UPSIDE-DOWN ON AN INVESTMENT PROPERTY?
If you own property that is not your primary residence (rentals, vacation homes, or other commercial property) that is “upside-down” insofar as you owe more on it than it is worth, you should consider a variety of strategic alternatives.
What should you do?
The answer depends on several important considerations, including:
Property Location and State Law
Whether you have a 2nd Mortgage or Equity Line of Credit
Whether the Bank Might Go After Your Other Assets
Credit Rating Considerations and Importance
Specific Lender Policies
Investors and speculators are in a very different position that those who cannot afford to pay for their primary residence. As a general rule, speculators seek to minimize their credit exposure and to perform a cost-benefit analysis with respect to the investment.
PROPERTY LOCATION & STATE LAW
The laws that apply to property, including foreclosure laws, are state specific. If you own a piece of property in Florida, then Florida law will apply to your investment. If it’s in California, then California law applies – it does not matter where you and your lender are located.
ARE YOUR OTHER ASSETS AT RISK? Recourse Loans & Anti Deficiency Statutes
Whether your separate assets are at risk will require a complex analysis. If your loan is a recourse loan (meaning the bank reserves the right to bring an action to recover your personal assets) the bank may be able to get a court judgment against you for any shortfall in a foreclosure sale. If you refinanced your home, you probably have a recourse loan.
Another component to consider is whether you have a second mortgage or home equity line of credit. A 2nd mortgage or line of credit holder will generally have the right to bring an action against you if the foreclosure sale does not generate proceeds to cover the principle owed.
Procedures and implications of foreclosure vary from state to state, and can get rather complicated. One of the more important concepts in the analysis is a group of laws that originated out of the Great Depression called Anti-Deficiency Statutes.
Anti-deficiency statutes protect your assets that are not related to the specific real property. Many states have them. For specifics about California law, see our Personal Liability for Mortgages / Deficiency Judgments page.
The statutes are called “anti-deficiency” because they prevent the bank from obtaining a deficiency judgment against you for the difference between the foreclosure sale price and the principal owed on the property.
Some states do not have anti-deficiency statutes and lenders have the ability to pursue borrowers for the full amount of the loan, plus expenses (you should consult a lawyer in the state where the property is located for detailed advice).
CREDIT RATING CONSIDERATIONS
Another important thing to think about is the effect your foreclosure solution will have on your credit score. In general, a short-sale, deed in lieu of foreclosure, loan modification or other compromise worked-out with your bank will be much easier on your credit score than other alternatives such as bankruptcy or actual foreclosure.
The credit rating system used by the reporting agencies is very vague, and it is difficult to predict the exact hit your credit rating will suffer. It is important to realize that the credit effects of a foreclosure are cumulative, i.e. 30 days past due, 60 days past due, and a foreclosure will all appear individually on your credit report for the same loan.
LENDER & LOAN SERVICER POLICIES
More often than not, the actual lender does not interact with you on the loan, but rather employs a loan servicing agent to do the work. The servicer generally acts in the place of the lender for the purposes of loan work-outs. Loans are typically bundled together and purchased by banks or Wall Street investors.The distinction between servicing agents, banks, investors and lenders often gets convoluted, and for the purposes of this discussion they we be discussed collectively as “lenders.”
Lenders’ policies with respect to delinquent mortgage payment vary considerably.
Don’t be afraid to propose a creative solution, as the lenders often have wide discretion to make arrangements that will benefit their clients. Investors generally are not as concerned with losing the property, but rather with the credit and other financial implications of the investment. The recent economic crisis caused lenders to rethink their policies and implement innovative programs and departments to help resolve these problems.
OTHER OPTIONS: MODIFICATIONS, DEED IN LIEU, SHORT SALE
The various options available to homeowners (discussed on our Avoiding Foreclosure page) are generally available for investment properties, but the bank’s often approach their analysis differently for commercial properties. Your options will depend upon your specific financial situation and your lender’s internal policies.