I have written extensively on strategic default. I have been an advocate of strategic default because it is generally the best financial decision for a family. When a loan owner is underwater and making payments far larger than the cost of a comparable rental, they are throwing their money away on mortgage interest to support a depreciating asset. That’s pretty stupid.
One reason millions of underwater loan owners don’t strategically default is because they perceive it as immoral. We have debated this issue at length in the astute observations of this blog, but it comes down to a simple choice between competing values. Is a borrowers promise to repay their debt a greater moral obligation than their need to provide financial stability for their family? In my mind the key distinction is who the borrower values more, the bondholders of the bank, or their own family. One of the two is going to suffer financially.
Loan owner options
When a loan owner is underwater, and they want to get out from under the weight of their mortgage obligations, they have three options: (1) keep paying, (2) strategically default, or (3) short sell the property. 
Most of the discussions about strategic default have focused on the first two options, pay or default because short sales take forever, and because the borrower is often forced to chose between the first two options anyway. However, lately lenders have been more willing to approve short sales, probably due to the increased incentives under HAMP II and the losses they must document under the robo-signer settlement. Banks will now approve short sales in as little as 20 days.
Lenders are frightened about the prospect of millions of underwater loan owners strategically defaulting because the losses would be staggering.The new shift to short sales raises unsettling problems for the banks. What if the millions drowning in debt decide they want to short sell? The strategic short sale is advantageous for the same reasons strategic default is. Those that short-sell today will be able to repurchase at the bottom, and they will have equity far sooner than if they hold on to their existing bloated mortgages. And now that lenders are willing to approve short sales, it’s likely that millions will chose that path.
Short sales are morally acceptable
Short sales have little or no stigma associated with them. Unlike strategic default, short sales are completely acceptable despite the fact there is basically no difference between the two. In a short sale, the borrower is failing to live up to the promises they made to repay the lender according to the contract just as in a strategic default. The one and only difference between a short sale and a strategic default is permission from the lender. In a short sale, the lender agrees that paying them less is okay. In a strategic default, the lender makes no such concession.
Apparently, getting permission from the lender to break the contract makes it morally acceptable. Lenders don’t want to approve short sales. They want all their money back. The only reason they are approving these sales is because they feel they have to. The underwater borrower has tremendous leverage. If the lender does not want to approve the short sale, the borrower can always strategic default and leave the lender holding property worth far less than the loan balance. In my opinion, the concession under duress is not freely given and therefore not morally pure. Short sellers don’t worry about such nuances. Short sellers don’t have issue with taking advantage of the lender’s weakened bargaining position to force a unilateral contract change totally in favor of the borrower.
Perhaps a short sale is like a loan modification on steroids. Loan modifications are morally acceptable, right? They suffer from the same coercion problem I outlined above, but borrowers have come to view these unilateral contract changes in their favor as an entitlement. A short sale is a mutually agreed upon loan modification where the lender takes less than the outstanding balance as payment in full. Loan modifications, and short sales are both unilateral contract changes forced on lenders under duress. These are substantive changes to the initial agreement. At least a strategic default doesn’t change the agreement. In the mortgage, the borrower agrees to give up the property if they quit paying under the terms of the note.
Despite the variety of moral ambiguities with strategic default, loan modifications and short sales, the consensus of opinion on the subject is simple. Most borrowers believe strategic default is wrong, and short sales and loan modifications are right. So be it.
Hurry and cash in on short-sale tax savings
Mortgage debt relief law set to expire at the end of the year
Amy Hoak’s Home Economics — June 4, 2012, 12:01 a.m. EDT
CHICAGO (MarketWatch)—An increasing number of homeowners who are underwater on their mortgage are selling their homes by short sale, and that could become an even more popular option during the rest of the year.
That’s partly because of a law set to expire at the end of 2012 that offers tax relief for homeowners who sold their home in a short sale or have had some other sort of mortgage debt forgiven or canceled, such as in a foreclosure or modification that included principal reduction. While there are efforts in Washington to extend these tax benefits, it’s hard to guess whether they’ll be renewed.
The tax forgiveness will almost certainly be extended, but the threat of an expiring deduction will be used by realtors to get more people to short sell their properties.
So those who think they might be able to take advantage have been stepping up, while they still can.
“Everybody [considering a short sale] needs to talk to a CPA and see if now is the time for them to get off the Titanic and in a lifeboat before this law expires,” said Marge Peck, associate broker and co-owner of Discover Arizona Real Estate in Mesa, Ariz. The company specializes in short sales. “I’ve just hired more staff. We’re prepared for the tsunami of people saying ‘I’ve waited long enough, nothing’s going to change.’”
