Everyone Does Not Qualify for a Loan Mod

Loan modification fever is here. Families all over the U.S. are struggling to make their mortgage payments and many are expressing frustration that their lender won’t modify their loan.  Any of us could try to make a rational argument that a lender is better off modifying a mortgage loan instead of foreclosing but this is a simple answer to a complex problem.  This blog post will help homeowners understand who is not going to get a loan mod.  Hopefully homeowners will be able to then move forward toward other solutions.

Loan modifications are not for people in temporary financial distress. Temporary financial distress is when a homeowner missed a payment for one or two months because of a temporary hardship.  Lenders can and do help these folks with a forbearance and repayment plan where the missed payments are made up over time or tacked on to the end of the mortgage.  This is not a loan modification, it’s a repayment plan. If your financial distress is only TEMPORARY then asking for a full-on loan mod is wasting your time and everyone elses time.  New research out this week from CR shows us that 30% of all delinquent borrowers self-cure without receiving any kind of loan modification. This means lenders who can effectively triage out borrowers likely to self-cure are behaving rationally by setting aside pleas for loan mods.

Long term financial hardship means homeowners need long term financial solutions. A loan modification is only ONE of MANY long term solutions. In order for a homeowner to receive a loan mod, the homeowner must be able to document stable monthly income.  Lenders have to re-underwrite the file to make sure that the loan modification will not result in further loss to the lender.  This takes time. If a homeowner’s monthly income has dropped so low, to the point where they really can’t qualify to repay the modified loan, this loan modification will not be approved nor should it.  (Note: Lender guidelines on qualifications vary and change often, just like the retail side of lending.) This homeowner should consider other options which will be outlined below.  It should be beyond clear by now that lenders are not going to voluntarily start reducing principal balances unless forced by gunpoint.  The government can try to shame them into it but let’s face it: most corporations are shameless and nothing any of us say and do is going to change this.

Long term financial hardship cases do happen. Case in point. I received an email last night from a homeowner who is on permanent disability. Her husband just got laid off.  They are seeking a loan mod.  In no way can they afford the $4500/month payment on their interest only loan so they’d like the lender to lower the payment (lower the interest-only rate, extend the term).  They are $100,000 negative equity.  Sounds rough, doesn’t it?  However, they happen to have $250,00 in the bank.  This is not a case of financial hardship! A lender would be wasting time and money modifying this loan. These homeowners HAVE MONEY in the bank to continue to make their existing payment for many more months.  Besides, looking at the amount of money coming in the door each month, once their money runs out, chance of a re-default is sky high.  The only thing a loan mod does for these homeowners is it keeps them in their home for a little while longer. If the husband can become re-employed at his same rate of pay, maybe the chance of default drops a bit, but  no lender will modify this loan if there’s literally zero money coming in every month.  This lender is making a good business decision to put this file on ice while they continue to pay as agreed each month using their $250K.

I agree with CR: “If it became widely known that lenders routinely reduce the principal balance for delinquent borrowers with negative equity, this would be an incentive for a large number of additional homeowners to stop paying their mortgages.” It would be rational for negative equity homeowners to make the decision to trash their credit score in exchange for a shot at wiping out $50K, $100K+ negative equity if they wanted to keep their home.  We shouldn’t hold our breath for lenders to make principal balance reductions en masse.

I have not worked in loan servicing for many years but when I did, there was a triage system of making sure cases that were going to cost the bank the most money were prioritized over cases that could wait longer.  We already know that loan servicing departments are far understaffed for the tsunami that’s hitting them full on.  If we want banks to beef up staffing and spend money hiring and training more loss mitigation underwriters, the expense for these costs is going to be priced into new mortgage loans made tomorrow and in the future.  Even so, this will take time.  Working in loan servicing is a very high stress job. Imagine what it’s like to work 8 to 5 every day with a 1 hour break from lunch and 2, 15-minute breaks…with the rest of your day spent being yelled at by Realtors asking for their short sales to be approved RIGHT NOW. High stress = high turnover. I could never do that job today because I’d yell back and surely get fired. 

Homeowners with bonafide cases of lender law violations or predatory lending can and should be prioritized in getting help modifying their loans.  These homeowners are better served by hiring competent legal counsel to represent their interests in negotiating fair and just mortgage terms.  But that’s not what’s happening today.

