A word from The Tim: This post is from long-time Seattle Bubble participant Jillayne Schlicke, real estate educator through her company CE Forward. Jillayne keeps a close watch on legislative issues, and agreed to write up this in-depth analysis of SB 6337 for the readers here. Thanks, Jillayne!
Senate Bill 6337 was recently introduced in the WA State Legislature regarding short sales.
After a short selling homeowner gets the shortfall deficiency waived, the homeowner receives a 1099 in the mail because debt forgiveness is a taxable event. Some people may have to pay taxes on the deficiency, others may not depending on their circumstances. More about that from the IRS here.
When a bank/lender issues a 1099 for debt forgiveness that means the bank also gets to write off the deficiency as a bad debt which may decrease the amount of taxes the bank/lender owes the IRS. Seems fair.
SB 6337 is asking the WA State Legislature to no longer allow a bank to pursue a homeowner for the deficiency on a short sale once the bank issues a 1099. Okay, still seems fair…
Here’s an excerpt from the Realtor Summary Sheet on the issue:
Provide certainty and consumer protections for short sale sellers is critical in the current real estate market. Successful short sales often prevent foreclosures that would harm consumers, tax revenue and economic recovery.
Okay, hold on a minute. Foreclosures are a natural and necessary part of the market cycle. Not everyone is going to be able to hang on to home ownership. It’s beyond debate that the high home ownership rates we saw at the top of the bubble were not sustainable. Foreclosed homes will be sold to investors and other home buyers who can afford home ownership using rational underwriting guidelines instead of the insanity of the bubble days. BTW, here’s what default rates look like for loans originated in 10-11 compared w/the bubble.
There are many foreclosure prevention programs available today, including the new changes to the Home Affordable Modification Program. Many homeowners in foreclosure have been in the system 18 months to 2 years without making a payment. Yes, their credit score will plunge, but they’re also living rent free for 2 years. Seems to me that this might be a sort-of stealth economic shot in the arm, unless they’re using the money to shoot things into their arm.
Regarding tax revenue, there’s no excise tax paid on a trustee deed v. a short sale which is conveyed using a warranty deed, however, after foreclosure there IS excise tax paid when the foreclosed REO home is sold.
Regarding economic recovery, this particular law is not going to help our economy in WA State recover any faster. The banks are foreclosing slowly so as not to crash the market with REOs. If we really want an economic recovery to happen faster, let the foreclosures commence. We will hit bottom VERY fast and then everyone will be super busy again. But that ain’t gonna happen and I fail to see how this bill could be tied to an economic recovery in our state.
This legislation will protect short sale sellers from mortgage debt collection actions when the short sale seller was issued a 1099-C Form and thus must pay income tax on the discharged debt.
Wait a minute. If a homeowner HAS assets, what’s the lender’s motivation to approve a short sale without the ability to collect the shortfall either at the close of escrow in the form of a new unsecured note, or in the future? Put yourself in the lender’s shoes just for a minute: If you sold a home and took back the paper/held the note, and now the new home buyer wants to sell short, would you just simply “forgive” the difference out of the goodness of your heart? NO. Not if you have a cold black heart like mine. I’d want the person to prove financial hardship first. I’d run the numbers and if it makes sense to take the write off, well then maybe my heart could be convinced to melt just a little, for, say 5 minutes which is enough time to sign the paperwork. If however, your home buyer had assets, why would you want to waive the short fall? If all banks/lenders just give a blanket hall pass on all short sale deficiency then the masses would suddenly sell short. Oh now I get it. Maybe this would motivate more people to….list their home, which means more real estate commissions. Okay, I’m getting it now. Realtors, I love you, but I’m not convinced this is in the best interest of homeowners. There’s more:
Lenders still have the ability to decide whether to reserve the right to collect mortgage debt owed after a short sale, or whether to issue a 1099-C and claim a deduction for tax purposes.
Oh goodie. I’m sure the bankers will thank us for that small token of appreciation.
Go to the 1 hour 9 minute mark (1:09) of this video to hear the six minutes of dialogue from the bill sponsor and the banker and lender who showed up.
One of the possible consequences if this bill is passed is that if banks/lenders are discouraged from pursuing homeowners (with assets) for the short sale deficiency, then it is entirely possible that
banks/lenders will then decide to just foreclose, which is the opposite outcome that the bill’s sponsors desire.
I’d like to hear/see/touch/feel/taste real examples of homeowners who were pursued for the deficiency and see if these are people who are financially destitute or if these are people with assets.
It looks like WA SB 6337 is a copy/paste of a bill that passed in Oregon last summer. Do we have access to stats from Oregon that could show us what happened to short sales/foreclosures after the law went into effect?
If we are serious about “protecting short sale sellers,” let’s require all homeowners obtain prepaid legal counsel before the short sale is listed. Attorneys would make sure the final paperwork has no deficiency clause and seller’s legal questions can be answered by someone who is a member of the WA State Bar Assoc.
As it is written, SB 6337 has the potential for increasing foreclosures in WA State, and that might be a good thing, depending on your vantage point. Either way, go forth into the conversations surrounding this bill educated on the possible consequences.