, which bought Countrywide Financial for $4 billion in stock in early 2008, has come under pressure from the Massachusetts Attorney General, as a result of Countrywide's notorious lending practices.  Bank of America's move is part of an agreement to settle claims over certain high-risk loans made by Countrywide.  See link to Wall Street Journal article.

Bank of America's program is limited to Countrywide borrowers whose loan balance is at least 120% of the estimated home value, who are at least 60 days overdue, and who can show that financial hardship makes them unable to meet current payments. The bank estimated that 45,000 customers will qualify for principal reductions averaging more than $60,000.  In the end, only the riskiest loans will be eligible. They include sub-prime loans; "option adjustable-rate" mortgages entailing minimal payments now but big increases later; and certain loans that have a fixed rate for two years and then adjust annually.

Any thought that principal reduction is the path the lenders are heading in should consider the limited scope of the agreement between Bank of America and the Massachusetts Attorney General.  Nonetheless, the action by Bank of America is notable because it is the largest mortgage servicer, collecting loan payments on one of every five home loans in the U.S. At the end of last year, 14.76% of them were at least 30 days past due or in foreclosure, versus an industry average of 12.31%, according to Inside Mortgage Finance. 

Principal reduction is clearly the direction that the large majority of underwater borrowers clearly are hoping the major banks are leaning towards.  Given that lenders must incur substantial costs in foreclosing, only to take a wash when they sell the foreclose property as a Real Estate Owned property, it only seems practical to try and keep people in their homes by reducing the principal.  I have seen many properties where the bank ended up selling a foreclosed property for substantially less than they would have made had they just worked with the homeowner.  No one claims that reason is driving this ship. 

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University of Arizona College of Law Professor Brent T. White has stirred quite a bit of controversy over his recent article in the Arizona Legal Studies entitled "Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis."  

His basic thesis is that despite the increasing number of homeowners walking away from their underwater mortgages, most homeowners continue to try and hold on to their homes even when it does not make economic sense to do so.  He suggests that homeowners choose to try and hold on to their homes to avoid the shame and guilt of foreclosure and because of the  "exaggerated anxiety" over the perceived consequences of a foreclosure created by "social control agents."  In short, he believes that underwater homeowners (in Arizona and California) are not knowingly making bad choices, they just can not "cognitively grasp" that they would be better off financially by simply walking away.  At the end of the day, argues White, many more underwater homeowners should be walking away from their mortgage obligations. 

As a justification for his thesis, White suggests that the "norms governing homeowner behavior stand in sharp contrast to norms governing lenders, who seek to maximize profits or minimize losses irrespective of concerns of morality or social responsibility. This norm asymmetry leads to distributional inequalities in which individual homeowners shoulder a disproportionate burden from the housing collapse."  

White argues that there are costs associated with walking away, but they are not outweighed by the financial benefits of a "strategic default."  While White's thesis is controversial, as it applies to Arizona borrowers, he is correct.  Arizona's anti-deficiency laws are incredibly broad and protect the large majority of borrowers who are now trying to keep pace with a subdivision home that is severely underwater.  Arizona's anti-deficiency statute (A.R.S. Section 33-814(G)) prevents lenders from pursuing a deficiency (the difference between the amount owed by the borrower and the price bid at a trustee's sale) against the borrower.  While a borrower's credit rating will undoubtedly take a severe beating from a foreclosure and the borrower may have to wait several years to obtain a federally guaranteed loan, for many underwater borrowers, the calculus leads to the undeniable conclusion that walking away makes the most financial sense. 

As for the moral aspect of walking away, White reasons that the overriding message to borrowers is that they have a moral responsibility to pay off their obligation.  White counters this message by pointing out that lenders are operating amorally according to market norms and could have acted to protect themselves by following prudent underwriting practices.  White's final point is that  "it is time to take morals out of the picture and search for an equitable solution to the negative equity problem."  While White is correct in many respects, had lenders and borrowers employed a stronger sense of morals when it came to underwriting and borrowing, we might not have experienced such a severe market bubble and attendant bust. 

