New Version of "Musical Chairs"

Sometimes a comment on one of RCG’s posts is SO interesting that you just have to turn it into its own post, so people don’t miss it. Like this one from Dave in Sacramento:

“In my neighborhood in Sacramento, California, I am seeing a chain of people buying a foreclosed upon or short sale home while they still have good credit, then allowing their former home (which is in the same neighborhood with the same floor plan) to go into foreclosure or otherwise disposed of. Then a second person with good credit buys that newly foreclosed upon home and – guess what – let’s their old house go to the bank! With no down payment and (often) no tax consequences, one is effectively reducing his debt from $300K to $200K for the same home. They feel they have won the lottery!

The only disadvantage is a bad credit rating, which doesn’t seem like such a big deal (they may regret this later). Still, $100K makes up for a lot of pain from poor credit.. I actually have my own home up for sale and I have had four offers, mostly from our own neighbors that want to have the same house for less money. Maybe the banks should just write off some of the principal and save themselves the trouble..

But not me – I am going to be a renter. I bought in 2006 for $300K ($15K down) and can only get $210K for the house now. As a military member, I’ll have to move in summer 2009, prices won’t go up, and rents won’t cover the mortgage – too many people renting right now. I already have one upside-down rental in West Virginia from my last move draining my time and money. Anyway, I have to sell. I’ll lose my $15K and the bank will lose about almost $100K. I thought I’d get a modest 2%-3% increase each year 2006-2009 and be able to sell for what I owed plus closing costs, but there’s no way. I wasn’t greedy; I just wanted a decent place to live with a yard and peace/quiet. I don’t worry about the $15K – that’s the past – but I hate having my good credit get trashed and being unable to buy a new home, but what can I do? Cash out my entire 401K? Maybe I should buy another house now?

My bank refuses to consider four good offers or talk with me at all until I miss three payments, so I am now saving up all of those monthly payments and will move into an apartment whenever the bank wants me to go. Apartments here seem willing to rent to me even when I tell them I am in a short sale; I am just one of many people with bad credit filling a lot of unwanted apartment vacancies.

But, for now, I am staying put and at least the yard gets watered and the trash gets picked-up while the bank comes to grips with the fact they are getting their house back. I feel that my trying to preserve the home’s value until I go is the very least I could do to be “ethical

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ARDELL is a Managing Broker with Better Properties METRO King County. ARDELL was named one of the Most Influential Real Estate Bloggers in the U.S. by Inman News and has 33+ years experience in Real Estate up and down both Coasts, representing both buyers and sellers of homes in Seattle and on The Eastside. email: cell: 206-910-1000

88 thoughts on “New Version of "Musical Chairs"

  1. “Maybe the banks should just write off some of the principal and save themselves the trouble..” – Dave from Sacramento

    Countrywide’s Angelo Mozilo is already suggesting this in his testimony to a Congressional panel (I think it was this morning).

  2. If the bank writes off principal on an upside-down house, can they tell those whose house is not upside-down yet to keep paying the old price?

    That would be unjust. But who cares, except the investors and people who put down too much downpay.

  3. my point, then whole neighborhoods are going to get write-offs and banks would lose money too.

  4. Anna,

    What do you think about the part of the story where Dave had four offers, but the bank won’t even talk to him until he’s three payments or more in arrears?

    This is pretty standard. People can’t scrimp and hang on by their fingernails and keep paying the mortgage while they are selling. If the net effect of the sale is a lower amount, the lender won’t talk to an owner that isn’t behind in his payments.

    What I don’t understand is how people could afford the homes IF the prices kept going up, but not if it goes down. The payment is the same. Were they borrowing against the growth to make the payment?

  5. PSB,

    I have seen more than a few people whining when they sell that “they are not making ANY money!” only to find that they were borrowing out their equity and living on it for years.

    But when I say you DID make money, you just already spent it, that doesn’t seem to make sense to them.

  6. “What I don’t understand is how people could afford the homes IF the prices kept going up, but not if it goes down.” – Ardell

    Excellent thought.

    This is a classic statement and should be a separate addendum in closing docs: “you are affirming that you can afford the payment regardless of future gain or loss of the value of subject property.”

    So how could they afford it going up, but not down? Because as the borrower peeks at their personal balance sheet and if it has lots of negative numbers it may take years to recover from it. We are in an instant gratification society and “years” is such an unknown and troubling proposition. The connotations of “anchored” to my home watching it’s value drop makes a lot of people grit their teeth. At some point mobility trumps the “anchor.”

    As some point in the process, people make the decision to pull anchor.

