Home foreclosure - sound business move?

[Martha]

California and Arizona and a few other states have anti-deficiency statutes for purchase money home mortgages. But most states allow a deficiency when there is a judicial foreclosure. Some states only allow a deficiency if the value is proved up in court.

VA mortgages require the option of a deficiency under federal law. There has been some push by lenders in California to repeal the anti-deficiency statute but as of yet, they have had no luck.

Back in the early 80s when a number of home loans were underwater in the midwest, lenders who previously sought no deficiency started to get and try to collect deficiency judgments. What ended up occurring was a lot of bankruptcies.

Back when I was a bankruptcy trustee, I also saw a number of people who ended up with deficiency judgments resulting after home foreclosures out east. They ended up filing bankruptcy too.

I don't know what the current market will bring and what lenders will decide to do. At least in California borrowers have no worries. (Though there are some exceptions, like fraud and "waste" of the property.) It is interesting that the anti-deficiency statute does not seem to effect the sale of the mortgages on the market.

 

[toofrugalformycat]

I mentioned in another thread that in the 1980's in Anchorage people were turning in their keys and walking away in droves. I always wondered why they didn't have to pay the deficiency. Now I think you've splained it.
At the time I wondered why the town didn't go up in flames, then learned that homeowner's insurance only pays you to rebuild the same house, it won't give you cash.
DH and I stuck it out because luckily our little house was ok, but many people were in new developments that after a couple of years became unliveable schlock moldering in wetlands, or nice condos that emptied out and then turned into rentals full of druggies. At that time in my generation we were young and believed "you couldn't lose" when you bought a house to live in, because we'd never known otherwise.

 

[cashflo2u2]

ok, so if in CA the home mortgages are non-recourse debt then the homeowner is completely within their rights to walk. The awareness of this possibility would be known up front by the lender and the borrower, so I don't even see a moral obligation to pay, let alone a legal one. The certainly have an obligation not to trash the place in the meantime.

 

[Gumby]

ok, so if in CA the home mortgages are non-recourse debt then the homeowner is completely within their rights to walk. The awareness of this possibility would be known up front by the lender and the borrower, so I don't even see a moral obligation to pay, let alone a legal one. The certainly have an obligation not to trash the place in the meantime.

In a perfect market, mortgage loans in a non-deficiency state would be priced to reflect this difference, but I have no idea if that was actually the case.

 

[youbet]

At least in California borrowers have no worries. .

Is the presence of a foreclosure on one's credit history such a minor thing that it's "no worry?" Things sure have changed since I was a lad!

 

[Walt34]

That may be so, but what about the banker's shareholders, and his employees, and his suppliers, and his landlord, and his other depositors, and his community?

That's my question too. When I sign a contract, I will honor my end of it. Doesn't matter who it's with, my sister or Citibank. Speaking of Citibank, a lot of people who invested THEIR hard-earned dollars are going to lose because of people thinking their obligations can be changed by changing circumstances.

I don't buy it.

And I have better sense than to take an ARM, remembering the inflation of the '70's and '80's.

 

[Sandy]

I find this fascinating. This tactic of walking away would never occur to me. I have always repaid debt, even when in a pinch. If pushed to the wall, I still don't think I would have come up with this plan on my own. My sense of obligation would not have let me create this option.

However, having read it somewhere else, the idea is now planted. Now, I wonder. How slammed would I need to be? Still doesn't change the sense of obligation I carry, but I am enough of a realist to recognize that when faced with bad and worse options people often make decisions they would not otherwise consider.

 

[donheff]

So what is up here? The rapacious lenders who gave us NINJA loans and brought us this whole mess are now ready to finance somebody who bailed on their last loan? Something is wrong with this picture.

 

[ChrisC]

That's my question too. When I sign a contract, I will honor my end of it. Doesn't matter who it's with, my sister or Citibank. Speaking of Citibank, a lot of people who invested THEIR hard-earned dollars are going to lose because of people thinking their obligations can be changed by changing circumstances.

I don't buy it.

And I have better sense than to take an ARM, remembering the inflation of the '70's and '80's.

Promises should always be kept, but I don't begrudge anyone who doesn't keep his promises, if keeping them would result in major financial difficulty. Sure, there is a moral aspect to keeping your promises -- it's not something I would cavalierly not do. I can't really see the major moral problem that you all see in someone getting off the hook when it's in their economic interest to do so. Keeping your promises is not a categorical imperative for me.