Today, it seems that the masses believe they deserve a loan mod based on whatever is going on in their lives.  Job loss, reduction in hours, on and on….I know I may sound heartless here but lenders need to make sure you are able to repay a modified loan and that you are eligible for a loan modification under their specific guidelines.  Not everyone will qualify.

Options beyond a loan modification:

Move out of the house
If you don’t want to sell the home, perhaps you will be able to rent out your home and cover or almost cover the mortgage payment. Then you can seek out other living arrangements that comport with your ability to pay. When your income adjusts upward again, you can move back in.

Take on a tenant
Maybe you can rent out your basement or spare room to a tenant.  I know several people who are doing this just so that they can make their own mortgage payment.  Check your local city or county rental guidelines.

Sell the home
If you have negative equity, interview at least three real estate agents who are COMPETENT in the practice of listing and selling short sales. Do NOT hire an agent who has no experience in short sales.  If you decide to hire a Realtor who’s your friend or relative and that person has no experience listing and selling short sales, you get what you deserve.

Hire an attorney
Some homeowners seek out a loan modification only to find out that the real problem was far beyond just the mortgage but instead was an abundance of consumer credit card debt.  Maybe an appointment with an attorney who represents debtors is in your future. An attorney can fully explain all the reasons for and reasons against letting the home go to foreclosure, as well as all the legal consequences.  News today suggests a foreclosed homeowner might even be able to rent back their home from the lender!

Whatever you do, do NOT pay ANYONE cash up front for services before the services are actually performed (with the exception of when you hire an attorney.)  If you part with cash to pay a loan mod company, you are setting yourself up to become re-victimized.  They will tell you anything you want to hear in order to get your money because they know you are desperate. If you have money, hire your own attorney who will represent you directly. If you do not have money, contact your state’s bar association for a referral to free legal aid. 

Also worth saying: Avoid any third party who claims to have a solution to all your problems and asks you to sign anything.  Especially if they say, “This is perfectly legal.”  Before signing anything hire your own local legal counsel. Foreclosure rescue scams continue to be on the rise nationwide. 

Not everyone will qualify for a loan mod and not everyone is going to get their loan mod processed in a timeframe that the majority would consider anywhere near “good customer service.”  Loan servicing doesn’t have to provide you with good customer service because you have no where else to go.  There is no automated underwriting slam dunk approval system for loan mods.  There’s no stated income program for loan mods. Real humans underwrite the file and this takes time.  It’s going to take many, many years to work all the bad loans out of the system. We are in for a long ride.  If you don’t qualify for a loan mod it might be time to move on to other solutions.

$8K Tax Credit Closing Deadline of Nov 30 Could Slow Interest in Short Sales

Kary brings up an excellent point here. 

“One other agent short sale issue is going to pop up shortly, if it hasn’t already, but it will be a buyer’s agent issue. The $8,000 first time home buyer credit needs a property to close by November 30. Making an offer on a short sale property, without advising a first time homeowner of the risk of not closing by the deadline is probably malpractice. It’s sort of a “suitability” issue for real estate.”

It’s not outside the realm of possibility that falling in love with a short sale today means the transaction may not close by Nov 30, 2009.  I suppose there might be a chance that the tax credit will be extended or even expanded.  Yet many homeowners with Option ARMs were given verbal assurances that they would be able to easily refinance. 

I wonder what life is going to be like inside loan servicing during the month of November, when the pressure will be sky high to get these short sales APPROVED so the buyers can make the closing deadline?

Notice of Trustee Sales v. Trustee Deeds

Each month, Alan from Seattle Bubble religiously posts the Notice of Trustee Sale (NTS) numbers for King County. I’m very appreciative of his work because it saves me time each month so thanks again, Alan.  Cruising SB last night, I found Alan’s numbers alarming for June:  1615 NTS were filed.  Here are more numbers from Alan:

King County Notice of Trustee Sales

6/2009 – 1615
6/2008 – 576
6/2007 – 304
6/2006 – 299

180% YOY (280% of last year)

The last few months:
6/2009 – 1615
5/2009 – 992
4/2009 – 938
3/2009: 1089
2/2009: 838
1/2009: 909
12/2008: 660
11/2008: 540
10/2008: 643
9/2008: 607
8/2008: 575
7/2008: 728

If we’re seeing 180% increase year over year with notice of trustee sale filings, then where are the REOs? Well as it turns out, if you compare the trustee deed filings for the same month, you’ll see that a low percentage of Notice of Trustee Sales actually go all the way through the auction process. Here’s comparison data courtesy of Jess and Julie Lyda, which gives us a visual comparing NTS v. Trustee Deeds, which means title changed hands from the owner in default to a new owner. That new owner could be the bank/lender or someone who was the high bidder at the trustee sale. Here’s a link to a larger image of the graph.

