December 10, 2008
Assuming They Can And Will Pay, Ignoring The Collateral If They Don't
"Fannie Mae and Freddie Mac, the mortgage-finance companies seized by the U.S. government, are considering waiving a requirement for new appraisals on refinanced loans, their regulator said."
First Published: December 10, 2008 11:45 AM
Comments from "Plugged In" Readers
That's so-o-o-o, "Pre-Nationalization."
What we need is to do away entirely with the complications of financing or refinancing, and just give home-leasing occupants the house free & clear, courtesy of Uncle Sam.
(Err... or his to-date friendly public creditors in Asia.)
We need to do it, for the children. And because it's in all our interests. Because people are hurting. There's real pain.
Posted by: Debtpocalypse at December 10, 2008 12:36 PM
Appraisals are meaningless anyway. They either value the property at the sales price, regardless of the comps, or they are too conservative because the lenders are putting pressure on the appraisers not to over value the property. If you're refinancing a problem loan to avoid foreclosure, then it doesn't matter what the property is worth.
Posted by: Money Man at December 10, 2008 12:44 PM
Ignorance is bliss. FRE and FNM don't want to know what's in their books and above all how much the co-laterals are worth.
And whatever loss they will suffer will be someone else's anyway!
Posted by: San FronziScheme at December 10, 2008 12:47 PM
Appraisals are meaningless anyway.... If you're refinancing a problem loan to avoid foreclosure, then it doesn't matter what the property is worth.
This message of financial illiteracy was brought o you a self-styled "Money Man."
Posted by: Debtpocalypse at December 10, 2008 12:52 PM
Um, if you are trying to refinance people who are underwater to prevent them from walking away, why on earth would you have them get an actual appraisal and tell them what their home is REALLY worth. Because you want to tell them they are stupid? Because you want them to walk away in greater numbers?
I'm sure they are doing this because as the appraisals come back, people attempting to refinance are walking away in GREATER numbers than those who don't try to refinance. Either that or they just threaten the lender to reduce the principal or they'll walk.
In any event, I think avoiding appraisals is exactly what those guys SHOULD be doing. Moneyman is right: they aren't doing this for any other reason than to keep the homeowner on the hook. It serves no useful purpose for the lender for the parties to find out what it's worth.
Posted by: tipster at December 10, 2008 1:05 PM
There is a step missing which will be fixed in due course.
Other federally insured loans are not disbursable in bankruptcy. Some day, federally financed non-collateralized loans will have to be made the same.
The interest rate will be incredibly low, but if you fail to pay the federales will put a lein on your paycheck. Hello debt slavery!
Posted by: Jay at December 10, 2008 1:12 PM
Step One: refinance loans that can never be paid back, using even worse lending guidelines and government money!
Step Two: ???
Step Three: Profit!
Posted by: ex SF-er at December 10, 2008 1:22 PM
"This message of financial illiteracy was brought o you a self-styled "Money Man.""
What's so illiterate about it? Just because it doesn't comport with the tiresome and repetitive group-think that seems to have taken over here recently doesn't make it wrong.
Should FNM and FRE refuse to modify loans that are under water if it means they may get paid a bit more? Should they require pointing out to the borrower that they're totally underwater and could just walk away if they want to?
Posted by: #23 at December 10, 2008 1:26 PM
What's so illiterate about it?
it wasn't me who said it, but saying this is financially illiterate:
If you're refinancing a problem loan to avoid foreclosure, then it doesn't matter what the property is worth.
I agree with the sentiment of Money Man with a twist:
if the goal is to hide the problem as long as possible and hope and pray that it will just fix itself, then what is being done is just fine and it doesn't matter what the property is worth.
however, property values DO matter when it comes to foreclosure. maybe not immediately, but with time. the reason: if the owner owes way more than it is 'worth' then they need to stay for a longer and longer time before they can sell the property. the longer they have to stay, the higher the likelihood that a life problem (divorce, job loss, etc) will come up, which will cause them to re-default.
as example: this is one reason why people believed the tripe that Californians were rich... because they never defaulted! but they never defaulted because home prices just kept going up so people in trouble could just sell! now the opposite is true. people can't afford the payments, and they can't afford to sell!
so the property value DOES matter when it comes to foreclosures.
currently government, Fannie/Freddie, the Investment and Commercial banks, etc don't want to know the values.
we will see a lot more of this shenanigans as well. we'll see changes in accounting rules as I've said before, so that the banks/companies can hide their losses.