That’s capitulation. Loan owners have been holding out hoping for principal reduction or the return of inflated market prices. Lenders have been eager to foster false hope in borrowers to keep them paying and make the banks look solvent. The strategic short sale may be a sign of final capitulation.
… Without the current tax law, if the bank forgives that amount the borrower is underwater, such as through a short sale, they’d be subject to pay taxes on that forgiven amount, since the Internal Revenue Service regards it as income.
… “Of course, the concept always strikes people as strange. They’re struggling and trying to get debt forgiven and then are hit with a tax,” Luscombe said.
It may strike them as strange, but debt forgiveness is income. At one point, these borrowers were given a lot of money by a lender who hoped to get it back. This money was not taxed as income at the time because the borrower was supposed to repay it. However, when the borrower doesn’t repay it, it was a gift of free money from the bank that should be treated as income.
To help taxpayers during the housing bust, Congress passed the Mortgage Debt Relief Act of 2007, removing that tax burden. …
The law has been renewed once already, Luscombe said. Trade groups such as the National Association of Realtors are currently lobbying for the relief to be extended once more.
But eventually this law is expected to expire. It’s just a matter of when: “This one is probably going to sunset at some point. It’s a question of whether Congress thinks this is the right time or not,” Luscombe said. …
It’s very unlikely Congress will put the screws to loan owners any time soon. They could just pass a law extending this tax break permanently for anyone will a loan from 2007 or earlier, but they won’t. By having to extend it every year, they can create false urgency to motivate sellers.
Short sales rising
Short sales made up 9.1% of all home sales in March, up from 7.39% in March 2011, 6.67% in March 2010 and 4.79% in March 2009, according to figures from CoreLogic, a provider of consumer, financial and property information.
Pre-foreclosure sales were up 25% in the first quarter, compared with the first quarter of 2011, according to a report from RealtyTrac….
“I think we will continue to see them go up,” Blomquist said. “It’s like the pattern you saw with the home buyer tax credit—the biggest spike is at the end of the deadline. I would expect to see a similar pattern with the pre-foreclosure sales.”
We will see more short sales this year, but as I pointed out in a recent post, banks cannot force a short sale.
But short sales don’t have to be for homes in the foreclosure process….
Underwater loan owners who are delinquent on their mortgages but who haven’t been served a notice are shadow inventory. Any sales from shadow inventory would be short sales. There are only a few ways a property escapes shadow inventory: (1) short sale, (2) cured loan, (3) foreclosure, and (4) rising prices. Since prices are not rising and since very, very few loans get cured, most shadow inventory ends up as short sales or foreclosures.
In fact, in six out of 10 short-sale listings her company takes on now, the borrower is current on his or her mortgage, Peck said. While banks may want a monetary contribution from the borrower in this case, the situation often means less damage to the homeowner’s credit score, she said.
Most underwater loan owners are still paying their mortgage. I didn’t realize that 60% of short sellers were current on their mortgage. I would have guessed it was much smaller. What’s the point paying when you know you are going to sell with no equity? Either way the loan owners credit is hurt. The common perception is that the credit score is hurt less, so people keep paying. What is 40 points on a credit score worth?
“I work with homeowners that brought properties at the wrong time because the market was sky high… now so many homeowners don’t know what to do,” she said.
Almost 16 million U.S. homeowners with mortgages were underwater in the first quarter of 2012, meaning they owe more than their home is worth, according to recent data from Zillow, a real estate website. But 90% of those underwater borrowers are paying their mortgage on time.
There’s still time
While short sales have notoriously taken a long time to complete, there’s still time for sellers to get these transactions done before the end of the year….
Lenders may be more open to approving these transactions, too….
Thank the robo-signer settlement for that one.
Also, in June, new policies go into effect for Fannie Mae and Freddie Mac mortgages in an attempt to streamline short sales. Mortgage servicers will be required to review and respond to requests for short sales within 30 days of receiving a short sale offer, the Federal Housing Finance Agency announced in April. They’ll have to provide weekly status updates if the short sale is under review beyond those 30 days, and will need to get a final decision to the borrower within 60 days of the offer.
If the GSEs and the FHA are speeding up short sales, we will see many more of them this year. Short sales are another form of lender capitulation. They want to clear out their shadow inventory, and short sales and foreclosures are their only viable alternatives.
Stereotypical Ponzis
The former owners of today’s featured property are a familiar stereotype. They put nothing down, Ponzi borrowed as lenders offered them free money, then they walked away when the ATM machine was shut down.
- This property was purchased on 10/4/2001 for $249,000. The property records say they borrowed $249,000 and put nothing down.
