Lenders ambush newly solvent borrowers seeking old bad debts

For people who purchased properties in California, a non-recourse state, and never refinanced, lenders cannot come after them seeking to recoup their losses on a foreclosure. For those who live in recourse states, or California loanowners who refinanced, the situation is quite different. Lenders still have the right to pursue these borrowers for the deficiency, unless they agreed to a short sale in California after July 15, 2011.

Most borrowers walked away thinking the debt was extinguished. While it was detached from the property, borrowers are still legally liable for any shortfall on the lender’s books.

Lenders haven’t done much to collect on these old debts so far. Most lenders reason that they couldn’t get blood from a turnip, so they have been biding their time waiting for debtors to become solvent again and save some money that they can go after.

Lenders seek court actions against homeowners years after foreclosure

Kimbriell Kelly — Published: June 15

For Jose Santos Benavides, the ordeal of losing his home was over.

The Salvadoran immigrant had worked for years as a self-employed landscaper to make a $15,000 down payment on a four-bedroom house in Rockville. He had achieved a portion of the American dream, earning nearly six figures.

Then the economy soured, and lean paychecks turned into late mortgage payments. On Aug. 20, 2008, one year after he bought his dream home for $469,000, the bank’s threat to take his house became real via a letter in the mail. Just four days before the bank seized the property, he moved out, along with his wife and their two young children.

That wasn’t the worst of it.

In November, more than three years after the foreclosure, he was stunned to learn he still owed $115,000 — with the interest alone growing at a rate high enough to lease a luxury car.

“I’m scared, you know,” Benavides said. “I can’t pay.”

The 42-year-old is among the many homeowners being taken to court by their lenders long after their houses were taken in foreclosure. Lenders are filing new motions in old foreclosure lawsuits and hiring debt collectors to pursue leftover debt, plus court fees, attorneys’ fees and tens of thousands in interest that had been accruing for years.

It’s an aftershock of the foreclosure crisis, and most homeowners don’t know it’s coming.

“When people take out a loan, they generally think the home is the security for the loan,” said Alys Cohen, an attorney in the Washington office of the National Consumer Law Center. When they no longer have that home, “people don’t expect that debt to follow them,” she said.

Jose is not alone. Very few people who default and walk away from the property realize the debt is attached to them, not the house.

It works like this: A property with a $500,000 mortgage might be worth only $300,000 following the housing crisis. The $200,000 difference, or what’s commonly referred to as the “underwater amount,” is known to lenders as a deficiency balance.

It’s unclear how many people walk away from homes when they can still afford to pay the mortgage. Likewise, there is little publicly available data on how many people pay off their deficiency judgments. A recent government audit found the recovery rate at one-fifth of 1 percent. …

One-fifth of one percent? That’s a very, very small recovery rate. That comes to $1 out of $500. Of course, people are broke in the aftermath of the Great Recession, so they don’t have the money to pay even if they wanted to, which they don’t. However, once the recovery gets going, these people might have assets again, and the banks have something to gain by pursuing them.

Among the lenders pursuing the judgments are Fannie Mae and Freddie Mac, the two quasi-governmental lending agencies … Officials at those agencies said the judgments are necessary to recoup money lost in the crisis.

“Pursuing deficiency judgments has always been a remedy that we have looked at to mitigate our losses prior to the recent housing crash,” said Freddie Mac spokesman Brad German. “It is not a new thing.”

German said Freddie Mac is targeting “strategic defaulters,” which the agency defines as “someone who had the means but chose to go into default, that there were no extenuating circumstances that affected their ability to pay. If you’re choosing not to pay off your mortgage, but you’re paying other bills, we would consider that strategic default.”

Banks have blustered about going after strategic defaulters from the beginning of the housing bust, but they’ve done little about it. Perhaps they are waiting for more of those former borrowers to have assets, or perhaps it was just a bluff that millions of borrowers called.