Posted by: ex SF-er at December 10, 2008 1:37 PM
It serves no useful purpose for the lender for the parties to find out what it's worth.
Yes it does. Risk is calculated based on default rates and exposure, and rates are calculated based on this risk assessment.
I forgot. They nationalized lending! Which means only TAXPAYERS are exposed to this risk. And keeping us informed on what we are probably going to lose would serve no useful purpose or would it?
I'll say they could stack the deck all the way and decide in congress what the $/sf of homes should be by zip code on any given year. And they'd decide on a mandatory increase in RE prices of 6%/year. That will keep all professions happy.
Posted by: San FronziScheme at December 10, 2008 1:46 PM
Any private lender worth its salt rationally considers - or appraises - the current market value of an asset being pledged as collateral for a loan, since its resale is the only recourse in the event of default.
Now, here's the thing...
PUBLIC CAPITAL SHOULD BE HELD TO AT LEAST - IF NOT AN EVEN HIGHER - STANDARD.
Not a lower standard.
Not a cavalier indifference.
The debt that is floated to make available to the deadbeat on easy terms will have to be paid down the road by someone. All this endless bailout garbage is being casually stuck on a national credit card issued taken out in my 2 year old's name without his consent.
It's his liability: he wants an appraisal, damn it.
And if it doesn't appraise conveniently, my toddler wants the current owner tossed out onto the street, and the asset sold at a loss to the prior lender, to expedite resolution to the horrible financial mess this generation has wrought, so that he isn't still paying for their stupid self-serving decision making 20 years down the road as an income earner.
Posted by: Debtpocalypse at December 10, 2008 2:19 PM
"I forgot. They nationalized lending! Which means only TAXPAYERS ..."
There's the stuff!
Anyway, after thinking about this a bit more, I think it does matter what the houses are worth. In each of these loan mods, you have a (real or de-facto) non-recourse loan secured by an asset that's presumably worth less than the outstanding loan balance. You also have a borrower that wants to continue paying this loan anyway if the loan can be restructured to make repaying it more affordable.
The more underwater a property is, the more the lender can afford to modify the loan while still leaving itself in a better position than it would have been in had it foreclosed. But how do you know how much (if any) modification you can afford to do if you don't know what the property is worth? Hmm.
Posted by: #23 at December 10, 2008 2:21 PM
What is the point of all the hyperbole? The number of homeowners potentially helped by proposed government programs continues to be a small fraction of those who are in trouble, and foreclosures are continuing and piling up inventory. Pretending otherwise doesn't help anyone.
Appraisals could be more robust, but they are already enough to have a huge effect on markets. I know of many deals that were pending and fell through because appraisals turned out to be well below the agreed upon price. Appraisals have served as one of the only brakes on this out of control mess, so trivializing them does not make sense. Really accurate numbers aren't needed just to throw a wrench in the works.
Talk of nationalizing lending is just stupid. There are multiple trillions of bogus credit dollars being unwound. The government does not even begin to have any way to raise even a significant fraction of that.
The whole point to this exercise is that values and numbers matter, so it makes no sense and helps no one to view the bailout silliness with the same distortions that realtors were projecting onto properties until recently. All the distortions are bad, and all will be wrung out by the markets in time.
Posted by: Mole Man at December 10, 2008 3:17 PM
Wow, this what our tax dollars is buying:
Less transparency from companies with a dismal track record of risk assessment. Yeah, we can trust them with our hard earned taxes.
Posted by: San FronziScheme at December 10, 2008 3:21 PM
Talk of nationalizing lending is just stupid.
why do you say this?
Fannie Mae, Freddie Mac, and FHA now make up over 80% of the mortgage market. and that amount is increasing.
those 3 organizaitons are now controlled by the govt.
I would personally say that govt controlling 80% of lending would be "nationalization"
The number of homeowners potentially helped by proposed government programs continues to be a small fraction of those who are in trouble,
I agree with this. but one of the reasons that few people are aided by the various bailouts is because the govt programs have attempted to put in some lending guidelines (as opposed to the criteria initially used to put these "homeowners" into mortgages).
but clearly that can change. one way to change this: make it so that appraisals aren't important! one can also start changing other requirements such as income verification and debt to income ratios.