  7. “But when I say you DID make money, you just already spent it, that doesn’t seem to make sense to them.”

    It’s like how people “unlock” the equity from their home and think that’s a good way to buy a car or RV. That poor equity, all locked up, lonely and sad. It’s TRAPPED in the home! Release it!!! FREE IT!

  8. …and drive your equity down the street until it disappears…LOL! Maybe they should make car loan interest deductible. THAT would do more to prevent people from borrowing out their equity than many of the “new ideas” to “assist”.

  9. Anna,

    > What do you think about the part of the story where Dave had four offers, but the bank won’t even talk to him until he’s three payments or more in arrears?

    I understood he didn’t have offers from others, but he made offers to the bank. I don’t know what he meant by “good offers”, I assume it’s on a par with a short sale or a foreclosure. If so, then bank may do better not accepting it. Because if bank start lowering his principal, then sooner or later everyone would want their principals lowered, and bank lose money and may even run into legal problems from investor side or from people who don’t get a lowered principals.

    I understand what he’s doing, I applaud his trying to maintain the house, but I think that bank has no good choices in this case. Someone would end up the sucker and that’s likely the tax payers of the future.

  10. One thing that really bothers me about the congress and president is their stupidity.

    The current “walk away” phenomenon is preventable. Just snap taxes on the walk aways, especially the people who used the house as cash machines then walked away. Instead the congress give tax relief to people who negotiated down principals, and encouraging this no-payment, walk away music chair phenomenon.

    Similarly, massive food inflation is also exacerbated by ethanol subsidies and is largely predictable and preventable. The people has elected a bunch of self interested idiots.

  11. “What I don’t understand is how people could afford the homes IF the prices kept going up, but not if it goes down.”

    What did you think was going on when home equity withdrawls peaked at 8% of consumer spending and 90%+ of refinances involved taking cash out? It’s no surprise that a small but significant portion of home owners were paying part (or maybe all) of their mortgage payments with equity withdrawls.

    The banks encouraged serial refinancing, and as long as values were going up at double digit rates there was plenty of cash available to pay the loan fees and the mortgage. People like to joke about how irresponsible it was to spend cash out equity on luxury goods like boats, H2’s and fancy vacations- but the real destabilizing influence is from people that spent the equity on mortgage interest payments.

  12. I don’t see what the difference for the lender is with writing off some of the principal for an existing home-owner, or going through foreclosure and taking a big hit selling the house for less than the mortgage. Either way the lender (and mortgage investors) lose. In fact, the lender will lose more going through a foreclosure, since there are a lot off expenses (and time) associated with that.

    If the lender is certain a borrower can make the payments, then it makes sense to reduce their principal if the only other option is foreclosure (i.e. because anyone who is under-water is just going to walk anyway).

  13. I should also add that Countrywide’s CEO came out a few months ago and admitted that their (failed) loan performance models assumed people would use equity to pay their mortgage. Shocking admission, no doubt. But it goes a long way towards explaining why so many housing markets quickly went negative as soon as appreciation stopped.

    In late 2006, just as loan performance started to deteriorate, I heard a quote from a guy involved in analyzing portfolios of mortgage backed securities. What he said was “at this point, the only common and strong factor between mortgage failures in geographically separate markets is that they are rising wherever home prices are not increasing. “

  14. This is not tax or legal advice. You are advised to seek appropriate counsel.

    Generally, any forgiven debt is considered taxable income. It is reported to the IRS.

    This is a big shocker to many many people.

    Michael P. Lindekugel
    Financial Analyst
    RE/MAX Commercial
    Team Reba – RE/MAX Metro Realty, Inc

  15. sniglet –

    I think the problem is that the principle lowering scheme is a never-ending process. At least in foreclosure/short sale they can take a single hit and be done with it. But what happens if they lower your principle $50k, but then the market goes down further and you are underwater again and want another write off? Now they have lost $50k and either have to foreclose and sell for a much lower price than they would have before, or write it off again. Rinse and repeat and I can see why banks are reluctant to do this, even though it seems like Bernanke might force them based on his last testimony.

  16. What I don’t understand is how people could afford the homes IF the prices kept going up, but not if it goes down.

    When I moved here I was asking how people could afford their homes at all. I knew I couldn’t buy anything decent here. The conclusion I came to was that they couldn’t either. People have been using their growth equity to delay the inevitable. Now that prices have stopped rocketing to the moon and easy financing is not quite as easy, foreclosures are going up — even in King County.