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It seems that the small glimmer of hope that everyone is hoping for in the housing market is not likely to come anytime soon.  Mathew Padilla has posted an excellent blog article discussing that the discussion of another wave of foreclosure implies that the current wave has already receded.  Sam Khater, a senior economist with First American CoreLogic has stated: “To say there is a second wave implies the (current) wave has receded . . . I don’t see that the wave has receded.”

Call it what you will, the next foreclosure wave to hit will largely involve Pay Option ARMs.  Pay Option ARMs are adjustable rate mortgages on which the interest rate adjusts monthly and the payment adjusts annually, with borrowers offered options on how large a payment they will make. The options include interest-only, and a "minimum" payment that is usually less than the interest-only payment. The minimum payment option results in a growing loan balance, termed "negative amortization."  As Long and Foster's Ron Sitrin recently commented: because these loans "had negative amortization for so long, they can't refinance out of them and they cannot sell them because the loans are worth more than the properties themselves."

For the most part the expensive gated communities have avoided the impact of the current foreclosure wave, but its job loss consequences are coming home to roost in the upper income brackets.  This graph puts the Pay Option ARM problem in stark terms: 

As a recent post on Dr. Housing Bubble stated: "The Pay Option ARM is one of the most poorly construed mortgage product ever to face this planet. It was a pathetic attempt to allow a larger majority of Americans to have a piece of the great American credit ponzi scheme."  How's that for upbeat? 

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On May 20, 2009, President Obama signed into law Senate Bill 896, also known as the "Helping Families Save Their Homes Act of 2009."  Section 702 of that Act - the "Protecting Tenants at Foreclosure Act" is very broad in scope and affects the ability of the new owner of certain foreclosure property (including Section 8 properties) to take immediate possession of that property. 

The new Act has effectively mandated a tenant-friendly "non-disturbance clause", common in commercial leases, into the residential landlord-tenant world.  The Act now requires landlords to provide tenants residing in foreclosed residential properties to be provided 90 days advance notice to vacate the property.  However, except where the purchaser intends to occupy a given property as the primary residence, the terms of any bona fide lease remains in effect.

A lease or tenancy must meet the following requirements to be a bona fide lease: (1) The tenant cannot be the mortgagor or the child, spouse, or parent of the mortgagor; (2) The lease or tenancy must be the result of an arms-length transaction, and; (3) The rent required under the lease cannot be substantially less than fair market rent for the property or the rent is subsidized by a Federal, State or local subsidy. 

This is a watershed change in the law and now provides residential tenants protections that, though common in commercial leases, rarely have been seen in the residential context.  It also brings the law a small step closer to the long-past English feudal system of attornment, whereby a a new landlord had to obtain the consent of the tenant before becoming the new landlord.  Such a system was abolished in 1705, but it is clear that the pendulum is swinging towards tenant protections.  In light of the massive foreclosure wave that has swept this country, it is not surprising to see such a change.  A lot of unsuspecting tenants were left holding the bag after their landlord lost the property to foreclosure.  For what it is worth though, such a change is temporary.  The Act sunsets at the end of 2012. 
 

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When I hear the term "cram down" authority in the bankruptcy context, I keep picturing some poor mortgage lender warily stepping into a bankruptcy judge's chambers only to have a long metal pipe shoved down his throat until the lender is willing to give in on a loan modification.  Only a month ago it appeared that bankruptcy judges were on their way to wielding such foie gras power. 

While a "cram down" bill made it through the House of Representatives in March, Senate Bill 61 met fierce resistance and failed to muster the necessary votes to pass.  Brett Weiss, a bankruptcy attorney in Maryland, provides some excellent insight in his article as to why Senate Bill 61 bill could not pass despite President Obama's apparent 100-day mandate clout and a Democratically controlled Congress.  One is left to wonder why President Obama, who supported such "cram down" authority was unwilling to use some of his political capital to see this one through.

