Wednesday, March 28, 2012

Pitfalls of Bank's Pilot Mortgage Forgiveness Program

       Recently a large national bank has announced that it is launching a pilot program that will allow some homeowners facing foreclosure stay in their homes. The program would allow homeowners, who are behind in their mortgage, deed the property back to the bank and then have their mortgage debt forgiven. At this point the former homeowner would then lease the property from the bank at a lower rent than the monthly mortgage payment. The tenant would also not be responsible for the property taxes or insurance.

       This program benefits the bank for a few reasons. The bank saves the expenses it costs them to do a foreclosure (The average foreclosure takes nearly two years to complete, according to Florida-based Lender Processing Services, and costs nearly $78,000, according to a Congressional estimate.). However, the bank will face some additional costs/ responsibilities. The bank will bear the costs of property taxes, insurance, maintenance, land scaping, repairs, security, waste disposal, and other property management requirements. Furthermore, the bank would need to employ an attorney to oversee any evictions that would occur.

       For the property owner this may seem like a good way to remain in his home, however there would be some negative consequences. For instance, forgiveness on a debt is considered by the IRS as taxable income, so the homeowner could be left with a very large tax bill after a $150,000 mortgage is forgiven. Moreover, the former homeowner could be removed from the property a lot faster than if he owned the home. If the property were being foreclosed, the procedure could a couple of months and the homeowner has the protection of the Bankruptcy Code, where filing bankruptcy would cease the foreclosure and allow the debtor to make up any missed payments. However, with the former homeowner now renting his house, he can be evicted from the house in about two to three weeks if he were to miss a rent payment. Also, the Bankruptcy Code is very favorable to landlords. Remaining in the house during a bankruptcy does not alleviate the tenant's responsibilities from paying rent, while a homeowner can remain in the home a lot longer without making a mortgage payment; the post-petition rent that comes due during the bankruptcy will also not be discharged, and the tenant can later be sued for it, unlike a homeowner.

       Though it seems like this program could help the bank and homeowner, it may also be just substituting one problem with another.

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