I recently heard from a reader who wrote that when she was “living in Florida (and was young and stupid)” she bought a condo. Since then, the local real estate market crashed and the condo has lost nearly 70 percent of the value.
Her life has changed since the purchase: she married a military officer, and had to relocate. Her condo was rented, but the rent doesn’t cover expenses and the condo building is about to outlaw tenants.
She, and thousands (perhaps millions) of readers are wondering what they can do with investment property that has lost most of its value and doesn’t bring in enough rent to cover expenses. Add a condo building that doesn’t want renters and you’re left with two options: a short sale or a strategic default.
A short sale only works if there are buyers lurking and if the bank is ready to approve a huge loss on the mortgage. If you have any assets at all, the bank may not even agree to the short sale unless you pledge some or all of those assets. Be prepared to be cleaned out financially.
In this case, there could also be a taxable event. If you live in a home and it’s your primary residence and it is sold short, the IRS won’t recognize the difference between what you owed on the loan and what you paid off as income (through 2013).
But if the property is no longer your primary residence, and is rented out, the IRS may look at the amount the bank forgives as a gift, on which taxes must be paid. That difference is considered income to the homeowner because the lender accepted less than the full amount owed.
Then there’s the option of a strategic default, where you purposefully allow the property to go back to the lender. Since you control the timing, a strategic default can make some financial sense.
But in some states, if the money from the sale of the property is not sufficient to pay off the debt owed to the bank, or if there was a second loan or home equity line of credit on the property, the lender can come after you for the deficiency, that is the difference between what the bank gets when it ultimately gets rid of the property and what the borrower owed the bank. In other states, lenders don’t have the right to come after you for the deficiency if the home was your principal residence. In states where lenders can get a deficiency judgment, they might choose not to get the deficiency judgment or they might get the judgment and then sell that judgment to a collection agency, which will go after the borrowers for whatever they can get.
As there have been millions of foreclosures in the last couple of years in states that allow deficiency judgments, there may be a huge number of upcoming cases where banks go after their former borrowers for these deficiencies. Collection agencies are already knocking on former (and unsuspecting) homeowners’ doors.
If you are able to sell your home in a short sale – that is where the sales price for the home does not net enough to pay all of the expenses of the sale and the amount owed the lender – you can try to negotiate with the lender to waive any right to go after you for the deficiency. However, I have heard from a number of attorneys that lenders have been reluctant to agree to waive their rights to go after the borrowers for any amount that may be owed the banks.
If you can do a short sale, it’s probably a better (though certainly longer and more frustrating) move than letting the property go into foreclosure. Frequently lenders get less money in a foreclosure sale than you would get in a short sale, so you’d think it would make more sense for the lender to agree to a short sale. But if, for whatever reason, the lender won’t agree to the short sale, your options may be limited.
It’s also interesting to note that some condo associations have decided not to allow their owners to rent units even if there aren’t any buyers willing to pony up for a unit in the building.
While it is better to have owner-occupied units than rental units, I think it’s far worse to have vacant units with owners who won’t or can’t pay their share of the condominium expenses. That just puts a bigger burden on all of the other owners of the property.
In many cases, condo associations are better off allowing more unit owners to rent properties if that will stabilize cash flow and allow the property to be properly maintained.
When you live in a condo building or townhome development, walking away from the unit will not be a popular choice with your neighbors or others who believe you have a duty and an obligation to continue to make your payments not matter what. That said, there are also condo unit boards who have had trouble with tenants including bad renters, high turnover and additional costs associated with that high rate of turnover.
But for some homeowners, who simply can’t afford to carry their vacant properties, it may be their only choice. If you decide to go in this direction, consult with a real estate attorney first, to make sure you understand your legal options and what consequences you may face.
And, when it comes to homeowner associations, they will have to make a determination about which way they want to go during these uncertain times.