In 2011, Fannie and Freddie flagged 12 percent of 298,327 properties they had foreclosed on — more than 35,000 — for deficiency judgments in an attempt to collect $2.1 billion in unpaid mortgage debt …

Good luck with collections. I doubt they recover much. If the going rate is one-fifth of one percent, they stand to rake in a whopping $4.2 million. Given what they will spend in attorney’s fees to get this money, they’ll be lucky to make anything.

Fannie is also pursuing defaulting homeowners as a “deterrent” for people who might be thinking about defaulting in the future, Van Order said. Fannie Mae has hired debt collectors to pursue people in 38 states and the District, while Freddie Mac has taken homeowners to court in 17 states and the District.

Suing people immediately after foreclosure was problematic. For one thing, lenders usually could not get more money out of already broke homeowners. But, if lenders waited a few years, some forecast that people would have money again once the economy recovered.

The irony is not lost on Evan Goitein, a Bethesda-based foreclosure attorney.

“There is very little to be gained from the bank’s perspective to be suing people for the money at this point,” Goitein said. “While deficiency judgments are not really a problem right now, I can see it being a big problem in the future. So seven years from now when my client has recovered from his foreclosure, he’s got a job again, he’s saved up enough money . . . [from the bank’s perspective], that would be a great time for the bank to try to sue them.”

And that’s why they wait, patiently, for the economy to get better.

Rep. Elijah E. Cummings (D-Md.), who in the past has been a defendant in foreclosure filings on his personal home, said he supports deficiency judgment reform.

“I strongly support policies and aid initiatives that will minimize or even waive deficiency judgments against borrowers to help ensure that such judgments do not compound the harms borrowers have already suffered,” he said.

Bankruptcy is always an option. We don’t need deficiency judgement reform. Either people must repay their debts or give up their assets to pay what they can. Money is fungible. Any deficiency judgement reform that allows people to extinguish debt without surrendering their assets is state-sanctioned theft.

Already-foreclosed homeowners won’t know that they’re being targeted until they receive the court notice. In many cases, it is hard to even know who owns the debt until the notice arrives. Often times, the entity pursuing the debt is not the original lender, because that debt can be sold by the homeowner’s lender to someone on the secondary debt market for pennies on the dollar. Most of the deficiency cases that Goitein said he sees involve smaller banks.

Because the debt is old, accruing interest becomes a major cost to homeowners.

Getting that letter in the mail is akin to opening a package From Ted Kaczynski. Can you imagine how you would feel opening that letter?

The wave of deficiency judgments had a prologue in Texas.

During the 1980s in Houston, the bottom went out of the oil market, with the price dropping to about $15 a barrel. Homes that had been assessed at $200,000 couldn’t be sold for $100,000. More than 200,000 people lost their jobs and could not pay their mortgages.

The lenders foreclosed on the homes and then pursued the homeowners for the outstanding balance.

Once a judgment was granted, debt collectors had 10 years to collect, according to the Texas statute at the time, and another 10 years if the debt collector petitioned the court to renew the judgment.

“It was an absolute disaster,” Mixon said.

In response to the situation, the state passed laws increasing consumer protections in deficiency cases.

“It’s less an event in Texas today than it was back then,” Mixon said. “But Texas still provides the object lesson of what could happen.”

But for the moment, efforts to pursue deficiency judgments are ramping up rather than winding down.

A friend of mine in graduate school had gone through the oil bust, lost his house, and owed the bank $35,000. He worked out a payment plan because he had assets and didn’t want to give them up. I felt sorry for him because he was one of many caught up in circumstances beyond their control, but sometimes shit happens, and he found a solution that worked for him. Many others who didn’t have assets declared bankruptcy and started over.

Both parties are acting badly

I am bothered by both how borrowers and bankers are acting in this circumstance.

First, most borrowers are walking away from their responsibilities without ensuring the debt can’t chase them. Like the fool in the cartoon above who thinks the bank has merely forgotten about him, most borrowers believe that if the bill collectors aren’t hassling them, they must not owe money. This is a mistake. Borrowers in these circumstances should contact a debt and bankruptcy attorney and find out what they must do to protect themselves. It would be wiser to declare bankruptcy while they’re broke rather than have to make that decision later when they recover.