Senate Republican Leader Mitch McConnell of Kentucky seemed to echo the standard line being floated by the likes of J.P. Morgan Chase & Co., Bank of America Corp., and Wells Fargo & Co, namely that the vote was "a bipartisan rejection of an interest-rate hike, which is exactly the wrong solution for jobs, homeowners and the economy." 

However, as Brett Weiss notes in his article, mortgage insurance was the real issue.  Mortgage insurance gives lenders a very strong incentive not to write down principal, and gives them more money if they foreclose, even where the property is sold at a significant loss, than to work to make the loan performing.  In the end it seems that saving the likes of the stronger financial institutions was more practical than forcing the likely failure of MGIC, RMIC and Genworth, mortgage insurers already on the ropes.

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As the foreclosure wave has grown into a tsunami-like crisis, advocacy groups such as the Association of Community Organizations for Reform Now (ACORN) have taken to the streets in campaigns to lobby legislators about implementing new regulations that will help stem the foreclosure crisis and curtail predatory lending.  When I left the Pima County courthouse yesterday, there was an ACORN protest taking place at the same time that a Trustee's Sale was going on.  An interesting contrast between ACORN's bullhorn calls to action and the trustee calling out bids. 

Unquestionably, the foreclosure epidemic has resulted in some very impassioned debate as to whether and how the government should act.  Rick Santelli's recent rant highlights just how impassioned this debate has become.  While Santelli's rant has garnered much of the media hype, Stuart Varney's recent interview with ACORN's Bertha Lewis demonstrates just how zealous some people have become at the prospect of the government aiding struggling homeowners, who many view as irresponsible.  Varney was incredulous at ACORN's suggestion that people on the verge of foreclosure should stay in their homes.

As always, the foreclosure epidemic is far more nuanced than many of the talking heads are willing to discuss.  Predatory lending certainly was in force and many people were not informed of what they were getting into.  Likewise, many, many people bought far more home than they could ever afford.  Only time will tell whether massive government intervention or the force of the market will prevail. 

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It is clear that that lending industry has been slow to confront the ever-widening foreclosure crisis that began to pick up steam in 2007.  Indeed, Sandor E. Samuels, the former chief legal officer of Countrywide Financial was quoted as saying "We are going to keep making these loans [subprime teaser loans] until the last second they are legal."  Samuels' comments seem to reflect some of the general industry denial about the problem.  Despite such denial, many have been advocating changes that will help address the crisis. 

Last month, Arizona Attorney General Terry Goddard, along with twenty one other Attorneys General sent a letter to the U.S. House and Senate leadership urging an amendment to the bankruptcy code that would permit federal bankruptcy courts to order loan modifications, also known as "cramdown authority" in Chapter 13 bankruptcies.  The Attorneys General are advocating broader authority in the bankruptcy courts to stem the foreclosure tide. 

However, the lending industry has been actively lobbying against granting such cramdown authority, which they argue would reward irresponsible borrowers and result in higher borrowing costs.  The general intransigence is perhaps better explained by the accounting nuances involved in allowing wide-scale modifications.  Aubrey Cohen has a good blog post that describes how the securitization of loans has complicated the process. 

Nonetheless, Citi recently dropped its opposition to cramdown authority, but has stood alone among the lending industry.  One is left to wonder whether Citi was pressured into such a stance given that it has come to the Treasury trough twice in recent months for bailout funds.  Meanwhile, the Mortgage Bankers Association recently launched a "Stop the Bankruptcy Cram Down Resource Center" to try and ward off any further attempts to empower the bankruptcy courts to force modifications.  Time will tell whether the banks are able to ward off continued congressional pressure to force modifications.  No small task. 

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RealtyTrac just released its 2008 U.S. Foreclosure Market Report, which reported that there were a total of 3,157,806 foreclosure filings (default notices, auction sale notices, and bank repossessions) on 2,330,483 properties during 2008.  That was an 81 percent increase over 2007 and a 225 percent increase over 2006.  To get a feel for the breadth and scope of just how serious the foreclosure Juggernaut is, take a look at this map to see just how hard hit certain parts of the country were in 2008.