Fannie, Freddie, and FHA for all intents and purposes IS the mortgage market right now. They are all controlled by their regulators (the govt). they are nationalized in everything except name (and that will likely come as well).
Posted by: ex SF-er at December 10, 2008 4:58 PM
The GSEs aren't allowed by their charters to hold mortgages for mre than 80% LTV. This "idea" let's them get around their own charters. Freddie announced it was doing away with appraisale for refinancings as long as the owner "certified" the value had not declined.
So now we have a new set of liar loans. Instead of stating your income, you get to state the value of the property. In return, the government will give you a negative amortization loan.
That, of course, is not how to get out of this mess, it's how we got IN to this mess. So that just tells me we have no idea how to get out of this mess, other than the Japanese model to boil the frogs slowly AND to have the rest of us jump into the pot with them.
Posted by: tipster at December 10, 2008 6:30 PM
Here's the deal - the appraisal has already been completely marginalized in the latest market cycle for both commercial and residential loans. Regulations put in place from the Depression of 1929 mandated that appraisals were necessary when loans are made with money backed by the federal government. The strength of these appraisal regulations ebbs and flows with the market cycles - generally the stronger real estate is performing the more it seems like the appraisal is a wasted expense in the loan process. When values are declining however, it is significantly more important and more attention is usually paid to the appraisal to ensure that the collateral is there in the first place because it could be even lower before the end of the market cycle. So we had a weakening of appraisal regulations under BushCo. for the last 8 years which was capped off by the current status quo of having the loan officer or mortgage broker pick the appraiser - basically ensuring that someone pliable and sympathetic to "make the number" would do the appraisal (if they weren't they wouldn't get anymore work and the mortgage broker/loan officer would find another more pliable appraiser). So now we have the lowest quality most ethically challenged appraisers doing the lion's share of the appraisal work whereas an appraiser doing his/her job and calling BS on an over-inflated purchase price or refi request is twisting in the wind with no work. And now FNMA and Freddie want to do away completely with the appraisal...just brilliant! Keep on going with that de-regulation of the lending process there - it's working swimmingly so far isn't it? This economic meltdown is looking more like the Japanese lost decade every day - deny and close your eyes and hope everything will turn out all right.
Posted by: Appraiser at December 10, 2008 8:44 PM
I'm curious if any of you have looked at the freddie fannie loans. At least for apartment buildings, their lending criteria is so strict that it is very difficult for anyone who needs it to qualify. And the prepayment penalty is 5 points!
As far as Money Man's comment, I have to agree and disagree. Appraisals are pretty bogus. However what they are trying to do is not help the home owners, rather help the banks get big loans on worthless properties. It would really be in the homeowners best interest to know (well at least the best you can from a bogus appraisal) what their property is worth so they can decide.
IMO the banks should keep people in their home by letting them decrease the loan based on current value. It's cheaper for the bank than a foreclosure.
Posted by: sometech at December 11, 2008 5:51 AM
"IMO the banks should keep people in their home by letting them decrease the loan based on current value. It's cheaper for the bank than a foreclosure."
Until everyone who is making payments on their mortgages decides to stop so they can get a principal writedown as well.
There are no easy soluttions to a credit deflation (except of course to let it collapse well and truly and then pick up the pieces).
Posted by: LMRiM at December 11, 2008 6:21 AM
"...the banks should keep people in their home by..." The banks and mortgage companies who initiated these loans no longer have any control over the vast majority of them. They were sliced, diced and recombined into instruments that were sold off as low risk securities to sovereign wealth funds, pension funds, hedge funds, other banks, etc. And although the money from monthly payments seems to find its way to the appropriate owners of these securities apparently there is no way to unwind them short of foreclosure or refinancing.
Some of these securities literally have no market value. They still throw off cash but no-one is willing to buy them. For securities that do have buyers, fifty cents on the dollar seems to be the current price, more or less. All combined that's the equivalent of a de facto premium reduction of more than 50%. And it's getting larger as the price of these securities continues to sink.
Conclusions from all this? One: appraisals are pretty useless in this climate. You're probably better off just taking the purchase price and discounting it by some percentage. Two: as their price decreases, the returns from mortgage backed securities, currently about twice the original, become commensurate to their risk. They will overshoot of course. (They may already have done so.) And some people will make a nice chunk of change by buying them when they do. Three: the price changes in the underlying real estate will be less volatile.