So what assumptions can we make given facts that we already know? We already know that banks and lenders are postponing the majority of trustee sales in King County. We don’t have any data as to how long postponements are lasting.  If a homeowner is trying for a short sale or loan modification, we do know that the average wait time for banks to process these requests could easily be months based on nationwide reports from Realtors, home buyers and homeowners.  We also know that there are many banks who have turned into zombies, waiting for their number to be called and the regulators to show up on a Friday afternoon.  Postponing the losses from a foreclosure means the bankers can collect a paycheck for a few more months.

We also know that 50% of all loan modifications re-default by the 6 month mark. This pushes the foreclosure out longer and increases the overall losses to the bank/lender.  Another assumption we can make comparing data from Alan and Julie is that hundreds of REOs will be coming back on the market each month, which will put further pressure on home values.  Prime delinquencies are starting to surge and so are delinquencies in the upper home price ranges.

With what we know, home values will continue to feel pressure from many angles including higher inventory levels, continued tightening of underwriting guidelines, the lower prices of REO resales and short sales.

More on home price declines:

House Prices: The Long Tail from Calculated Risk
Case Shiller: Anemic Spring Bounce in April from Seattle Bubble
CR explains the difference between a bottom in housing starts and new construction homes and a bottom in residential resale homes in this post; Housing: Two Bottoms.

The Buyers are out, and trying to buy, but…

Buyers are out, and trying to buy, but they don’t seem to be quite as successful as some of the more breathless news reports would lead you to believe.  I have always liked the Pending Sales statistics from NWMLS because they represent the most recent monthly snapshot of new contracts on listed properties – i.e. a Buyer and a Seller have made a deal.  But recently a lot of those ‘deals’ have not closed, the Seller has not gotten his or her money, and the Buyer has not gotten possession of the property. It appears that a lot of these current transactions, which are indicating a high level of Buyer’s intent to purchase, are falling out or being delayed for long periods.

Here is a chart built from NWMLS published statistics of Pending vs Sold data – the chart is built by taking a two-month moving average of Pending (previous month) vs Sold (current month) data. Note that this post expands on an earlier post by Ardell in her Sunday Night Stats.

Let’s call this chart the Fall-Out Ratio – we may want to keep an eye on it.

(Required disclaimer: Statistics not compiled or published by the Northwest Multiple Listing Service)reilingteamcom-fall-out-ratio-0906

Historically the fall-out rate has been well under 10%, but then in early 2008 the fall-out rate started climbing like a rocket. Recall that we had the mortgage market meltdown in late 2007, and lenders started dramatically tightening their lending practices. Then we had the larger financial and business crash in late 2008, and more people started losing their jobs – and the other 90% got nervous. It was also in late 2008 that we started seeing a lot more short sales in our Seattle/Bellevue area. Recall that in a short sale, the insolvent seller is trying to avoid foreclosure by selling the property and getting the lender to accept less than is owed on it. That lender approval process is often slow and uncertain, and it certainly is contributing to this rise in the Fall-Out Ratio. Short sales may be 20% or more of our current sales activity, and those delays may also be a major contributor to why the average Days-on-Market measure isn’t dropping in concert with Months Supply. Other contributors to the fall-out rate would include failure to reach agreement on inspection, and failure of financing. I’m sure we’ll get a lot more insight on causes from the comments by our great RCG contributors.

California Attorney General Demands All Loan Modification Firms Register with his Office and Post a 100K Bond

From the Orange County Attorney General’s Office:

Oakland — Continuing his fight against scam artists who “prey on” vulnerable Californians, Attorney General Edmund G. Brown Jr. today issued a directive forcing foreclosure consultants to register with his office and post a $100,000 bond by July 1, 2009. Those who fail to do so will be in violation of state law, subject to criminal penalties of up to a year in jail and fines ranging from $1,000 to $25,000 per violation.