Arizona reported the third highest foreclosure rate of all states in 2008.  4.49 percent of all housing units in Arizona received at least one foreclosure filing during the year.  Indeed, 116,911 properties in Arizona received a foreclosure filing, which also put Arizona third for total foreclosure filings.  Amazingly, foreclosure activity in Arizona during 2008 increased 203 percent from 2007 and 665 percent from 2006.  That last percentage far surpasses the two top foreclosure activity states - California (412 percent increase since 2006) and Florida (412 percent increase since 2006).  

Not surprisingly, Pinal and Maricopa County were particularly hard hit.  The Phoenix metropolitan area reported 97,684 foreclosure filings in 2008, an increase of 220.77 percent from 2007.  That put the Phoenix metropolitan area fifth on the top 100 metropolitan areas, which is fairly consistent with its metropolitan population ranking.  The Tucson metropolitan area reported 9,043 foreclosure filings in 2008, an increase of 113.33 percent.  The Tucson metropolitan area ranked 37th on the top 100 metropolitan areas, which is again fairly close to the Tucson metropolitan population ranking. 

The burn-off of the Arizona housing bubble seems to be gaining momentum faster than the meteoric rise in real estate prices.  For example, take a look at the graph of median home prices in Phoenix between 1989 and 2009.  Look at the incredible bell curve between about 2005 and 2008.  The scary thing that some commentators are noting, is that while the bell curve has basically been erased and median prices are near 2004 levels, the current inventory of homes is far greater than 2004 levels, not to mention, it is much more difficult to qualify now.  Looks like we may not hit a bottom for a while yet.  The bubbly hangover may be more painful than the euphoria of the upswing, eh? 

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So a borrower defaults under a promissory note and the deed of trust.  Normally, the lender in that circumstance will exercise the power of sale clause in the deed of trust and begin the foreclosure process by noticing a trustee's sale.  However, the lender may also choose to call the note due and accelerate the entire amount and proceed with a judicial foreclosure.  Most lenders choose to go the trustee's sale route because it is faster and cheaper than a judicial foreclosure. 

What I recently discovered, is that many attorneys do not know about a borrower's statutory right of reinstatement and how that right applies in the context of both a trustee's sale and a judicial foreclosure.  Under Arizona Revised Statute Section 33-813(A), the trustor under a deed of trust (borrower) may reinstate (or cure the default under the promissory note) by paying the lender "the entire amount then due . . ., other than the portion of the principal as would not then be due had no default occurred . . ."  In other words, the borrower only needs to come up with the amount he or she is in default, not the entire amount due under the promissory note.  Nonetheless, many lenders' attorneys seem to believe that if the lender calls the promissory note due and exercises its right to accelerate the promissory note, the borrower must immediately pay the entire amount owed under the promissory note in order to cure the default, not just the defaulted amount. 

However, in Chapparral Development v. RMED Intern, 170 Ariz. 309, 823 P.2d 1317 (App. 1991), the Arizona Court of Appeals ruled that under A.R.S. Section 33-813(A), a trustor has an absolute right to reinstatement whether a lender chooses to foreclose by means of trustee's sale or a judicial foreclosure.  The difference being, if a lender chooses to pursue judicial foreclosure, a borrower's statutory right of reinstatement is cut off once the lender files the judicial foreclosure action and the borrower will have to pay the entire amount owed on the promissory note.  On the other hand, in the context of a trustee's sale, the borrower can reinstate up until 5:00 p.m. the day before the date of the trustee's sale.  But once the trustee's sale has been held, that right of reinstatement is extinguished.

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What do the traditional Japanese Ninja and the the American Ninja have in common? Both destablize and cause social chaos. While traditional Ninjas allegedly intended to destabilize and cause social chaos in enemy territory or against opposing rules, the American Ninja never intended to do anything but make money.

The American Ninja is actually an acronym, which stands for (N)o (I)ncome, (N)o (J)ob, no (A)ssets. Apparently, HCL Finance, who dubs itself "Home of the No Doc Loan," coined the term during the go-go days of the real estate bubble. Indeed, this "innovative product," like so many others, was a driving force in the boom.