Posted by: Salarywoman at December 11, 2008 11:24 AM
Won't waiving appraisals hurt most of all the homeowners who lack the financial savvy to know it's better to walk away now instead of 5 years from now, when their house is worth even less?
Isn't it unethical for our government to literally trap these "owners" into depreciating assets?
Isn't this policy mostly targeting the financially uneducated--who else would sign up for these toxic loans--disproportionally made up of the poor and minorities?
Wasn't slavery outlawed in the 13th Amendment?
Posted by: DataDude at December 11, 2008 11:53 AM
Okay, you can call me finacially illiterate, but I'm saying that appraisals aren't worth the paper they're written on because they are unreliable. When the market's going up, the appraisers just value the property at the sales price, even if it's 10% over all the comps in the neighborhood. If the market is diving downwward like today's market, then it's a moving target anyway. If the lender wants to avoid a foreclosure and the borrower can't afford to pay down the loan to get it out of "underwater" status, then the appraisal serves no purpose, except to document the disaster. I realize that the lenders aren't going to stop requiring appraisals, if for nothing more than complying with guidelines, but they're still a waste of money.
Posted by: Money Man at December 11, 2008 1:06 PM
DataDude-your comments are ridiculous. The government is "trapping" owners by offering a way to avoid foreclosure? It's not the government's fault that they bought a home that has gone down in value, and offering to help with refinancing is also offering a way to keep from ruining their credit history and lose their home.
I don't think requiring an appraisal is the only way for a homeowner to know that his home is worth far less than they owe--unless they are completely illiterate themselves. And it's very wrong to say that most of the uderwater loans are caused by toxic loans to minorities.
The government's role in this mess is the lack of regulation of wall street, rating agencies, mortgage brokers and others who managed to make and sell loans as Triple A securites, when in fact they should have been rated as far more riskier assets. If they had been given the rating they deserve, then the rates would have gone up so much, that no borrower would want the loans in the first place.
Posted by: Money Man at December 11, 2008 1:15 PM
"The banks and mortgage companies who initiated these loans no longer have any control over the vast majority of them."
In the vast majority of cases, the loan servicer has control over the terms of the loan. Most PSA's contain a loss mitigation provision. So long as it is more valuable to offer modification rather than foreclosure, servicers should modify the terms of the loan.
The problem is that this creates more work for the servicer and they do not have much incentive to modify. If they allow foreclosure procedings to begin they just pass it off to the company that handles the trustee sale (in CA, other states may be different).
Posted by: Publius at December 11, 2008 2:21 PM
Money Man, maybe "trapping" is not the right word, but I think that Data Dude's point is valid. Are we really doing any homeowner a favor by modifying a mortgage so that instead of owing $500,000 on a home that is now worth $300,000 (and soon to be worth $200,000) they now only owe $400,000? The rational move for such an owner would be to just walk away. By getting them to agree to such a modification, we are, in a sense, conning them into agreeing to continue paying on a debt that they could shed. This primarily benefits the banks, not the homeowners.
Posted by: Trip at December 11, 2008 2:28 PM
Trip - While I don't necessarily disagree, situations are often more complicated than that. Of course, from a purely financial perspective you are correct. However, many homeowners would like to stay in their home. Foreclosure is often a distressing process for homeowners. Particularly where the homeowner is not well aware of their rights. Families would like to keep their kids at the same school. Finally, some are still worried about the social stigma associated with foreclosures (although this is probably an invalid concern in this climate).
Some homeowners are more than willing to pay a little more than they are legally obligated to keep themselves in their current home. They understand that doing so may not be the best decision based solely on financial considerations, but finances are not the only factor that many of these homeowners consider.
Posted by: Publius at December 11, 2008 2:44 PM
Sorry, but I don't sign documents that say I can walk away if the market goes against me. What kind of note rate would we get in the future, if everyone took this attitude?
The idea is to stay in your home and make your payments as promised and wait for the market to bring the value back up.
This is why lenders are stupid to make loans to people who have nothing to lose. They should have never allowed 2nd lien loans behind their firsts, in place of down payments and/or PMI insurance. Zero down loans should be a thing of the past too.
Posted by: Money Man at December 11, 2008 2:45 PM
I should know better to come to this site. I end up spending way too much time here once I do. Oh well.