BTW, it's not the ARM that's the problem, it's the credit worthiness and lax underwriting that took place for subprime borrowers who took out ARMs. I have two ARMs and I'm doing fine with them.

 

[ChrisC]

In a perfect market, mortgage loans in a non-deficiency state would be priced to reflect this difference, but I have no idea if that was actually the case.

I'm not sure any loan secured by collateral (whether a purchase money mortgage loan or consumer debt like car loans) prices the potential for going beyond the collateral if the borrower defaults. As pointed out, bankrutpcy can discharge the "deficiency portion" of a loan secured by a residential mortgage. So, the market might be pricing all of these loans correctly -- i.e. the value of the collateral is the value of the loan minus collection costs -- as the contingency for collecting a deficiency judgement, even in states that allow it, can be wiped out.

 

[Milton]

That's my question too. When I sign a contract, I will honor my end of it. Doesn't matter who it's with, my sister or Citibank.

Obviously I don't know the specific contract terms, but from the sounds of it (??) these non-recourse mortgages expressly limit the mortgagors' obligations to the mortgagees. If so, it doesn't appear that there is any question of people not living up to their obligations.

The real problem is [-]non-existent[/-] sloppy credit underwriting. Non-recourse mortgages! 'Liar loans'! Interest-only payments! Zero-down, 100% financing!

Why anyone would invest in an American bank is beyond me.

 

[ERD50]

That may be so, but what about the banker's shareholders, and his employees, and his suppliers, and his landlord, and his other depositors, and his community? ....

IMHO, a marketplace where contractual obligations are optional is a marketplace that's circling the drain.

That's my question too. When I sign a contract, I will honor my end of it.

I think what you are missing here (and someone please correct me if I'm wrong), is that no 'contractual obligations' were broken.

The contract (in a non-deficiency state) basically says:

A) Make your payments and you can live in the house, and we will credit your principal per the rules, and at the end of the term the house is yours.

B) Don't make your payments, and you can no longer live in the house. We will sell the house to recover what we can.

Turn it around - in theory, the bank should be factoring this risk into the loan terms. So in good times, I end up paying this higher rate, and the bank gets to keep the money. They bank is not 'breaking promises' when they keep the money, but did not need it.

I certainly understand that on an emotional level, it seems unethical for these people to walk - but if the contract is written that way, I just don't see it as a 'real' ethical issue. Now, if they trash the house on the way out - then I have a problem. I think Martha alluded to this, that the occupants are contractually obligated to maintain the property (just like I am obligated to have insurance), and I would hope that the law provides recourse for the lender in that case.

-ERD50

 

[cashflo2u2]

As far as "living up to the contractual promise no matter what" is flawed logic imo. A non-recourse loan specifically limits the lenders recovery in the event of a default to the underlying collateral. That's the deal going in. As someone recently said on the Kudlow show- "I don't know why banks keep inventing new ways to lose money when the old ways worked fine!" Can you imagine no down payment, teaser rate interest, no proof of income required (alt A), no personal liability if things go south and you can buy a house? Gad, the problem must be of gigantic proportions in CA.

 

[Hamlet]

Depends on which American bank you buy. My favorite part of TCF's recent earnings call (they're a medium-sized bank based in Minneapolis):

"We would point once again the things that TCF didn't do, and doesn't do according to our philosophy. There are no teaser rates, sub-prime programs. We have done no option arms. We do not have any collateralized CDOs or SIVs, Structured Investments Vehicles or any other off balance sheet-type activities, which have resulted in a large charges that we've been seeing in other institutions."

These guys are doing fine. Their foreclosure rate actually went down in the most recent quarter.

Obviously I don't know the specific contract terms, but from the sounds of it (??) these non-recourse mortgages expressly limit the mortgagors' obligations to the mortgagees. If so, it doesn't appear that there is any question of people not living up to their obligations.

The real problem is [-]non-existent[/-] sloppy credit underwriting. Non-recourse mortgages! 'Liar loans'! Interest-only payments! Zero-down, 100% financing!

Why anyone would invest in an American bank is beyond me.

