A tipping point? “Foreclose me ... I’ll save money”

Posted by Kendall Harmon

A homeowner who can't sell his house tells the L.A.Times, "Foreclose me. ... I'll live in the house for free for 12 months, and I'll save my money and I'll move on."

Banks and lenders fear this kind of thinking -- that walking away from a house could be the smart economic move -- appears to be on the rise. Wachovia, in a conference call yesterday, warned investors that increasing numbers of homeowners are walking away from their homes by choice: "... people that have otherwise had the capacity to pay, but have basically just decided not to because they feel like they've lost equity, value in their properties..."

Read it all and follow the links.

Filed under: * Economics, PoliticsEconomyHousing/Real Estate Market

20 Comments
Posted January 28, 2008 at 12:23 pm [Printer Friendly] [Print w/ comments]



1. Steven in Falls Church wrote:

Actually, the first thing to do is to call the bank and tell them you are about to walk away.  You may be surprised how flexible banks will be in working out alternative financing arrangements or payment schedule.  Banks are in the business of lending, not managing properties, and they would rather keep customers at a lower revenue stream than eat the cost of maintaining properties that will take 12-18 months to sell at a loss.

January 28, 1:34 pm | [comment link]
2. KAR wrote:

Banks used to be unwilling to refinance these sub-prime loans in the past, because the value of the house is less than the loan (see <u>60 Minutes</u> last night), however, they beginning to be burnt enough and now holders of taxable land draining into their coffers ever so slowly as well as depreciation form vandalism and lack of repairs that I’ll bet they’re becoming very willing to work with homeowners and refinance loans to a level people can afford, even if a third (or more) over current market value.

January 28, 2:10 pm | [comment link]
3. Jim the Puritan wrote:

This only makes sense for states like California that generally provide you can’t get a “deficiency judgment” against a residential borrower.  This means they can only take the house, but cannot get a personal judgment against you for the difference between the auction price and the amount of the loan.

That’s not true in many states.  There, if your property is “upside down” (value can’t cover indebtedness), you are looking at losing the rest of your assets and/or personal bankruptcy on top of losing your home.

January 28, 2:21 pm | [comment link]
4. Matthew A (formerly mousestalker) wrote:

If Wachovia’s lending profile in California is similar to that in Georgia, they aren’t holding a lot of firsts. The Wachovia mortgages (security deeds for us Georgians) have mostly been home equity loans/lines of credit.

That suggests that there might be some particularly nasty credit abuse going on. Since a fair number of home equity loans are in excess of equity, an unscrupulous person could buy a house, takle out a conventional first, take out a credit line, max the line of credit out and walk away with cash in pocket. Both loans get foreclosed on and Wachovia’s line of credit gets cut out by the first.

January 28, 3:18 pm | [comment link]
5. w.w. wrote:

“... people that have otherwise had the capacity to pay, but have basically just decided not to because they feel like they’ve lost equity, value in their properties…”

At least, it demonstrates again Scripture’s premise: ‘total depravity’ still applies.

w.w.

January 28, 3:28 pm | [comment link]
6. John Wilkins wrote:

W.W. - its a business decision.  A rational one supported by our economic system.  Corporations are smart enough to use it.  Why not individuals.

Although plenty of people think that corporations are depraved.

January 28, 3:39 pm | [comment link]
7. CharlesB wrote:

Somebody educate me.  If a house is foreclosed and it auctions off for less than the mortgage, who is liable for the shortfall?  Is the house the sole guarantor for the debt, or is the motgage holder still liable for anything?  Thanks.  Oh, and BTW: Even though I do not agree with this approach, if you look at the big picture, banks, realtors and builders have been enjoying a bonanza for years and the home buyer (consumer) has been paying for it with rapidly escalating home prices, taxes based on inflated assessments, etc.  So they bear some if not most of the blame, especially for sub-prime loans.

January 28, 3:48 pm | [comment link]
8. R. Scott Purdy wrote:

Charles B
Your question does not have one simple answer which holds across the country.  Real Estate law is generally State law and the particulars vary from state to state.  Your specific example of the foreclosure auction proceeds being less than the debt owed has different answers depending on which State the property is in, AND within many States, the answer further depends on which foreclosure process was followed.