“California is awash with con artists who prey on vulnerable families facing foreclosure,” Brown said. “By forcing foreclosure consultants to submit detailed information to my office and post a $100,000 bond, this registry will help bring long-overdue transparency to this shadowy world.”  Up and down the state, scam artists pose as legitimate foreclosure consultants, promising homeowners they will prevent foreclosure. In reality, these scam artists charge huge up-front costs, but don’t provide an ounce of help.

Earlier this month, Brown’s office prosecuted a scam artist who provided hundreds of homeowners with forged bank documents and directed them to send their mortgage payments to accounts she had created, instead of the homeowners’ lender. Additionally, Brown’s office has seen a significant increase in the number of complaints from homeowners regarding foreclosure consultants.

The registry unveiled today will provide Californians with information about potential consultants and recourse in the event that a consultant violates the law. All foreclosure consultants operating in California must post a $100,000 bond and register with Brown’s office by July 1, 2009 and submit the following information:

– Name, address, and telephone number;
– All names, addresses, telephone numbers, websites, and e-mail addresses used or proposed to be
used in connection with their business;
– Copies of all advertising;
– Copies of each different contract the consultant will use with consumers; and
– A copy of its $100,000 bond.

Foreclosure consultants who provide proper information will receive a Certificate of Registration. Brown’s office, however, may refuse to issue, or revoke, a Certificate of Registration if the foreclosure consultant has made any misstatement in its registration form, has been convicted of fraud or misrepresentation, has been convicted of a violation of the state’s foreclosure consultant laws, California’s false advertising, unfair or deceptive practices laws or other laws dealing with mortgages. If the company violates the law, a court may order restitution to victims out of proceeds from the $100,000 bond. After July 1, 2009, consumers can call the Attorney General’s office to determine whether the company they are considering dealing with has been issued a Certificate of Registration.

There is more in the press release including the names of several companies busted by his office.  California is asking all “foreclosure rescue” firms to register which includes the pre-foreclosure scam artists and also loan modification firms.  I wonder how long it will be before Washington State Attorney General Rob McKenna makes a similar move towards foreclosure rescue companies? Unlicensed loan mod firms out of California continue to make a run for Washington State homeowners (based on the phone calls and emails I continue to receive about this company which sends paperwork to another loan mod firm under a different name for processing,) even though loan mod firms doing business in WA State must be licensed under DFI.

Do you think this registration system will help California homeowners?  Should we consider a similar system for Washington State?

Foreclosure Rescue Scammer or AG Victim: You be the Judge

In order to go into the foreclosure rescue business, foreclosure rescuers must make themselves believe that they are helping the homeowner. This is done in a cognitive way, by attending many foreclosure seminars, reading lots of books and memorizing scripts that can be played back inside the foreclosure rescuer’s head over and over again until it becomes real and true to them.

Similar to how we fool ourselves over and over again when we say to ourselves “it’s only one drink,” “it’s only a cookie” and “it’s not really sex.”  Self deception is very powerful and it appears to be working well with foreclosure rescuers.  I hear many phrases over and over again such as, “it’s perfectly legal,” “homeowners want to stay in their homes,” and “if it wasn’t for me, then….”  With the case of Joe Kaiser, we are starting to hear a different song. It’s the whine of the victim.  You know the type of person I’m talking about who constantly complains about being victimized to the point where they transform into victim.

Joe Kaiser (doing business as PreFlop, LLC, G. Hobus Investments, LLC, Bobo Buys Real Estate, and Unclaimed Funds, Inc.) makes money selling foreclosure rescue sales courses and books (examples: ‘The Subterranean Marketplace in 2009″ for $997. “Learn How to Day Trade in Real Estate Online Using Craigslist for $667.) though not everyone has been a satisfied customer.  Joe buys and sells homes in foreclosure but not just any kind of foreclosure: tax foreclosure.  Some of you will remember fine movie, “The House of Sand and Fog” very well acted by Sir Ben Kingsley, Jennifer Connelly, and the beautiful Shohreh Aghdashloo. I assign this movie as extra credit for my college students because of all the possible title insurance issues surrounding the tax foreclosure plot.  This movie should be required viewing for anyone thinking about entering the world of tax foreclosures.