 

[Milton]

Essentially, the banks gave people free money to gamble with:

• heads, you win (the value of your home goes up and you can flip it at a profit);
• tails, I lose (the value of your home goes down, you walk away and I'm left with the dubious security of a foreclosed house in a declining market).

I'm finally beginning to understand why so many Americans bought multiple houses, notwithstanding their very limited means and the adjustable rate terms of their mortgages: they had nothing to lose and potentially much to gain. The lending system promoted speculation on a vast scale.

 

[ChrisC]

Obviously I don't know the specific contract terms, but from the sounds of it (??) these non-recourse mortgages expressly limit the mortgagors' obligations to the mortgagees. If so, it doesn't appear that there is any question of people not living up to their obligations.

The real problem is [-]non-existent[/-] sloppy credit underwriting. Non-recourse mortgages! 'Liar loans'! Interest-only payments! Zero-down, 100% financing!

Why anyone would invest in an American bank is beyond me.

I think you might be oversimplyfying things here about the lending practices. I don't think the lenders are voluntarily agreeing to residential home loan mortgages whose payments are entirely secured by the collateral -- it's that there are some states that limit the lender's ability to pursue the borrower after the property securing the loan has been foreclosed. Some of these states say you do not have any recourse against the borrower, regardless of what your loan papers say, whenever you seize the collateral. There might be some Federal agency loan programs like VA or FHA that specifically have so-called non-recourse features, but I'm not aware of private lenders, banks, thrifts, credit unions or mortgage bankers, that have non-recourse mortgage loans. I could be wrong, but I don't think I am.

Irrespective of whether a lender can go beyond the collateral to obtain payment of a debt, the question remains is that right for a borrower to do that simply because he does not want to remain on the hook for the loan. The fact that some states might handcuff lenders or the VA or HUD might not pursue you beyond foreclosure of the property is irrelevant to me -- the borrower's obligation on the underlining debt still remains -- it's just that the lender has no ability to coerce the borrower to keep his promise! I don't see this as a moral problem for the borrower but others seem to be troubled by it.

 

[Milton]

I think you might be oversimplyfying things here about the lending practices. I don't think the lenders are voluntarily agreeing to residential home loan mortgages whose payments are entirely secured by the collateral -- it's that there are some states that limit the lender's ability to pursue the borrower after the property securing the loan has been foreclosed. Some of these states say you do not have any recourse against the borrower, regardless of what your loan papers say, whenever you seize the collateral. There might be some Federal agency loan programs like VA or FHA that specifically have so-called non-recourse features, but I'm not aware of private lenders, banks, thrifts, credit unions or mortgage bankers, that have non-recourse mortgage loans. I could be wrong, but I don't think I am.

Sounds like neither one of us really knows much about the topic under discussion. Perhaps we are talking about mere semantics. Whether a bank includes dubious provisions in its own mortgage terms, or writes mortgages in states that impose dubious restrictions via legislation, makes little real difference, does it? In either case, the bank is setting itself up for failure.

Irrespective of whether a lender can go beyond the collateral to obtain payment of a debt, the question remains is that right for a borrower to do that simply because he does not want to remain on the hook for the loan. The fact that some states might handcuff lenders or the VA or HUD might not pursue you byond foreclosure of the property is irrelevant to me -- the borrower's obligation on the underlining debt still remains -- it's just that the lender has no ability to coerce the borrower to keep his promise!

It depends upon exactly what promises were made. If the deal was "make the payments or lose the house", the mortgagee who bails out hasn't broken any promises; they've simply exercised an option.

I certainly don't like the idea of people skipping out on their debts. But in this case it sounds like people are playing by the rules, which they are entitled to do. Corporations and governments do it all the time ... why shouldn't little people have the same right?

The problem is a combination of lax lending standards, and legislation that promotes real estate speculation. Given such conditions, I prefer to keep well clear of American banks.

 

[aenlighten]

Moral retribution

Let the borrowers be punished through their credit ratings and lenders be punished with their losses. It is the only way they are likely to learn. Nothing immoral about that.

 

[ChrisC]

Sounds like neither one of us really knows much about the topic under discussion. Perhaps we are talking about mere semantics. Whether a bank includes dubious provisions in its own mortgage terms, or writes mortgages in states that impose dubious restrictions via legislation, makes little real difference, does it? In either case, the bank is setting itself up for failure.