So, combine Salomon Brothers' Lewis Ranieri's idea of buying mortgages, bundling them, and issuing bonds with the bundles as collateral and the Ninja loan, and we have the perfect recipe for disaster. The US housing market is far from bottom and the effects of ridiculous lending practices will continue to be felt for some time to come.

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RealtyTrac estimates that 1 in every 171 United States households were in the process of losing their home - up 121% on last year. To give some perspective on that number, RealtyTrac estimates that almost 740,000 United States homes entered the foreclosure process in the second quarter of 2008. That number includes receiving a default or bank repossession notice or warning of an impending auction. That is an incredible number for three months.

Not surprisingly, the worst hit areas were Nevada, California, Florida and Arizona, which had seen the biggest house price rises during the boom years, and the largest volume of sub-prime lending. Indeed, California had the most filings - 202,599 - which was up 198% from the same period a year ago.

CONGRESSIONAL RESPONSE

In response to the worsening foreclosure crisis and credit crunch, both the House and the Senante approved a housing bill - The American Housing Rescue and Foreclosure Prevention Act of 2008 - that will provide mortgage relief for 400,000 struggling homeowners. The housing plan is aimed in large part at calming the financial markets, which have been riding a roller coaster of late, due in no small part to concerns over the financial stability of Freddie Mac, Fannie Mae, and the banking industry as a whole.

THREATENED VETO

Despite an early veto threat, President Bush said he will sign the bill promptly. President Bush opposed the bill because he claimed that $3.9 billion in proposed neighborhood grants did nothing to help homeowners. President Bush had objected to the neighborhood grants, which would be for buying and fixing up foreclosed properties, saying that they were aimed at helping bankers and lenders, not homeowners who are in trouble.

OVERHAULING FHA

The bill headed for the President's signature aims to spare an estimated 400,000 debt-strapped homeowners from foreclosure by allowing them to get more affordable mortgages backed by the Federal Housing Authority ("FHA"). The FHA could insure $300 billion in such mortgages. However, banks would first have to agree to take a large loss on the existing loans in exchange for avoiding costly foreclosures.

The bill also seeks to overhaul FHA by requiring lenders to show how high a borrower's payment could get under the terms of his mortgage. The bill also provides $180 million in pre-foreclosure counseling for struggling homeowners.

EASING THE CREDIT CRUNCH

The bill also is designed to relieve a broader credit crunch that has taken hold because of rising defaults and falling home values. To free up safer and more affordable mortgage credit, the bill permanently would increase to $625,000 the size of home loans that Fannie Mae and Freddie Mac can buy and the FHA can insure. They also could buy and back mortgages 15 percent higher than the median home price in certain areas.

The Treasury Department will also gain unlimited power, until the end of 2009, to lend money to Fannie Mae and Freddie Mac or buy their stock should they need it. The Federal Reserve will also more actively oversee the two mortgage giants.

OTHER PROVISIONS

The bill also includes $15 billion in tax cuts, including a significant expansion of the low-income housing tax credit and a credit of up to $7,500 for first-time home buyers for houses purchased between April 9, 2008, and July 1, 2009. The bill also allows people who don't itemize their taxes to claim a $500-$1,000 deduction on their 2008 property taxes. That chiefly benefits homeowners who have paid off their homes and can't claim a deduction for mortgage interest.

Democratic leaders also tacked on an $800 billion increase, to $10.6 trillion, in the statutory limit on the national debt, which clearly irked many conservative Republicans. Those same Republicans were vehemently opposed to the bill, particularly the help for Fannie Mae and Freddie Mac. Many argue that the companies enjoy lavish profits in good times and wield their outsized political clout to resist regulation while depending on the government to bail them out should they falter.

The Congressional Budget Office ("CBO") announced that the bailout plan could cost the government $25 billion over two years. Hard to argue that US taxpayers are not once again on the hook for a significant bailout. The difficult part in all this is to identify what the alternative is. All this "propping up" lenders and "calming" the markets gives one the feel that this is all a delicate house of cards just waiting to fall. We shall see.