@ Money Man -
"Sorry, but I don't sign documents that say I can walk away if the market goes against me."
That is precisely what you do if you live in California. I won't rehash it here, but there are very strong policy considerations for this law. Lenders are well aware of these laws and understand the risks when they lend to California home buyers. This is true in most other states as well. But if you don't like the policy you can always move to Texas where they do not have such protection.
The strongest policy rationale in my option for this rule is that the lenders are the professionals and this policy puts pressure to accuratly value an asset. Of course, with the securitization of mortgages this became less important as the risk was handed off to someone else.
Posted by: Publius at December 11, 2008 3:00 PM
"I don't sign documents that say I can walk away if the market goes against me."
My gosh, why would you refuse to sign such a document? Someone gives you a no-risk option and you refuse? If you bought a home in California, you signed exactly this type of document because it is the law. I completely agree that lenders were stupid to make these loans (or investors were stupid to buy them in the secondary markets), but that's done. And I agree that if the market were remotely likely to recover anytime soon, then it might make some sense to wait it out. But that is not likely at all.
Publius, I agree with everything you post above. But these are being targeted (generally) at those with an extreme lack of financial savvy -- that is why they are in this predicament. If they recognized their bargaining power, they would be able to negotiate a loan modification down to the current value of the home (and if the lender refused, they should walk), rather than the less favorable deals that are being offered.
Posted by: Trip at December 11, 2008 3:00 PM
@ Money Man
This is why lenders are stupid to make loans to people who have nothing to lose. They should have never allowed 2nd lien loans behind their firsts, in place of down payments and/or PMI insurance. Zero down loans should be a thing of the past too.
Agreed. Part of the problem is that many banks also had nothing to lose. The loan officer who was supposed to assess would-be borrowers had incentives to sign up as many mortgages as possible, regardless of the risk, because individual mortgages were bundled together and sold to third parties. It's OK to pollute as long as you can sweep your garbage under somebody else's rug.
If banks originating the mortgages had been forced to keep 100% of the loans on their books, they would have been much more careful about who they gave money to, as well as loan structure. And we wouldn't have experienced such a real estate bubble. Whenever decision making and responsibility are de-coupled, it's a recipe for disaster.
Posted by: DataDude at December 11, 2008 3:03 PM
"This is why lenders are stupid to make loans to people who have nothing to lose."
No. The lenders were smart because they knew the Fed would bail them out, and even if it didn't, they would make so much $$ before it all blew up, they'd walk away with hundreds of millions, even billions. (For instance, Angelo Mozilo and our very own Henry Paulson, the same Paulson who got the SEC to lift the leverage limits in 2004 so Government Sachs stock could net him $500 million, tax free).
The dumb ones were the buyers who put down their own hard earned cash on assets that were priced at the margin based on fraudulent lending by banks and investment banks.
As Publius wrote, there are many other considerations besides just financial (schools, stability of living arrangement, neighbors, etc.), but please people don't let notions of "morality" get in the way of doing what is best for you and your family.
The contracts were written with the option of your walking away, they were (mis)priced accordingly by "professionals" who know far more than you do about finance, and they had no reason to expect that you would sacrifice your financial security to rectify their mistake. It's just a business decision. That's the appropriate attitude IMO towards a house that the financial community made into just another "investment vehicle". It didn't pan out, cut your losses, and move on.
Posted by: LMRiM at December 11, 2008 3:05 PM
@ Money Man
DataDude-your comments are ridiculous. The government is "trapping" owners by offering a way to avoid foreclosure? It's not the government's fault that they bought a home that has gone down in value...
Oh, yes it is the government's fault! At least partially.
Here's an excerpt from an open letter written by Sci Fi author and Democrat Orson Scott Card:
It was a direct result of the political decision, back in the late 1990s, to loosen the rules of lending so that home loans would be more accessible to poor people. Fannie Mae and Freddie Mac were authorized to approve risky loans.
Full letter here:
This is what happens when the government--with their good intentions--tries to engineer things so that unaffordable housing can become affordable.
Guess what, people still can't afford their homes, and now they're stuck in a sinking asset.
Government meddling = unintended consequences
Like you, Money Man, I also blame the people who bit off more than they can chew. And the loan officers. Plenty of blame to go around. But don't you dare let the government off the hook!