In a very methodical way, described in his books, Joe locates homeowners who are delinquent on their real property taxes, and also have equity in their home.  This is a bit like a needle in the haystack kind of work today but during the bubble run-up, as others swarmed the trustee sales, Joe focused on tax foreclosures. Interestingly, several of his victims have Hispanic surnames but I digress. Le’ts read the public records documents:

The Court found that Mr. Kaiser violated the Consumer Protection Act by soliciting homeowners with false promises to help them keep or save their home when partial interest deals do not actually result in the homeowner keeping or saving their home.  The Court also found that, in the course of creating partial interest deals, Mr. Kaiser violated the Consumer Protection Act by falsifying real property excise tax affidavits and by acting as both trustee and co-beneficiary seeking a profit from the trust.

Kaiser solicits homeowners facing tax foreclosure and induces them to place their home in a trust, with Kaiser, through his business entities, as trustee and co-beneficiary.  Mr. Kaiser does not pay the homeowner for their homes. Once title to the home is in Kaiser’s control, he pays the delinquent property taxes and stops the sale of the home.

The land trust…that Kaiser created give him complete title and control over the homes and leave the former owners with only two tenuous rights: 1) the right to some percentage of the sales proceeds if Mr. Kaiser chooses to sell the property, and 2) the right to occupy the property for one to three years, provided the former owner pays rent. These two rights are tenuous because the documents contain hair-trigger default provisions which void these rights if the former homeowner is even five days late on a rental payment or violates any of the other terms contained in the numerous documents Mr. Kaiser has them sign.

Mr. Kaiser testified that every partial interest deal he has created is actually in default…therefore, none of the former homeowners maintains their right to possession of the property or a percentage of the proceeds if Kaiser chooses to sell it.  By virtue of the lease provisions and other contractual provisions for reimbursement of all of Mr. Kaisers expenses, his terms entitle him to receive either the entire home vacant or his share of the home’s equity without having ultimately paid any money….Homeowners who enter the transactions believing they are saving their homes are actually stripped of any ownership interest and are not even given a right of first refusal to buy back their home.  No fully informed person, not acting under compulsion would enter a transaction with such onerous terms.

There is much more in the Findings of Fact and Conclusions of Law and if you want to learn how to “Negotiate Foreclosures Like a SWAT Team Leader” then by all means, meet Joe here.

There are some investors who feel sorry for Joe.  Joe feels like he has been attacked by the AG’s office and is blogging about his new role as a victim. Let’s see if this logically works.

In the F&G M. transaction, Mr. Kaiser claimed he saved F&G’s home…What Kaiser actually did was purchase the home at the foreclosure sale and then had Mr. M. sign over his rights to the overage money from the foreclosure sale. As a result, Kaiser obtained both the house and the $45,428.47 in overage money he had paid at the auction. Kaiser never sold the house back to Mr. M. even when Mr. M. obtained a Realtor and made an offer. Kaiser then sent Mr. M. an eviction notice demanding Mr. M. immediately pay $2700 in rent or vacate the property.

I’m trying to work up some tears but they’re just not coming.  Now it’s your turn: is Joe Kaiser a posterboy foreclosure rescue scammer, a victim, a sociopath, a combination thereof, or am I too  justice oriented to become a real estate investor guru?  I just can’t look at someone, flat-out lie to them, and steal their house and money.  If that’s what it takes to be a real estate investor guru, count me out.

Why are Banks Setting the Opening Auction Bid Below The Principal Balance?

I attended a foreclosure auction in Bellevue, WA last week to discover if the rumor was true that banks are opening their bids below the amount owed.  I received confirmation from three professional investors that yes, the banks have been doing that, it’s no secret, and there seems to be no discernable pattern.  It’s not one particular bank or lender, it’s not particular types of property or in any specific area. It appears to be random.

In addition to the 92 active trustee sales scheduled for that day in Bellevue (auctions were also going on in other King County locations,) there were 81 postponements.  Only a few of the trustee sales attracted bidders, and the rest were deeded back to the bank.  Out of the 92 active sales, 25 had opening bids below the amount owed to the bank.