Banks don't put dubious provisions in their mortgage terms that undermine the credit quality of an asset like a mortgage loan. They don't say we'll only take the property from you and not hold you accountable for the underlying debt if the collateral isn't sufficient to pay the loan. That was my first point. And in writing mortages in states that have "dubious restrictions" like strict foreclosure, election of remedy provisions or anti-deficiency judgment statutes, lenders are only taking what the playing field gives them and they make adjustments like requiring higher loan to value ratios or over-collateralizing debt, etc. So, banks aren't setting themselves for failure. Mortgage lending has traditionally been a safe and stable credit for financial institutions; it's the subprime lending that has gotten the balance out of whack.

It depends upon exactly what promises were made. If the deal was "make the payments or lose the house", the mortgagee who bails out hasn't broken any promises; they've simply exercised an option.

I certainly don't like the idea of people skipping out on their debts. But in this case it sounds like people are playing by the rules, which they are entitled to do. Corporations and governments do it all the time ... why shouldn't little people have the same right?

The problem is a combination of lax lending standards, and legislation that promotes real estate speculation. Given such conditions, I prefer to keep well clear of American banks.

Now this is really legal semantics on my part. What you are talking about are promises that are made, broken, and cannot be enforced by the other party to whom the promise was made. I promise to pay you back the $100 you lent me plus interest over 5 years on a monthly basis and here's my house as collateral for that loan. This is the typical mortgage loan. If I don't pay back that loan to you, I have broken my promise to pay you the money I borrowed. If you take my house as collateral, and the house is worth more than the loan balance, then you owe me the amount that exceeds my debt to you and my promise has been fulfilled, right? If you take my house and the house is worth less than the loan, how has my promise to pay you been discharged or fulfilled -- I haven't honored my promise to pay you that $100 loan, right? And if the law, state law or federal bankruptcy law, wipes out that debt, my promise to you has simply been rendered unenforceable. You ever wonder why "bankruptcy" had such a moral taint to it when the bankruptcy system was first put in place -- I think it was viewed as a slightly immoral way of not fulfilling your obligations.

Yes, people are playing by the rules, but in some instances I can understand why other people, not me by the way, would think this has a moral aspect to it. Personally, I don't like stiffing other people or welching on a debt, whether it be owed to a human being or corporation. I've always told my children to always try to keep their promises.

 

[clifp]

Let the borrowers be punished through their credit ratings and lenders be punished with their losses. It is the only way they are likely to learn. Nothing immoral about that.

In some ways I agree, although I have doubts if credit rating punishments are enough.

As a (recent) owner of Bank Of America, Wells Fargo and Countrywide, there is is good chance that California mortgage he is walking away from belongs to me. So part of the $100-150K he is gaining by walking away comes from me. In a very real sense he is stealing my money. Given that most people on the board own index funds and/or large cap mutual funds in some fashion he is also stealing all of your funds. Even for people without stocks, he is contributing to a big financial crisis which will have to be solved via some combination of government bailouts, higher inflation, or higher real interest rate, or a recession.
I think we can all agree that if you loan a friend a money, he refuses to pay you back while continuing to maintain an extragravent lifestyle he is acting immoral

What I think is even more important is I'd be willing to bet he is also acting illegally. There is an excellent chance that he lied on his second (and possibly his first) loan application. Most mortgage application require you to sign under penalty of perjury that all of the information is accurate.
I'd like to see a few high profile criminal prosecutions of borrowers, for perjury, loan fraud, or perhaps a creative federal prosecutor can nail them for bank robbery

Just like tossing folks from Enron, Tyco etc in jail had a positive deterence factor on greedy corp exec. I think a few jail sentences handed out to the worse of the mortgage loan liars would be good for society.

 

[Gumby]

Banks don't put dubious provisions in their mortgage terms that undermine the credit quality of an asset like a mortgage loan. They don't say we'll only take the property from you and not hold you accountable for the underlying debt if the collateral isn't sufficient to pay the loan. That was my first point. And in writing mortages in states that have "dubious restrictions" like strict foreclosure, election of remedy provisions or anti-deficiency judgment statutes, lenders are only taking what the playing field gives them and they make adjustments like requiring higher loan to value ratios or over-collateralizing debt, etc. So, banks aren't setting themselves for failure. Mortgage lending has traditionally been a safe and stable credit for financial institutions; it's the subprime lending that has gotten the balance out of whack.