Posted by: DataDude at December 11, 2008 3:14 PM
Trip - as you may have already guessed, I am dealing with a few of these right now. It started when I was at my old firm in PA where I took pro bono case that involved some very bad stuff done to just the type of person you reference.
Since that experience, I try to help out when I can. The problem is that the loan servicer does not have the same interests as the investor/holder of the note. Servicers will modify but do not look at the issue from a purely business perspective. It is pretty frustrating. Determing who the real investor is difficult enough as it is. But even where I have contacted them, they generally ask you to deal with the servicer.
Of course, a few well-crafted letters have motivated servicers that had refused to work with the borrower. Hopefully, legislation such as SB 1137 help influence the servicer to take action.
I think that many servicers want to see if borrowers are really willing to walk away. If this happens in large numbers we may see more willingness on their part.
Posted by: Publius at December 11, 2008 3:17 PM
Fannie and Freddie's loans to poor people did not trigger this problem. This is a misperception of the problem, in an effort to blame Fannie & Freddie for the whole subprime mortgage meltdown. It wasn't until Fannie & Freddie began buying the subprime mortgages made by wall street, that increased their exposure to riskier loans.
Nope, the bulk of the blame goes to wall street, not Fannie or Freddie. Saying that is buying into the repubican's campaign talking points that simplified the problem, so they could blame the democrats who were more supportive of the GSE's.
Posted by: Money Man at December 11, 2008 3:24 PM
The legality of borrowers walking away is state dependent, is that correct?
For instance, legal in CA but not in TX? I'm sure in either case it hurts one's credit.
One reason politicians keep saying the housing market will bottom out and start recovering in mid-2009 is because they don't want home owners to walk en masse. Most experts I've heard say that the earliest we'll bottom out is 2011, probably later. Housing prices are a delicate house of cards that will collapse with too much foot traffic, so politicians have an incentive to be overly optimistic.
Posted by: DataDude at December 11, 2008 3:34 PM
@ Money Man
Fan and Fred's involvement in this crisis is being slowly uncovered. From Today's Wall St. Journal:
But previously undisclosed internal documents that are now in Mr. Waxman's possession and that we've seen tell a different story. Memos and emails at the highest levels of Fannie and Freddie management in 2004 and 2005 paint a picture of two companies that saw their market share eroded by such products as option-ARMs and interest-only mortgages. The two companies were prepared to walk ever further out on the risk curve to maintain their market position.
Mr. Waxman's documents prove beyond doubt that Fan and Fred turbocharged the housing mania with a taxpayer-backed, Congressionally protected business model that has cost America dearly.
Full opinion piece here:
Posted by: DataDude at December 11, 2008 3:54 PM
"But these are being targeted (generally) at those with an extreme lack of financial savvy"
I completely agree with you regarding some of the modifications offers I have seen. The FDIC at least makes an attempt to create a situation where the borrower can afford the payment long term.
Other servicers however are just creating new problems with the modification. For instance, many times they only offer a reduced rate for several months. Some for several years. The neg am continues. Penalties, "attorney fees," and late payments are recapitalized so that the borrower ends up in an even worse situation.
The servicer can then claim that they are modifying customers. When they "re-default" they will claim that modification programs don't work so that they can try to lessen their work load. But I'm sure we'll see lots of press releases claiming that they have done all that they can to keep borrowers in their homes.
It is for this very reason why I think we will see some sort of regulation that requires something similar to the FDIC model.
Posted by: Publius at December 11, 2008 3:59 PM
The difference between Texas & California is that California is a single-action state. The lender can sue the borrower for the loan amount or take the property back, but not both. In Texas, the lender can foreclose and sue the borrower for the losses.
Posted by: Money Man at December 11, 2008 4:03 PM
You are correct Money Man. Additionally, in CA, even if the lender chooses judicial foreclosure (suit for the loan amount), they cannot obtain a deficiency judgment (the amount of the loan that is in excess of the current value of the home) for a purchase money transaction. Refinances may or may not be "purchase money" depending on the specific facts of the case. However, in almost every instance it is not in the interests of the lender to choose judicial foreclosure in CA because of the expense of court action.
Posted by: Publius at December 11, 2008 4:13 PM
or, in CA
when the house is underwater and the borrower walks away, yet is very solvent, lenders can forego using the security altogether -- either judicial or trustee sale -- and just sue on the note for full amount owed
However, it's never done b/c it's an expensive & time-consuming judicial process. Plus, they can never switch to the other route and attach/sell the security/house.