January 28, 4:12 pm | [comment link]
9. KevinBabb wrote:

Charles B.: That varies from state to state (like most legal matters). The bifurcation is between “deficiency states” and “non-deficiency states”. In deficiency states, when a borrower defaults on a loan that is secured by property (such as a home mortgage or auto loan), the lender may sue the borrower if sale of the property fails to satisfy the outstanding balance on the loan, and recover the difference from any other recoverable assets that the borrower has.  (Certain assets, such as tax-qualified retirement plan balances, are exempt from seizure by any entity other than….the government).  So, in this situation, the borrower bears the risk of diminishing value of the security, be it a home or a car. My state, Illinos, is a deficiency state. This law obviously favors creditors.

In non-deficiency states, a lender’s only remedy against default is repossession of the thing that secures the loan.  A borrower can send the house or car keys to the lender (and take any other steps necessary to vest title solely in the lender), and walk away from the loan with no fear of further lawsuits to collect any difference (deficiency) between the loan balance and the net amount that the lender makes from selling the collateral.  This system puts the risk of decreasing property values on the lender. It favors the borrower in the short term, although it may cause lenders to take other measures to secure the loan.

January 28, 4:13 pm | [comment link]
10. Jim the Puritan wrote:

#7, please see my #3.  In some states, a residential borrower is only liable to the value of the property, and the lender suffers the difference if property values have declined.  In other states, the borrower is still liable for any shortfall.  I don’t know whether that results in higher mortgage rates or costs in states with “anti-deficiency” provisions. 

Often it is in the larger states that have more “market” clout that you see these statutory provisions—the lenders are not going to get out of the market so they adjust their practices accordingly.  See here for info:  http://real-estate-law.freeadvice.com/mortgage_matters/anti_deficiency_laws.htm

January 28, 4:16 pm | [comment link]
11. TWilson wrote:

Charles B - The liability on a mortgage where the sale price on the foreclosed property is less than the amount owed can be covered in two ways: mortgage insurance (so-called PMI) which protects the lender; or a court may issue a deficiency judgment against the party holding the mortgage, though most states prohibit this in cases of residential first-trust mortgage (called non-recourse debt; second trusts, home equity loans, and refinances are usually not included in this).

The economics on walking away are often problematic. I’ve read cases of people walking away from large amounts of equity because they can’t afford a monthly payment.  Also, most banks will play ball, work out payment plans etc - there is an entire market for “short-sales” where a third party negotiates with the mortgagor and the bank. Strategic foreclosure comes with a cost, though - an individual’s creditworthiness will be damaged (a notice of foreclosure usually sits on one’s report for seven years) which will make future loans (or credit cards) harder to reach.

January 28, 4:26 pm | [comment link]
12. LTN wrote:

Jim the Puritan…the “anti deficiency law” that you cite pertaining to California is only half of it. In CA, the lender can either forclose on your house (and be subject to the “anti deficiency law”) OR bring an action against you in a court of law. If a lawsuit is filed and the borrower loses, the judgment (which will include attorney’s fees) will arguably be able to reach other personal assets subject to a court judgment (assuming there are any). The judgment will last for 10 years, screw up the borrower’s credit even more and will be renewable.

A borrower shouldn’t be so cavalier (even in California) as to place the lender in a position where the loss is so great that they would decide to bring a lawsuit to recover rather than using the quicker foreclosure route.

January 28, 4:34 pm | [comment link]
13. Jim the Puritan wrote:

#12—I understand the distinction, but in some states the judicial system is so inefficient that lenders generally opt out of the judicial foreclosure route and go by private sale/auction.  (Here it would take one to two years to get through the court system from filing a complaint to final judgment/deficiency judgment—imagine how much extra money is lost, plus the cost of attorney’s fees).

January 28, 4:39 pm | [comment link]
14. jkc1945 wrote:

Does anyone see a moral problem here with just walking away from an obligation that a borrower undertook because they thought (however foolish they were) that they would make a killing, and instead, their risk cost them?  I thnk I do.  This is not just a “Business decision.”  Jesus talks quite a bit about this kind of stuff, and walking away from a debt owed to another is not one of the alternatives He ever offers, I think.