Second, I don’t like how banks are acting either. They are laying in ambush. It’s a despicable, sneaky, underhanded, rotten way to behave. They are intentionally letting borrowers believe the debt is behind them so they will move on with their lives and obtain some assets they can later take. If borrowers realized they had this overhanging threat, they would likely do something to extinguish their debts rather than waiting to give everything to a zombie debt collector for something years past. Of course, many borrowers remain willfully ignorant to the old debt in hopes it just goes away, so each party is trying to take advantage of the other. It’s hard to feel sorry for either party because there is so little to praise about what either one is doing.

The American Dream

Many people want to immigrate to the United States so they too can have a chance at obtaining the American Dream. Can you imagine the stories that recent immigrants must have relayed to those in the “old country” when the housing boom was going on? How do you explain to someone who comes from a stable (or practically non-existent) housing finance system that doesn’t “innovate” what went on in America in 2004, 2005, and 2006?

Immigrant: “In America, they will give you a house with no job and no savings.”

Back Homey: “We have government housing too.”

Immigrant: “No, here in America, they give you the home. You own it.”

Back Homey: “No way!”

Immigrant: “It gets better. After a little while, the house goes up in value, and they give you that money too.”

Back Homey: “You’re making this up. That sounds just like our government housing and welfare. Who pays for all that?”

Immigrant: “The market. You see, house prices always go up, so the market pays for the house. The government doesn’t pay anything.”

Back Homey: “Wow! Those Americans are really smart and sophisticated. I wish our bankers were half as innovative as the Americans are. I want to come to America too.”

The former owners of today’s featured property paid $253,000 on 8/7/2003. They used a $202,560 first mortgage, a $37,980 second mortgage, and they opened a $37,980 HELOC, some of which was likely a down payment. They put little or nothing into the property.

The refinanced on 9/15/2005 with a $280,000 first mortgage, and they followed up with two HELOCs, one for $98,000 and one for $108,000. Assuming they maxed out this final HELOC, they extracted $135,000 from this property after putting nothing down in 2003.

I wonder what stories they told their relatives?

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2638 West MONTE CARLO Dr #28 Santa Ana, CA 92706

$299,900    ……..    Asking Price
$253,500    ……….    Purchase Price
8/7/2003    ……….    Purchase Date

$46,400    ……….    Gross Gain (Loss)
($23,992)    …………    Commissions and Costs at 8%
$22,408    ……….    Net Gain (Loss)
18.3%    ……….    Gross Percent Change
8.8%    ……….    Net Percent Change
1.7%    …………    Annual Appreciation

Cost of Home Ownership
$299,900    ……..    Asking Price
$10,497    …………    3.5% Down FHA Financing
4.02%    ………….    Mortgage Interest Rate
30    ………………    Number of Years
$289,404    ……..    Mortgage
$89,534    ……….    Income Requirement

$1,385    …………    Monthly Mortgage Payment
$260    …………    Property Tax at 1.04%
$0    …………    Mello Roos & Special Taxes
$62    …………    Homeowners Insurance at 0.25%
$326    …………    Private Mortgage Insurance
$280    …………    Homeowners Association Fees
$2,313    ……….    Monthly Cash Outlays

($208)    ……….    Tax Savings
($415)    ……….    Principal Amortization
$15    …………..    Opportunity Cost of Down Payment
$57    …………..    Maintenance and Replacement Reserves
$1,762    ……….    Monthly Cost of Ownership

Cash Acquisition Demands
$4,499    …………    Furnishing and Move-In Costs at 1% + $1,500
$4,499    …………    Closing Costs at 1% + $1,500
$2,894    …………    Interest Points at 1%
$10,497    …………    Down Payment
$22,389    ……….    Total Cash Costs
$27,000    ……….    Emergency Cash Reserves
$49,389    ……….    Total Savings Needed
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