  17. Alan –

    I agree, I think a lot of people also just stretched REALLY far to buy because they figured they could either refinance in two years, or sell in two years to make a ton of money. I knew many people who, from what I could tell, were putting every single penny they could into their house payment, and the banks loaning the money no longer looked for adequate debt to income ratios. Most people will skimp on living and scrape together payments for two years if it means they will get a free ride after that, when it doesn’t work out its the banks problem and they walk away. With declines starting in KC this attitude is only going to accelerate.

  18. I think the problem is that the principle lowering scheme is a never-ending process. At least in foreclosure/short sale they can take a single hit and be done with it.

    As long as prices keep depreciating defaults will be a never-ending process, regardless of what the lender does. The next person who buys a foreclosure is just going to walk as well when they (in turn) become under-water as well. Cycling through 3 or 4 foreclosures is a lot more costly than a few rounds of principal reduction with a single home-owner who never leaves.

  19. By the way, my sister bought a foreclosed home in Florida in January 2006, for about 20% off of what the owner had paid. Now, however, the home has lost another 30% of it’s value and she is talking about walking away. She is gainfully employed as a nurse, but her husband does building work which hasn’t been so hot lately. They can continue to scrimp and keep making payments, but with all the bleeding they see going on around them, with neighbour after neighbour going into foreclosure, they are just wondering if it’s worth it to stay.

    P.S. I spent a lot of time telling my sister about how I felt the real-estate market was going to tank big-time, but she went ahead and bought anyway. So much for trying to be a helpful brother. Now she is just resentful of me for having been predicted what would happen to her home.

  20. I believe insolvency is an exception to discharge of indebtedness being taxable, but how they determine you’re insolvent is an issue. Also, didn’t the legislation pass that offered an additional exception? Consult a tax advisor is the best advice in this situation. And don’t walk away from a house prior to doing so.

  21. I think the bank should consider how much the potential cost of the foreclosure will be in a “soft/down” market…and perhaps excuse that amount…if they (the bank) approved high ltv financing with low credit scores or stated income…they (the banks) are probably getting off easy. They gave the loan.

    It is tough for homeowners paying for their mortgages (not in trouble) to image that someone else down the street is getting “a deal” even though, that person down the street may be sufferning a great deal of financial (and emotional) stress.

  22. Why couldn’t they simply redo the loan at the current value so the owners could stay, and attach the shortfall indebtedness as a lien. This way if the property ever increased back to or over the value at the time of the original purchase, the bank would eventually be paid in full. Sounds like a win-win to me.

  23. Even better, let the owners apply for a loan based on conservative critera. Then give them a loan the way they should have gotten one in the first place, based on sound underwriting principles. The lender was at least responsible in part for giving more of a loan than they should have, and more than the borrower could reasonably have afforded to pay.

    Then attach the difference between what the owners actually qualify for and the original loan, as a lien to be collected against future equity. Possibly the lien for the amount the bank over-funded based on the buyer’s qualifications would be a tax an interest free lien, if the borrower’s circumstances has not changed since the original loan was made.

    “We gave you $600,000 when you only qualifed for $400,000. So we’re changing the loan to $400,000 and attaching the extra $200,000, interest free, as a lien against the property indefinitely.”

    Anyone like that solution?

  24. Sniglet –

    But that is the other banks problem then, right? I think thats how they would view it, at least if I ran a bank thats what I would. Foreclose the house, take what you get now and don’t loan anyone money for that house again without a sizable downpayment or until the market has bottomed. Keeping it on the books buy playing the principle lowering came just screws the bank over continually instead of once.

  25. Ardell –

    That is what Bernanke proposes, but I don’t think it will work that well. Consider you have a home with one of those liens on it, you gain nothing by selling it for more than you owe it just helps the bank. I would forsee a lot of folks either cash-back scamming such a deal, or many people just saying “who cares, let the nice family have it for $30k less, its only Wachovia that gets screwed”. Not only that, but selling it for a lower price would let them move it quicker to boot. If they were somehow forced to have to sell it such that the bank made back the cash, then we are in the situation we are in now with folks owing more than they can sell it for.

  26. Sniglet,

    If the people wanted the home in the first place and simply bit off more than they could chew, it should work. I’m assuming they stay in the house for a very long time with the new affordable payment.

    I have seen a situation where the owner could not participate in the growth in value with negative results. What they did was not put any money into fixing it for years and years. Lots of deferred maintenance. If they have no share in the growth until after the lien is satisfied, they may not want to put money into that new roof when they need one.

  27. b-the way that the silent seconds that some state bond money has is that the home owner will not have any penalties (or owe the second) if they retain the home for a certain period (like 7 years). If they sell or refi, before that time period, they are in deep weeds.