January 28, 4:42 pm | [comment link]
15. TWilson wrote:

#14: I think you are right. In some situations, it might be rational; and one might argue the lesser of evils in extreme cases. But Matthew 5:37 is pretty clear: “Let your yes be yes….”. A sophisticated person might argue that when signing a contract, you and the counterparty not only agree to the obligation but also to the possible adverse outcomes and their consequences.. not sure that flies.

January 28, 4:57 pm | [comment link]
16. KAR wrote:

#14—The moral issue is on all sides.

The borrowers took out money without a reasonable plan to pay it back often with incorrect information on the application. The lenders where looking to the long term high interest, thus did not verify the information on the application and required no documentation (at the same time extracting teeth from me for a simple 30 year fix-rate refinancing) thus greed and two set of weigh and measures.

In the mean time both sets overheated the market so average people who would qualify for a normal loan at normal market rates were either forced out or to borrow more than they should and possibly in one of these shady products. Thus the greed of borrower and lender began to have secondary effects. If you take the overtime construction paid in 2003 and the extra-cost billed to utility companies to place the infrastructure, only to have people scratching for work today, the externalities of the greed continues. The corrective dip below true equilibrium hurts those who are selling for a job relocation and estate or other normal course of life sales. The hit on the world stock market effect pension plans everywhere.

Basically, the greed of the borrowers to take “free money” that they could not afford and no plan to replay except continued inflation of prices combined with the greed of the lender to hook the eventual high interest rate with the false-guarentee of inflation of value, has lead to a mess for everybody.

January 28, 5:07 pm | [comment link]
17. John Wilkins wrote:

#14 - so, if someone seeks to exploit you, then… you have to fulfill an obligation to them?  there is a term called “wage slavery.”  what an employer would do is hire a worker and make them pay for all the tools, at an extortionary rate.  It would take years to pay the employer back, and there was never any hope for the worker.  If you want to play the game of credit, its an altogether different game than what Jesus would have played.  I suspect Jesus would have built his own house rather than offer or take any loan to begin with.

January 28, 5:54 pm | [comment link]
18. Philip Snyder wrote:

John,
Jesus would probably been angry with both the lender and the borrower here.  There are significant moral failings all around this issue for both the borrowers and the lenders. 

YBIC,
Phil Snyder

January 28, 8:24 pm | [comment link]
19. Bill Matz wrote:

LTN is correct that a CA deficiency judgment is possible with a judicial foreclosure. But, as a practical matter, in 26 years I have not heard of a single case of a judicial foreclosure. The main obstacle is not inefficiency of the judicial system, it is the one-year right of redemption. Furthermore, protection of the anti-deficiency provisions can depend upon the type of loan (purchase vs. refi) and occupancy (owner vs. tenant). For a rental property, there is an important limitation. The owner cannot collect rent and fail to pay the mortgage while waiting for foreclosure; that is a crime.

January 28, 8:37 pm | [comment link]
20. Cathy_Lou wrote:

Re: moral aspect - When we settled on our house and signed loan papers, I kept thinking of Proverbs 22:7 The borrower is servant to the lender, hating the thought, but recognizing we had voluntarily put ourselves in that position.

My grandfather was a wholesale butcher in Chicago during the depression.  He couldn’t pay the bills to his meat suppliers because no one was paying him.  But he faithfully paid on the debts little by little until they were paid off, even though others walked away.  Later, during WW II, when there was rationing and meat was in short supply, those same suppliers always made sure my grandfather got meat because they remembered how he had been true to his word.

I know there have been predatory practices and there is lots of blame to go around, but in our state (MD) there sure were a lot of mandated consumer protection disclosures that we had to read and sign attesting that we understood what we were agreeing to.  That being said, we also used a Christian realtor and mortgage company that we trusted, knowing that the rate might be a little higher, but that we were less likely to get cheated in the process. 

There but for the grace of God, it could be any of us in that situation.

-Cathy_Lou

January 29, 9:19 am | [comment link]
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