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A recent Reader's Digest article highlighted Clint Medford, referred to by some as "Mr. Foreclosure." While the foreclosure epidemic certainly has hit many homeowners and would-be investors hard, it has created a host of interesting opportunities for savvy investors and thieves alike.

Often a foreclosed home will sit empty for a time, which has invited a brand of looters who strip a home of its valuable materials. Indeed, as copper prices have sky-rocketed in recent years, desperate looters are stealing copper wires and pipes from foreclosed homes. Indeed, it has been reported that some owners of very expensive homes have stripped their own homes before foreclosure. This phenomenon is happening most prevalently in the Rust Belt states. Some estimate that the average home has over $1,000 in copper in it. Despite some recent legislative attempts to control the scrap metal market, thieves have successfully been able to find buyers for the stolen metal.

In those instances where a lender is sitting on a home that has sat for several months and no longer is inhabitable because of the destruction to the home, Medford steps in. He has created a network of banks that look to him to unload their rising stock of these uninhabitable homes. Medford has picked up houses for as little as a few thousand dollars. Rather than touch the hyper-inflated California markets, Medford focuses his purchases in the tough hit areas in the Rust Belt and places like Detroit, that has been especially hard hit.

Medford puts a little money into the house and turns around and sells it to investors looking for rental properties. Medford has a list of about 600 to 700 investors ready to purchase the homes he has picked up on the cheap from the banks. While selling to investors proved to be good business, Mr. Foreclosure has stepped into a completely new realm - mortgage lender.

For many in the foreclosure belt, many people may be able to afford some of the houses now for sale, but they can not get a mortgage. That is where Medford is stepping in. Rather than make the mistakes that many lenders were making during the rah-rah days of the hysterical real estate boom, Medford works with people by doing something unheard of - verifying their income. Hard to believe there was a time when people could get loans with NO income, just a credit score. The same buyers that obtained sub-prime loans and later faced foreclosure are the same people coming back to buy some of the homes that Medford has to offer. In other words, Medford is stepping in where the banks are all afraid to go right now.

Many question whether someone like Medford is a "foreclosure vulture" or someone willing to stop the forthcoming blight of neighborhoods hard hit by the foreclosure crisis. Sure Medford is charging 11 percent for a mortgage on a house he may have bought for a couple thousand dollars, but he is providing people an opportunity to get back into a house for less than they would be paying in rent in many places. That is a whole lot less shady than the other vultures who swoop in before a foreclosure only to grab someone's title and equity because they can think of no other options. It sure is interesting out there though.

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Simply speaking, a short sale is when a bank or mortgage lender agrees to allow a homeowner to sell their home for less than the outstanding balance on the home. Lenders often only consider this option if it makes if the cost of a foreclosure is greater than the loss it will suffer as a result of the short sale. Typically, lenders do not accept short sale offers or requests for short sales until a Notice of Default has been issued or recorded with the locality where the property is located. In other words, the lender wants to be assured that the homeowner truly is suffering financial hardship at the time the homeowner requests short sale relief.

As the foreclosure epidemic continues unabated, more and more people are considering the option of a short sale on their home to avoid foreclosure. While many real estate agents are touting this option as a way to avoid the impact on the homeowner's credit, there are other consequences that any potential homeowner must consider as well.

First, in some states like Texas, even if the lender agrees to the short sale, it may be still come after the homeowner for the difference between the amount owed and the amount of the sale, even it approved the short sale. This is known as seeking a deficiency judgment. Indeed, some lenders may not tell a homeowner this until well down the line when the homeowner is less likely to back out. The key issue to consider is whether the loan is a "recourse" or "non-recourse" debt. If the debt is recourse, the lender can come back after the borrower, even if the short sale has been approved. If the debt is non-recourse, the lender's only collateral is the property itself.

Fortunately for borrowers, Arizona has anti-deficiency statutes to protect against a lender going after a borrower for any deficiency.