And, biggest deterrent is probably the "right of redemption" which gives the borrower a year (I think?) to pay up and get the house back -- even after they've walked away (or something like that?)
Posted by: Rubicon at December 11, 2008 7:39 PM
"or, in CA
when the house is underwater and the borrower walks away, yet is very solvent, lenders can forego using the security altogether -- either judicial or trustee sale -- and just sue on the note for full amount owed"
Sorry Rubicon, this statement is just not true. The creditor must choose either a trustee's sale or judicial foreclosure. Deficiencies (amounts owed in excess of the sale of the security) are never allowed under the trustee's sale (580d). Deficiencies are allowed in judicial foreclosures unless the transaction is considered a "purchase money transaction" (580b).
If not barred by 580b, creditors may obtain a deficiency judgment. However, if a deficiency is allowed the borrower may have the right of redemption (I think this is what you are getting at). The redemption period is either three months or one year depending on whether the proceeds of the sale are sufficient to cover the total debt plus fees.
But there are a number of requirements that make obtaining a deficiency very difficult for lenders if the borrower is aware of the process (e.g. right to challenge FMV and other hearings).
But lenders have no right to "forego using the security altogether" whether the borrower is solvent or not.
Posted by: Publius at December 11, 2008 10:51 PM
From the way many contributors here feel the 'deal' with the lender is made, it seems to me the lender should therefore share in any profits at sale if the property value increases. Mortgage rates being some of the lowest rates to borrow at don't figure in a large margin for 'walking away' from those that 'just choose' to walk (versus 'real' distress of divorce, job loss, medical, etc.).
Posted by: my view at December 11, 2008 11:05 PM
my view -
The "deal" is governed by the law and lenders know it better than the vast majority of borrowers.
Lenders do just fine (review the concept of "reverse leverage" before you get too conerned about the poor lenders).
And they make out like bandits when the property is over-valued. There are very important policy reasons for the one action and anti-deficiency laws. This is not the first time we have seen this either:
"In the years leading up to the S&L crisis, many lenders had substantially relaxed their appraisal standards. Profits were high and the focus was on making loans, not on ensuring that the underlying security was adequate. When properties began to go into default at unprecedented rates, it became obvious that thousands of appraisals were inflated, and countless borrowers were unnecessarily exposed to debt far in excess of the value of their secured real property. In short order, this vicious cycle flooded the pool of Real Estate Owned (REO) properties in lender inventories and ultimately brought down a major industry.
A primary purpose of the antideficiency statutes is to place the risk of such overvaluation and inadequate security on the lenders who stand to profit directly from the loans they make. Taken together, sections 726, 580a, 580b, and 580d of the California Code of Civil Procedure constitute a comprehensive statutory scheme that specifically protects defaulting borrowers from being taken advantage of by overly aggressive lenders who may care more about making loans than protecting borrowers."
But if you think your lender should share in any profit are lucky enough to make on your house, feel free to send them some extra money. I'm sure they won't mind taking it.
Posted by: Publius at December 11, 2008 11:50 PM
I think I inartfully presented my point. I know lenders must choose judicial or trustee. But I believe they can do neither and, instead, sue for breach of contract on the promissory note. ie. not the deed of trust.
I could still be wrong -- this is coming from some donkey-quality materials I was studying for the RE broker's license. (Barron's I believe)
Posted by: Rubicon at December 12, 2008 12:19 PM
Sorry for the delay. Love this site, but can't make it here as often as I would like.
Re suit for breach of contract, you are right only in the most technical sense because the antideficiency statutes act as an affirmative defense even if the lender chooses to sue using a breach of contract cause of action. In practice, this action is "converted" to a judicial foreclosure when the borrower demands that the lender use the security.
There are a couple of interesting cases on this issue, but the facts are much more involved than your standard "walk-away" situation.
LOL - You're right about the "donkey-quality" materials for the broker's exam. Some of the materials I used were just a little off in some cases and just plain wrong in others. Good general knowledge though. Brokers aren't supposed to be real estate attorneys.
Posted by: Publius at December 16, 2008 7:32 PM
ahhhh, hadn't known the borrower could demand that the lender use the security instrument
anyway this pretty much renders my point moot
Posted by: Rubicon at December 22, 2008 12:37 PM