    We don’t do “state bond” at our company because of this…since we don’t do ’em…I’m not an expert on this.

    But…something like this could work where maybe the second mortgage is forgiven at a certain period of time to promote long term home ownership and detour “flipping” or speculators?

  28. Rhonda –

    I am not sure it would help very much in that case. The choice for these people would be basically: you get a freebie but are locked into the house for X years or you get screwed, otherwise you can walk away today and buy again in 3 years when your credit is better. I think most people would just still walk in that case. Not to mention the fact it would probably be politically hard to pass such a bailout, since I assume it would be the government eating the debt after X years as the banks have little incentive to do so.

  29. It’s amazing how once the do-do hits the fan, proposals that border on indentured servitude start looking attractive to otherwise rational people. What a mess.

    “As soon as you pay off this $200K lien, you’re free to go”

  30. rob-u-blind,

    Clearly they can leave anytime. All we’re saying is if the bank makes it possible for them to stay, the bank shouldn’t write off $100,000 and then the owner gets a big profit at the bank’s expense somewhere down the road. If they don’t sell until values go up again, they shouldn’t later pocket the money the bank forfeited at this time.

  31. ARDELL – March 8, 2008

    > If they don’t sell until values go up again, they shouldn’t later pocket the money the bank forfeited at this time.

    That’s a problem is it? The owner has 2 choices:
    A. walk away, buy another house free and clear at a lower price
    B. negotiate with bank to own the current house at a lower price, but
    with a lien.

    B. let owner to stay in the current house, assuming they have attachment, but A. holds more economic advantages.

    Walk away will continue, more owners would clamor for principal write downs, those who don’t get it will sue, bank lose more money than foreclosure.

    Personally I’m less against bailout of owners of 1 home that has no HELOC on them. But bailout of investors and HELOCers at the expense of banks and investors? No way.

  32. How many buyers in financial trouble are going to be able to get a decent loan on a new place? You’d probably need seller financing, which is tough to get these days due to due on sale clauses.

  33. Anna,

    I think it will depend on family circumstances. People moving out of the area for new jobs elsewhere may walk. People who moved in with three children who just started new schools, etc…would more likely be happy for temporary relief to hold them until things get better.

    There is no one size fits all solution. I’m not real supportive of people looking for relief or forgiveness of debt if the property was purchased as an investment vs. a primary residence. The nature of investment is sometimes it pans out and sometimes it doesn’t. I don’t understand how someone can have three successful flips projects that made money, and then want to be left whole if the fourth one doesn’t pan out.

  34. Ardell, the problem with your proposed solution is that it doesn’t help the fellow that you profiled. He’s in the military and will need to sell next year when he moves.

    His proposed solution (stop paying, save some cash until foreclosure) is the most rational choice he’s got. I just hope the military doesn’t hold it against him–I know bad credit can impact security clearances and even military promotions.

  35. Totally agree laxtosnoco. I was thinking more of the neighbors who are staying by buying each other’s homes.

    Dave is doing the best he can, and that’s all he can do. With a 1/3 price drop, it doesn’t make sense for him to wait for better times by renting it out. It would more than likely simply delay the inevitable. Better to get it behind him now.

    I hate the whole credit score system. Always did. Being just ” a number” was not good for our society in any way shape or form. 700 plus equals “good person” vs. 600 minus equals “bad person” makes me nauseous and does not come close to the real life circumstances I come across in real estate every day.

  36. I don’t know if he will or won’t need his “cheers”, but I do know that signature lines on a comment are redundant and inappropriate. No problem linking to your site as it does, and as many do. But signing off on comments as:

    Michael P. Lindekugel
    Financial Analyst
    RE/MAX Commercial
    Team Reba – RE/MAX Metro Realty, Inc

    Is considered blatant advertising and self-promotion on someone else’s blog. The absence of any others doing that is a tip off 🙂

  37. Before walking on the mortgage, you also need to investigate whether your state’s laws would allow the lender to sue you for a deficiency judgment by electing judicial foreclosure or a lawsuit on the promissory note you signed, instead of a non-judicial trustee sale type foreclosure. The lenders normally wouldn’t do that type of foreclosure because it is slower, and leaves you with redemption rights that complicate resale, but who knows what would happen if a solvent homeowner is trying to abuse the system as described in the original post about Sacramento.

    In California that would generally not be an available remedy to the lender because of strict anti-deficiency laws, but in Washington it might be possible for the lender to go after you for the deficiency. Legal advice should definitely be sought before walking on a mortgage, as others have said.

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