The other major consideration in a short sale is the potential tax hit to the seller. As if they pressures of a potential foreclosure are not enough, the IRS may hit you for any forgiven debt. In other words, if the bank agrees to a short sale, any amount between what was owed on the mortgage and what the property sells for may be viewed as income by the IRS.

Mortgage Forgiveness Debt Relief Act of 2007

As the foreclosure crisis mounted, Congress and President Bush took action. The Mortgage Forgiveness Debt Relief Act of 2007 was enacted on December 20, 2007. Generally, the Act allows exclusion of income realized as a result of modification of the terms of the mortgage or foreclosure on a homeowner's principal residence.

Usually, debt that is forgiven or cancelled by a lender must be included as income on your tax return and is taxable. The Mortgage Forgiveness Debt Relief Act of 2007 allows an owner to exclude certain cancelled debt on his or her's principal residence from income.

The Act applies only to forgiven or canceled debt used to buy, build or substantially improve the owner's principal residence, or to refinance debt incurred for those purposes. Rules for debt forgiveness:

1. The debt must have been discharged by the lender in 2007, 2008, or 2009.
2. The amount of debt that can be excluded is limited to $2 million.
3. The exclusion can be used only if the loan was taken out to acquire, build or substantially improve a principal residence. Forgiveness of debt on vacation homes, second homes and investment property doesn't qualify. This is a huge exception given the number of speculative investment purchases that have helped fuel the foreclosure crisis.
4. Debt forgiven on a cash-out refinance or home equity loan must be apportioned between the amounts used for home acquisition, construction or improvement and amounts used for other purposes such as tuition, travel or repayment of other debts. Only the allowable portion qualifies for the tax break, says John W. Roth, a senior tax analyst at CCH, a provider of tax services, software and information in Riverwoods, Illinois.

So, if a lender accepts a short sale, and the borrower does not meet the exceptions above, again, the IRS normally views the discounted loan amount as income. For the real estate investor, the taxable income may be used to offset other income, but that is an issue best handled by a tax adviser.

In the end, while the short sale seems like a good option on first blush, any sale is discretionary the part of the lender and it will take a significant amount of time to consummate any transaction. Finally, a short sale can have tremendous tax implications to a seller. This is an issue I am not sure that real estate agents are in a good position to advise their clients of. Sellers need to understand there are several issues at play in a short sale, and jumping in without adequate advice can only add more trouble to an already difficult situation.

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Clearly, the foreclosure crisis is real and is affecting a broad spectrum of people. In other words, the epidemic is not just hitting homeowners with subprime mortgages with adjusting rates. Indeed, it seems those at the upper echelons are being hit as well. Indeed, Ed McMahon's six-bedroom, five-bathroom, 7,000-square-foot house is on the verge of foreclosure.

While predatory lending certainly is component in the foreclosure epidemic, the example of Ed McMahon exemplifies the current problem - living beyond your means. Ed McMahon stated "If you spend more money than you make, you know what happens. . . " Indeed, this seems to be what is happening to many people in general. When lending was loose, people were qualifying for homes they likely had no business purchasing in the first place. Once the go-go days of the real estate boom ended, equity dried up and many are now upside down in their houses. It seems that no one expected for prices to turn so quickly and drop so hard.

I am not sure there is a silver lining in all of this, but I think with a foundering economy, high gas prices, and the steep downturn in the housing market, people are beginning to reassess their lifestyles, and perhaps question whether the immediate gratification mindset is sustainable any longer.

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I will be focusing many of my future posts on the foreclosure crisis. Here is a good article talking about the record number of foreclosures in the United States.

NEW YORK (CNNMoney.com) -- More than one million homes are now in foreclosure, the highest rate ever recorded, according to a trade group which warned Thursday that number will continue to climb. The Mortgage Bankers Association's first quarter report showed that a record 2.5% of all loans being serviced by its members are now in foreclosure, which works out to about 1.1 million homes. That's up from the 2% of loans, or about 938,000 homes, that were in foreclosure at the end of 2007.

