Loans in the foreclosures process are down nearly 28 percent from a year ago, according to Black Knight, but the pipeline, while no longer growing, is still large. More than 3 million borrowers are behind on their mortgage payments, and 1.24 million are in the foreclosure process. Many of those delinquent borrowers could avoid foreclosure through a short sale or principal reduction loan modification.
At her real estate office in Chicago, Marki Lemons offers seminars to educate troubled borrowers on their options, options that she says are suddenly shrinking.
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"All it's going to do is prolong recovery, and so we know these people can't afford these houses, they have to prove financial hardship, so if they don't have the money to keep a roof over their head, how are they going to be able to pay the IRS?" she asked.
Tony Janega, who attended her seminar, has been working on a short sale for three years. It was finally approved last week, about five weeks too late to qualify for the tax exemption. His home sold for $125,000 less than the amount he owed on the mortgage. Depending on his tax rate, he could owe Uncle Sam about $30,000. That is money he does not have.
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"I'm nervous, I'll be honest with you. There have been some long nights these last three years, just having to figure out what's going to happen, and now if this debt relief act isn't extended, I'm really nervous now. I've stayed up late at night—I can't sleep at night, it's been a lot of stress," said Janega.
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Even banks and investors could get hurt if borrowers can no longer afford short sales. Short sales have helped to clear much of the distress from the housing market, especially in states where the foreclosure process requires a judge. Those states have huge backlogs of delinquent loans.
"With fewer short sales, you're going to see longer liquidation timelines, so you're going to see more full foreclosures and REOs [bank repossessions]," said Sean Nelson of Fitch Ratings. "With longer timelines, you have more costs associated with liquidation of the properties. More costs translates to lower recoveries for investors.