Why would a bank or lender set their opening bid below the amount owed?

Banks and lenders have duties to their shareholders and investors to maximize profits and miminize losses (well, at least they use to.) If opening bids are set LOWER than what’s owed, perhaps the banks have already tallied their losses, realized that if they had to take back the house, get it cleaned out and cleaned up for resale, pay a real estate agent their commission to sell it, pay for title, escrow, excise tax, utilities, and any other carrying costs,  they might as well sell it at a discount at auction.  But maybe there are other reasons.  I wondered if the banks were trying to keep more REO inventory off the market in an attempt to prop up home values for their existing REO inventory.  Maybe appraisers can ignore trustee sale prices in their reports.  Not knowing the answer, I emailed three appraisers for help and here’s what I learned:  Appraisers need to mention trustee sales in the neighborhood if these trustee sales make up a significant percentage of available comps because they are legitimate sales even though title is transferred using a trustee deed instead of a warranty deed.  If an appraiser choses to ignore these, he/she will run the risk of having the appraisal run through an “enhanced review” process in order to catch trustee sale market activity.  If a trustee sale is a significant comparable sale, it can be used. The requirement to use closely comparable trustee sales as comps can also vary based on the requirement of the lender and investor.  It may not be absolutely required but it may be in the appraisers best interest to mention trustee sales. Thanks to Jonathan Miller, Shane Leady and Richard Hagar for teaching me something new today.

That still doesn’t explain the phenomenon of banks undercutting their own principal balances at the auction.  My theory is that banks are relying on third party information such as a mini appraisal or Broker Price Opinion (BPO) prior to auction.  If the BPO suggests that the outstanding principal balance is so high and out of range as to likely attract no bidders at auction, then the banks have nothing to lose by setting the opening bid closer to or significantly lower than the principal balance owed.  If no one bids at auction, they’re still only out the money they would have been out anyways and on the upside, if the low opening bid attracts investors, then perhaps the bidding will rise closer to the payoff.  If not, they have an immediate loss that could be significantly LESS than losses that would add up over time, having to carry the REO on its books for months of marketing time in addition to the other costs mentioned above.

If banks are undercutting their own payoffs, then why isn’t this phenomenon more widely publicized?  Okay, so we know that bidding on a home at a trustee sale is too frightening for most first time homebuyers but still, if more people know about this, then maybe there would be more folks showing up at the trustee sales and bidding those homes UP, thereby reducing the banks losses.  There certainly is NO shortage of tall, well-groomed, good looking, muscular investor gurus in shorts showing off tanned legs, even though it was only 63 degrees outside hanging out at foreclosure auctions with all kinds of downpayment solutions to offer newby real estate investors:  “We have zero down financing available for the right investor!” and “We have private hard money financing available for your purchase and you can refinance out of that loan in 30 days….My mortgage broker is right here, let me introduce you to her.”

Maybe the banks aren’t publicizing their low bids because they don’t want to bring buyer attention away from purchasing their REOs or short sales, knowing that investors are the ones who typically show up at the auction anyways.  The banks also have a vested interest in keeping traditional buyers focused on MLS listings. 

If I owned stock in a bank or lender that was undercutting their own payoff at auction, I’d want to be darn sure that this practice was saving the bank money and not hiding something else such as higher losses to be pushed on into the next earnings report…or the next stress test.

Foreclosure Auction Video Part 1
April 24, 2009
Bellevue, WA
Here is the rest of the auction.
Special thanks to Phil Leng for introducing me to all the investor bidders.

I’ll Be at the Factoria Courthouse Friday Morning at 10AM for the Foreclosure Auctions

Every Friday morning at 10:00 AM, Trustee Sales are held in various locations throughout the county.  Phil Leng, one of my students, invited me to attend the foreclosure auction with him this Friday at 3535 Factoria Blvd SE, Bellevue outside of the south entrance to the Northwest Trustee Services building.  I’ve been hearing rumors that banks are discounting their own opening bids right at auction and I want to check this out.

If you’ve been following along with Craig Blackmon’s foreclosure series, this means the amount of money owed to the bank, plus expenses, is the opening bid.  Bidders show up with cashier checks, receive a bid number, and typically bid UP from the bank’s opening bid.  During the height of the bubble run up, there were multiple bidders bidding the final price way up.  The rumor is that some banks or lenders may now be opening the auction at a bid price lower than their cost. I have heard of this happening in other states such as California, but not in Washington state. 