 

The report also showed that 448,000 homes, or about 1% of loans being serviced, began the foreclosure process during the first quarter. That's up from about 382,000 homes, or 0.83%, that entered foreclosure in the last three months of 2007. The seasonally-adjusted rate of homeowners behind on their mortgage payments also hit a record high. Nearly 3 million home loans, or 6.4%, have missed at least one payment, while about 737,000 are at least three months past due, but not yet in foreclosure.

Grim numbers

"The figures aren't surprising, but they're pretty ugly nonetheless," said Michael Larson, real estate analyst with Weiss Research. "We're talking higher delinquencies and foreclosures pretty much across the board." And he doubts that there's much reason to expect the foreclosure crisis to abate until next year at the earliest, adding that it could be a couple of years or more before foreclosure rates retreat to more normal historical averages. "It's the same story we've been seeing for a while now - we had too much reckless lending, and buyers who got over-extended," he said. "We've had an unprecedented decline in home prices on a nationwide basis, which is public enemy number one for mortgage loans. And now you've got an overall economy that has slowed adding to this toxic stew."

Good credit, bad credit

Much of the problem lies with subprime loans given to borrowers with weaker credit records, especially those loans that had adjustable rates. Nearly four out of ten subprime ARM loans are a month or more late, or in foreclosure. And subprime ARMs account for 39% of the loans that fell into foreclosure during the quarter. Prime fixed-rate loans, which are considered very low risk, have also seen sharp increases in their delinquency and foreclosure rates, although they are performing far better than the riskier loans on the market. There are 431,000 prime loans in foreclosure, a seasonally adjusted rate of 1.2% that is more than double the 0.5% rate a year ago. The report showed about 1.2 million prime mortgages are now a month or more past due, a seasonably adjusted rate of 3.7% of those loans. That's up from a rate of 2.6% a year ago. According to Jay Brinkman, MBA's vice president for research and economics, the prime loan segment was hurt by so-called Alt-A loans, which didn't require income verification for buyers with good credit. Prime loans are also getting into trouble in places such as Florida and California, which have seen sharp home price declines. "You still have people with prime fixed rate loans who lose their jobs, who get a divorce or have an illness come up, and can no longer afford a house," Brinkman said. "In areas where there's been home price appreciation, you can get out of that with the sale of a home or some other negotiation."

This marks the sixth straight quarter in which a record percentage of loans went into foreclosure.

The trend has led to a widespread decline in home prices, as well as huge losses for banks and other financial firms that issued or invested in the loans.

Nearly half of the homes in foreclosure are concentrated in six states. But those states are undergoing two very different types of housing meltdowns.

California, Florida, Arizona and Nevada have been hit by a hangover after a home building boom in the middle of the decade, which was fueled by rising home prices and investors snatching up real estate using risky mortgages. Those four states have nearly 400,000 homes in foreclosure, or a third of the nationwide total. Roughly 3.6% of all of the loans in these states are now in foreclosure.

"Clearly things in California and Florida are going to get worse before they get better," said Brinkman.

The other two states that are ground zero for the crisis - Michigan and Ohio - have been hit by the more traditional economic woes stemming from rising job losses, particularly in the automotive sector.

Ohio has about 61,000 homes in foreclosure, while Michigan has about 54,000. The foreclosure rate in those two states is 3.9%.

There is a glimmer of good news. The rate of homes going into foreclosure in Ohio and Michigan was narrowly lower than it was in the fourth quarter, and 18 other states also saw a decline in that rate.

Brinkman said he hoped that means the crisis is at or near a bottom in much of the country, and that foreclosure prevention efforts have started to have an effect. But he added that a slight improvement in one quarter doesn't necessarily mean the end is near.

Indeed, the rate of homes going into foreclosure continued to climb sharply higher in California and Florida, as has the rate of loans in those states that are 90 days or more past due but not yet in foreclosure. Brinkman said that in markets like these, where home prices have fallen so far from the market's peak, finding solutions to keep a home out of foreclosure are more difficult.

He also added that, given the large impact California and Florida are having on the national foreclosure numbers, and the fact that historically foreclosures peak about three years into the loan's life, he expects the number of foreclosures will continue to rise.

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