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Tom Kelly: Mortgage forbearance is not forgiveness, but it could be an option

Given the occurrences of the past several weeks, most lenders will bend over backward to help borrowers who are behind. Many have long-standing, alternative loan payment programs available while others have installed new packages – especially for genuine financial victims of the COVID-19 virus.

Alternative programs for mortgage payments are typically lumped into one category called “forbearance.” Forbearance is not free, nor does it mean forgiveness. It usually is a short-term agreement between borrower and lender permitting partial payments until normal payments can be resumed. Typically, forbearance agreements run three to six months.

Credit reports will show delinquent payments when full payments are not received. So, if you make partial forbearance payments for a short period, it’s best to petition credit bureaus to remove any “black marks” after full payment has been made. Explain the circumstances to the credit bureau in a letter to protect your future credit.

Forbearance does delay foreclosure, the process by which a homeowner who has not made timely payments of principal and interest on a mortgage loses title to the home. The foreclosure clock starts ticking once the borrower is in default. A borrower technically is in default one day after a payment is due. However, most lenders do not mail the borrower a Notice of Default until two to three payments are missed.

Most mortgage bankers do not eagerly await a default on the family home. Bankers are in the business of loaning money and they do not wish to have your home back. It takes considerable time and money (about $150 a day) to manage and maintain foreclosures. Lenders would prefer to spend their energies on processing applications and recruiting customers.

If you have little or no equity in your home and wish to stay there, the lender probably will be more agreeable to adjusting your mortgage contract if you can show that you will be able to repay the debt with a lower-paying job.

However, remember that while a lender will help solve temporary financial problems, a permanent financial setback could result in having to sell the home – especially if you have significant equity. The lender is out to avoid, or cut, his losses and your equity will provide that assurance. If you must sell, you will avoid delinquencies, keep your credit rating and retain the equity in your home.

Why not just sell your home and take a big tax deduction for the loss? A loss on a primary residence is not deductible.

According to real estate attorney Janet Portman, the only way you can obtain a deduction if you sell your home at a loss is to convert it to a rental property before you sell it. You should have the property’s value appraised as of the date of its conversion to rental property.

Because of this rule, if your personal residence has lost value since you bought it, turning it into a rental home won’t allow you to deduct the loss that occurred before the conversion when you eventually sell it. Only the drop in value after the conversion is deductible.

For example, let’s say Martha purchased a home in Tacoma for $250,000. She lived in the home for seven years, made $50,000 in improvements and then moved to Bremerton. Because of a slumping real estate market driven by a nearby controversial development, Martha decided to rent out her house instead of selling it.

The home’s tax basis when she moved out was $300,000. However, because of the decline in real estate values, its fair market value when Martha moved out was only $175,000 – a loss of $125,000. Since it’s lower than the home’s basis, Martha must use the $175,000 fair market value (less any depreciation deductions she takes) to determine her gain or loss when she sells the home. If she sells the house for $175,000, she has no deductible loss. She’ll have a loss only if she sells it for less than $175,000.

If you are facing mortgage problems, conduct a genuine assessment of your future possibilities. Perhaps you can dip into savings to get you over the hump. Then, talk to your lender and explore all options. If you don’t ask, you’ll never know what’s possible.

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