I’ll be there tomorrow. If you want to come and join me, I’ll be the one with a video camera recording as much as I can for a new class I’m writing.

When is Foreclosure Right for You? Part 2 of 2

This post is not legal advice. It is a general discussion of SOME of the relevant legal issues surrounding foreclosure. If you are considering or facing foreclosure, you need specific legal advice for your particular situation. Consult an attorney in your area.

In my last post, I discussed the difference between a judicial and a nonjudicial foreclosure, which is one of the two essential issues to understand when considering whether to allow your property to go into foreclosure. The other essential issue concerns the number of mortgages you have on the property.

For many reasons, people often took out a first and a second mortgage when they bought property. Others opened up a home equity line of credit which they then used to pay other bills. In either case, the owner has a first and a second mortgage on the property. Where there are two mortgages, foreclosure creates much greater risk.

First, some background: mortgages, like all other liens, are arranged by seniority. (A “lien” is a legal right to force the sale of particular property to repay a debt, whether on a mortgage, unpaid property taxes, an unpaid contractor’s bill, etc.) As a very general rule, seniority is determined by time; the older the lien (i.e. the longer ago it was created or placed on the property), the greater the seniority. The “first” mortgage (or any other lien) — known as “first position” — will be paid in full by the sale of the property before the second and all subsequent liens are paid. The second will be paid in full before the third and all subsequent liens are paid. The third will be paid in full before the fourth, and so on. So, in a market like this one, the only debtor who has any real chance of being repaid in full is the mortgage or other lien in first position.

Where an owner has two mortgages, one is senior to the other (usually in first and second position on the property). Typically, when an owner stops making payments on these mortgages, the first position mortgage will foreclose. By foreclosing, the first position mortgage (under authority created by the deed of trust) forces the sale of the property and the proceeds (after payment of costs) are used to satisfy the debt. If there are any remaining funds (very unlikely in today’s market), they are applied to the second position mortgage and then to the remaining liens in order of priority.

Now, here is the important part: foreclosure extinguishes the debt that is being foreclosed, but it does not extinguish the junior debts (such as a second mortgage). So, if the lender forecloses the first mortgage and the proceeds are insufficient to pay the total amount due, the balance is extinguished as a matter of law (with certain tax implications — perhaps the topic of a future post). In other words, even though the debt was not repaid in full, the debtor is off the hook and does not need to pay the difference on the first mortgage.

However, the debt of the second mortgage survives. Admittedly, the second lender can no longer foreclose on the property because the legal right to do is extinguished by the foreclosure of a senior debt. The problem for the owner, though, is that he still owes the money borrowed under the second mortgage. In WA, you have six years in which to sue for breach of contract. The owner/debtor’s failure to make payments on the second mortgage (per the terms of the promissory note) constitutes a breach of contract. So, after foreclosure of the first, the second lender will have six years in which to sue the debtor for the full amount of the debt. The debtor will probably lose that suit. At the end of that process, the lender will have a judgment against the debtor for the full amount of the balance due, plus interest and late fees, plus attorney’s fees and costs incurred by the suit. Judgments are bad (see Part 1).

So, if you’re thinking about foreclosure, you’re taking a very big risk if you have multiple mortgages. You could get a very, very unpleasant surprise five years later. At that point, bankruptcy may be the only viable option.

When is Foreclosure Right for You? Part 1 of 2

This post is not legal advice. It is a general discussion of SOME of the relevant legal issues surrounding foreclosure. If you are considering or facing foreclosure, you need specific legal advice for your particular situation. Consult an attorney in your area.

Practically every day, I get a call from a potential client wondering what to do with a property that is seriously “under water.” A property is under water where the owner owes more on the mortgage(s) than what the property is worth in today’s market. The problem can be compounded by high mortgage payments (in the go-go market of yesteryear, it was not uncommon for someone to buy “more house” than they needed in the hopes of continued double-digit appreciation — the more expensive the asset, the greater the total appreciation). At least once a week, I speak with someone who has mortgage payments of $3000+ per month, where they could rent a suitable place for half that and they owe $50,000+ on the property beyond what it is worth.