- On 1/6/2003 they were given $68,700 in free money through a HELOC.
- On 12/2/2003 they refinanced with a $300,000 first mortgage and obtained a $37,500 HELOC.
- On 2/2/2006 they refinanced with a $417,000 first mortgage bringing their mortgage equity withdrawal to $168,000. Small timers by OC standards.
- On 10/22/2010 they were issued a Notice of Default, so they quit paying in July 2010 at the latest.
- They turned over the keys with a Deed in Lieu of Foreclosure on 9/27/2011, and the bank sat on the property until this spring hoping to time the rally.
La Habra Overview
Median home price is $268,000. Based on a rental parity value of $437,000, this market is under valued.
Monthly payment affordability has been worsening over the last 2 month(s). Momentum suggests worsening affordability.
Resale prices on a $/SF basis increased from $207/SF to $207/SF.
Resale prices have been falling for 12 month(s). Price momentum suggests falling prices over the next three months.
Median rental rates increased $75 last month from $1,739 to $1,814.
Rents have been slowly rising for 1 month(s). Price momentum suggests slowly rising rents over the next three months.
Market rating = 6
Proprietary OC Housing News home purchase analysis 
2601 West STANTON Ave La Habra, CA 90631
$332,500 …….. Asking Price
$249,000 ………. Purchase Price
10/4/2001 ………. Purchase Date
$83,500 ………. Gross Gain (Loss)
($19,920) ………… Commissions and Costs at 8%
============================================
$63,580 ………. Net Gain (Loss)
============================================
33.5% ………. Gross Percent Change
25.5% ………. Net Percent Change
2.7% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$332,500 …….. Asking Price
$11,638 ………… 3.5% Down FHA Financing
3.74% …………. Mortgage Interest Rate
30 ……………… Number of Years
$320,863 …….. Mortgage
$84,761 ………. Income Requirement
$1,484 ………… Monthly Mortgage Payment
$288 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$83 ………… Homeowners Insurance at 0.3%
$334 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
============================================
$2,190 ………. Monthly Cash Outlays
($225) ………. Tax Savings
($484) ………. Equity Hidden in Payment
$14 ………….. Lost Income to Down Payment
$103 ………….. Maintenance and Replacement Reserves
============================================
$1,598 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$4,825 ………… Furnishing and Move In at 1% + $1,500
$4,825 ………… Closing Costs at 1% + $1,500
$3,209 ………… Interest Points
$11,638 ………… Down Payment
============================================
$24,496 ………. Total Cash Costs
$24,400 ………. Emergency Cash Reserves
============================================
$48,896 ………. Total Savings Needed
——————————————————————————————————————————————-
We're sorry, but we couldn't find MLS # F12069464 in our database. This property may be a new listing or possibly taken off the market. Please check back again.
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$324,900 2511 West LAMBERT Rd |
0.35 miles 3 bd / 1.75 ba 1,138 Sq. Ft. |
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$424,999 11832 LARRYLYN Dr |
0.47 miles 3 bd / 2 ba 1,427 Sq. Ft. |
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$359,999 640 MARDINA Way |
0.61 miles 3 bd / 2 ba 1,448 Sq. Ft. |
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$345,000 2381 FOXDALE Ave |
0.66 miles 3 bd / 1.5 ba 1,395 Sq. Ft. |
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$417,000 2271 CANTERBURY |
0.7 miles 3 bd / 1.75 ba 1,259 Sq. Ft. |
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$205,000 913 GLENCLIFF St |
0.76 miles 2 bd / 2 ba 1,140 Sq. Ft. |
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$299,500 590 JUNIPER Way |
0.78 miles 2 bd / 1.5 ba 1,435 Sq. Ft. |
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$329,000 16052 SANTA FE St |
0.8 miles 4 bd / 2 ba 1,220 Sq. Ft. |
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$379,900 2511 GREENBRIER Ln |
0.81 miles 3 bd / 2 ba 1,167 Sq. Ft. |
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$335,000 11717 GROVEDALE Dr |
0.82 miles 3 bd / 1.75 ba 1,382 Sq. Ft. |
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51 Responses to “Strategic short sales, the moral alternative to strategic default”
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I would have already thought the govt would have extended the mortgage forgiveness act, or we would be hearing more about it from congress. One way to speed up the bottoming process in housing, is to allow this law to sunset. There are thousands of Orange County squatters living mortgage free, and the threat of a receiving a huge 1099 at the end of the year might get them to act. We cannot have a housing recovery until they are out.