Now this is really legal semantics on my part. What you are talking about are promises that are made, broken, and cannot be enforced by the other party to whom the promise was made. I promise to pay you back the $100 you lent me plus interest over 5 years on a monthly basis and here's my house as collateral for that loan. This is the typical mortgage loan. If I don't pay back that loan to you, I have broken my promise to pay you the money I borrowed. If you take my house as collateral, and the house is worth more than the loan balance, then you owe me the amount that exceeds my debt to you and my promise has been fulfilled, right? If you take my house and the house is worth less than the loan, how has my promise to pay you been discharged or fulfilled -- I haven't honored my promise to pay you that $100 loan, right? And if the law, state law or federal bankruptcy law, wipes out that debt, my promise to you has simply been rendered unenforceable. You ever wonder why "bankruptcy" had such a moral taint to it when the bankruptcy system was first put in place -- I think it was viewed as a slightly immoral way of not fulfilling your obligations.

Yes, people are playing by the rules, but in some instances I can understand why other people, not me by the way, would think this has a moral aspect to it. Personally, I don't like stiffing other people or welching on a debt, whether it be owed to a human being or corporation. I've always told my children to always try to keep their promises.

This discussion reminds me of the "efficient breach" scenario from law school. For normal people -- efficient breach is a school of thought holding that if a company can increase its revenues by breaching a non-profitable contract after paying any contractually mandated damages to the non-breaching party then the company is obligated to its shareholders to breach the contract.

 

[kumquat]

Interesting discussion. I'm in Canada and most (I think) mortgages are of the recourse kind. That being said, why shouldn't someone abide by the terms of the loan? I think honobob had this in mind with his advice (which I disagree with) in this thread: http://www.early-retirement.org/forums/f28/down-payment-retirement-home-32800.html#post606050

I'm assuming (correct me if I'm wrong bob) that the risk of catastrophic loss will be shared because the lender has no recourse.

What do people think about this,a similar but inverse situation. In the early 80's my mother had a 30 year 4% mortgage. Interest rates hit about 21% here in the frozen north. Mortgage company sent here a nice letter telling her she could pay down the principle with no penalty. I suggested she offer to pay the entire amount at 50 cents on the dollar. She did, they accepted. Was that immoral?

 

[twaddle]

This discussion reminds me of the "efficient breach" scenario from law school.

It reminds me of the Costco return policy. It can be part of the normal cost of doing business until people abuse it en masse.

Of course, the lenders never thought California would see a 3.5% default rate (and growing).

 

[cashflo2u2]

California uses Trust Deeds (deed of trust), which are not exactly the same as a mortgage. This confuses many inexperienced mortgage brokers and Realtors. Relative to residential real estate 1-4 units...purchase money mortgages are non recourse. the lenders were forced to accept this element of the deal when they got the right to foreclose non judicially by way of trustees sale. the non judicial method is far faster so they must give up the right to a deficiency judgement when they elect to do so.

 

[Independent]

It wouldn't occur to me to walk away from a mortgage in this situation. But, now that someone got me thinking about it, I have trouble seeing anything "immoral" here.

Suppose the borrower were Corporation A. It borrowed money from Corporation B to buy an asset. The loan agreement explicitly stated that the only security for the loan was the named asset. The asset goes down in value, and A gives the asset to B. I wouldn't consider that immoral. I don't think that A's shareholders have "stolen" from B's shareholders.

If it's not immoral for A's shareholders to walk away, why is it immoral for an individual to walk away?

Certainly, in the mortgage case, any lender doing business in CA knows the laws. They may have assumed that the borrowers didn't know the law, but that's the risk they took. They made a business decision to sign a contract with an embedded option, the borrower made a business decision to exercise that option. End of story.


I'm treating this as "pure business". I could get to a different decision if the bank has a reputation for going above and beyond the letter of its contracts to help its customers or employees. I believe that some credit unions operate that way today. But I'd normally assume that any bank CEO would fire any employee and take any customer to court if it improved the long term bottom line. I'd expect his/her stockholders to support those decisions, maybe with bonuses. So I figure it's "all business" unless I see evidence otherwise.