Feb012013

GSEs now permit unrestricted strategic default with no financial consequences

Paul Simon wrote There Are 50 Ways to Leave Your Lover. There are many ways people can leave their unwanted properties, but if the debt is recourse, they can’t walk away from the debt as the lender can track them down to force repayment. In fact, zombie debt collection will be a significant growth industry over the next decade as those who thought their mortgage debts were extinguished find out otherwise. You can’t just “step out the back, Jack.”

Most banks will now let borrowers off the hook if they complete a short sale. Of course, banks use the opportunity to demand the borrower liquidate other assets to repay the debt or they won’t approve the short sale. The main reason short sales take so long is because mortgage holders and borrowers fail to come to an agreement on how much money must be repaid. Many borrowers who fail to execute a short sale merely stop paying their mortgage and wait for foreclosure. They stop communicating with their lenders entirely, put their heads in the sand, and hope the debt disappears.

Now the GSEs are providing another option. For those borrowers current on their mortgages, if for any reason they want to get out, the GSEs will accept a deed-in-lieu and not go after any other assets. This should open the floodgates for struggling loanowners to strategically default with no financial consequences. They will still endure a hit to their credit scores, but they won’t have to sell any other assets or repay the shortfall. It’s an outrageous tax subsidy to irresponsible borrowers.

Fannie To Allow Walkaways by On-Time Borrowers: Mortgages

By Kathleen M. Howley – Jan 28, 2013 10:37 AM PT

Fannie Mae (FNMA) and Freddie Mac will let some borrowers who kept up payments as their homes lost value erase their debts by giving up the properties, helping Americans escape underwater loans while adding to losses at the mortgage giants bailed out with $190 billion of taxpayer money.

Non-delinquent borrowers with illness, job changes or other reasons they need to move will become eligible in March to apply for a so-called deed-in-lieu transaction that erases the shortfall between a property’s value and the size of its mortgage.

And what “other reasons” might those be? This will be so loosely defined as to permit any reason at all. At some point, they will stop asking because they know the answer doesn’t matter. If they want out, they can get out.

It follows a change in November that lets on-time borrowers sell properties for less than they owe, known as short sales, wiping out the remaining mortgage debt. Normally, the lenders could pursue people to recoup their losses.

Committing not to go after deficiency judgements and now allowing unrestricted walkaways ought to bring more properties to the market. Every borrower with a GSE loan that’s struggling or severely underwater will walk away.

It’s an extraordinarily generous approach for companies still in debt to American taxpayers,” said Phillip Swagel, a professor at the University of Maryland’s School of Public Policy in College Park, Maryland. “We’re giving people an incentive to walk away, right when the housing market is starting to right itself.” …

Generous? It’s a bailout. And yes, it will give people a huge incentive to walk away. In the long run, it will be good for the economy to purge the excess mortgage debt, but I don’t like being the one who has to pay for it through my tax dollars.

“Fannie and Freddie are playing catch-up, making these changes when defaults are falling and the housing market is coming back to some extent,” said Kurt Eggert, a professor at Chapman University School of Law in Orange, California. “It should have happened a long time ago.”

Right on, Kurt. I hope you’re a reader.

“The government is saying you can just turn in your home and we’re not going to come after you for the money you still owe,” said Peter Schiff, chief executive officer of Connecticut-based brokerage firm Euro Pacific Capital. “Some of these are going to be people who might otherwise have stayed in their homes and kept making payments.” …

Yes, and it will increase our taxpayer liabilities as a result.

“Fannie and Freddie are finally recognizing that some people are stuck in their homes,” she said. “There are a lot of families who need to move who can’t do it if they’re going to have debt hanging over their heads. There’s no winner when someone is forced to default on their mortgage — not the investor, not the homeowner, and certainly not the neighborhood,” Gordon said.

Bullshit. The homeowner benefits by getting rid of the black hole on their family’s balance sheet. The neighborhood benefits when a solvent borrower buys the home, and the community benefits from the additional spending money put into the local economy. The bank or the mortgage investor gets hurt, but they made a stupid loan, so they deserve to get hurt. Perhaps they won’t make stupid loans again next time.

For either a deed-in-lieu or a short sale, the failure to pay off the full mortgage balance will be reported to credit bureaus even as the amount is forgiven. The effect on scores will be nearly as bad as foreclosures, according to Fair Isaac Corp. However, if borrowers keep current with their payments during the process, they won’t take additional hits for delinquencies.

At least these consequences are still in place to provide some punishment to the borrower for taking on the debt in the first place.

To qualify for the programs, borrowers are required to have a 55 percent debt-to-income ratio — meaning 55 percent of their monthly gross income goes to paying debt. To be eligible, homeowners have to document a hardship, such as illness, for Fannie Mae and Freddie Mac to consider the deal. For a deed-in- lieu transactions, servicers must confirm the property is being left in good condition.

Those conditions will be lessened or waived entirely within a year in my opinion.

While Fannie Mae and Freddie Mac forgive any remaining first-lien obligations, they can’t control what the holders of second mortgages do. Last year they said servicers can offer the owners of home equity debt up to $6,000 to release borrowers from requirements to pay off those loans.“The second-lien holder gets a say — they don’t have to release the title,” said Mark Goldman, a mortgage broker at C2 Financial Corp. in San Diego. “It can get complicated when other people have a stake in a property.”

Most second lien holders will try to cut a deal. Most of these borrowers have little or no assets, so playing hardball with them will drive the borrower into bankruptcy where the second lien holder gets nothing.

Fannie Mae and Freddie Mac may require repayment of some of the shortfall between the value of the home and the mortgage balance — if the borrowers have the means. Homeowners who apply for deed-in-lieu transactions may be asked to make cash contributions of up to 20 percent of their financial reserves, excluding retirement accounts, according to the guidelines.

Borrowers will hide their assets to avoid any repayment. They do it now for short sales. I expect this requirement will go away in time too.

“I don’t have a huge amount of sympathy for someone who says they need help from Fannie and Freddie when they still have a vacation home,” said Dean Baker, co-director of the Center for Economic and Policy Research in Washington.

Actually, that doesn’t bother me as much. In all likelihood, their vacation home is deeply underwater. There is no second home market right now, and there won’t be for the foreseeable future. People with second homes couldn’t sell them anyway because they have no equity. The smart ones will walk away from those properties too, if they already haven’t.

“There are lots of families who are trapped in their homes,” said Gordon, of the Center for American Progress. “They need a way to get out.”

I have been an advocate of strategic default from the beginning of the housing crash. It makes no sense for a family to keep paying a mortgage much larger than a comparable rental when they are deeply underwater. This issue has me torn between my desire to see people get out of their debt troubles and my desire to see taxpayers protected from losses. I just hope this doesn’t happen again.