So what to do? It’s been the topic of some discussion. One option is to hunker down, bite the bullet, and wait for the market to bounce back. After all, you’ve got to live somewhere. Eventually, the market will start going up and some day you’ll regain equity in the property (equity = value in the property greater than what is owed on it). However, depending on when you bought and what you paid, it may be a loooooooooonnnnng wait…. In the meantime, you’ll keep making those big mortgage payments.

Some people wonder whether they can just walk away from the property and be done with it. The usual plan: Let it go to foreclosure, temporarily ruin your credit, and start saving the difference between rent and the mortgage. To determine whether this is a good idea — or, more accurately, to get an idea as to the risks and benefits of doing so — you must first understand the difference between a judicial foreclosure and a nonjudicial foreclosure. [Author’s Note: This post is written for residents of Washington State. If you live somewhere else, your laws may differ. Yet another reason to consult an attorney.]

First, some background: When you bought the property, you borrowed money from a lender. In doing so, you signed two key documents: a promissory note, and a deed of trust. The promissory note is the legal document that sets forth the debt and the terms of repayment. The deed of trust is a type of deed (a document that transfers title to real property). Under a deed of trust, you transferred title to the property to a trustee, who “owns” the property for the sole purpose of guaranteeing that you repay the debt as set forth by the promissory note. If you fail to pay the debt, the trustee has the power to sell the property without your permission so that the proceeds of the sale can be used to repay the debt.

Now, the two types of foreclosure: A judicial foreclosure is a civil action filed in court by the lender. The lender sues for payment of the debt reflected by the promissory note. The process takes 12+ months and is expensive. At the end of the process, the court will order the sale of the property, the property will be sold at public auction, and the proceeds from that sale (after costs incurred) are applied to the amount owed. If there is a balance remaining on the debt, that difference becomes a judgment against you. This is a “deficiency judgment” because it is a judgment for the deficiency between the amount paid (via the sale) and the amount owed. A “judgment” is a court order requiring a person to pay a specific sum, and if not paid immediately it accrues simple interest at 12% until paid. A judgment expires 10 years after it is entered by the court, but it can easily be renewed for another 10 years. Once a creditor has a judgment, the creditor can use various legal tools to extract payment from the debtor without the debtor’s consent. For example, the creditor can garnish the debtor’s wages (the employer pays a portion of the wages directly to the creditor) or garnish the debtor’s bank account (the bank disburses the funds in the account directly to the creditor). It is safe to say that judgments are bad. So, one should avoid a judicial foreclosure.

The other type of foreclosure is a nonjudicial foreclosure. With this type of foreclosure, the trustee orders the sale of the property under the authority conferred on him or her by the deed of trust. Once again, the proceeds (less costs of sale) are applied to the debt owed under the promissory note. This process is quicker and cheaper than a judicial foreclosure. However, a nonjudicial foreclosure extinguishes the debt set forth in the promissory note, even if the sale does not net enough to repay the debt in full. There is no possible deficiency judgment. Thus, with a nonjudicial foreclosure, the debtor knows that he or she will not owe anything following the foreclosure, regardless of whether or not the lender is repaid in full following the sale.

Obviously, then, foreclosure may make sense if the lender foreclosures nonjudicially, but probably does not make sense if the lender forecloses judicially. Which will happen to you? Unfortunately for debtors, lenders do not advertise in advance which method of foreclosure they intend to use. That said, the vast majority of foreclosures are nonjudicial. A judicial foreclosure would make sense for a lender if the debtor has other assets that can be used to satisfy the deficiency judgment. If the debtor has no other assets, then they are “judgment proof” (a term used to describe someone who simply has no money to satisfy a judgment, thereby discouraging anyone (including a lender) from incurring the costs of a lawsuit). Where the debtor is judgment proof, it makes no sense at all for the lender to incur the costs of obtaining a judgment.

So, if you’re willing to assume the risk of a judicial foreclosure, and/or you have no assets whatsoever such that you are comfortable being judgment proof, then it may make sense to just walk away. [Note: you’ll have a hard time getting credit, finding a landlord, or otherwise living in the modern world if there is an unpaid judgment against you.] However, this is only ONE of the TWO key factors you need to consider. Stay tuned for Part 2.