However, these are politicians that are in an affair with the banks … and they always take the easy road when it comes to money … therefore they’ll probably extend the law right before it expires.
I don’t believe the congress will ever eliminate the mortgage interest tax deduction … at least not in our lifetime. However, I think they will restrict it on high income earners and high mortgage balances. And I do think this will happen quicker than most believe.
http://www.npr.org/blogs/money/2012/06/06/154344781/why-does-the-mortgage-interest-tax-deduction-still-exist
Do you don’t think they will do a 20 year phase out? Or something like that I know people love it, but the governments looks at the deduction as lost income.
Au contraire…. with 30yr money sub-4% (on its way to 3) the benefit of the mort interest deduction is dimished accordingly. When a benefit becomes negligible, it will be easier to eliminate.
It’s happening with me. I hope it gets phased out over a long period. Let’s not subsidized home owners and not renters. Let’s just end it.
Agreed. The federal government is foregoing less and less tax income collection as mortgage rates go down to new historic record lows. We should be at 8.5% on average. We’re seeing 3.25% and lower.
Now, when rates finally do go back up, well the benefit of MID starts to raise eyebrows again.
As a homedebtor right now, I would be indifferent. Retracting MID would not destroy my ability to afford and pay. This is not the case for all homedebtors in CA. Many literally rely on it just to get by.
However, many countries like UK and Canada do not have MID, and I used to believe this helped stabilize their housing markets. I was wrong to think that. But the one thing an absence of MID does provide is fairness. Renters are of course “paying the mortgage” too (as I did for 6 years myself) and received zero income tax or property tax benefit. And it pissed me off. Such a configuration is not just.
A better question is “what is the main objective of a mortgage interest deduction, and is this strategy still valid for the country?”
If it were completely eliminated for 2012, our taxes would increase $17K! That’s one reason some sort of phase-out would need to be discussed.
I agree Lee. That’s one of the many reasons I want to refi. The MID reduces our taxes $1,400+ each month. It really takes a bite out of the 2007 mortgage rates we’re paying.
I expect our taxes to increase over the next few years, further increasing the benefit of the MID. I just don’t think we can count on it lasting.
The HMID is a likely target for elimination because it’s such a costly subsidy that does little other than inflate house prices for high wage earners. If there were no HMID, you would likely have paid much less for your house, and your mortgage payment would have reduced by the $1,400 you are currently saving on taxes. The market will find a new equilibrium based on what people can afford to pay from their incomes.
In a typical mort contract, there is no specific reference to a ‘moral’ obligation to repay, thus, should a debtor chose not to repay, the act of strategic default could not be deemed – immoral. Just say’n
I have made the same argument many times. Most counter with the notion of the morality of keeping your promises. In the promissory note, the borrower promised to repay, and when they strategically default, they are breaking their promise.
What about the morality of passing your debts off the commons?
Politicians deserve the blame for that. If they hadn’t agreed to pick up the tab for the bank’s losses, the commons wouldn’t be paying the price.
Morality has nothing to do with business contracts. Entering a contract knowing that you will default is one thing…I think that is rarely the case. There is always a clause of what will happen if you quit making payments. Guido comes to tow away your car, bill collectors hound you, you get booted from your house, etc.
Regarding all the HELOC abuse cases you profile, I’m sure most of these fools thought this would go on forever (real estate only goes up!). The music stopped and they had to pay the piper which was probably unexpected.
I have an ebook on Amazon, Apple and BN that proves strategic default is moral because of the ponzi scheme that the financial elite created. The author fails to hit the nail on the head here. My ebook: Personal Finance:Strategic Default will set struggling homeowners straight on what is happening. Also, if the tax forgiveness runs out at the end of the year or whatever, these homeowners will be in a world of hurt.
You are new to my writing. Check out this post: Strategic default is moral imperative to prevent future housing bubbles.
“Strategic default has been portrayed as immoral by lenders. This is wrong. Lenders were immoral when they abdicated their responsibility to sound lending practices that ensured their borrowers could remain solvent. It is outrageous after such irresponsible lender behavior that lenders have the nerve to chastise borrowers for being immoral when borrowers fail to repay their debts.
Borrowers have moral responsibility to default on loans where the payment on an amortizing mortgage exceeds the cost of a comparable rental.
If borrowers don’t default, if lenders are given a free pass to make another generation insolvent, then we have failed our children. We are sentencing them to live in a world where lenders enslave them through excessive mortgage payments to afford properties comparable to rentals.
Without the fear of strategic default, lenders will conflate asset-backed debt and signatory debt again. Lenders will inflate future housing bubbles, and our children will be faced with the decision to own something far less desirable than what they can rent or sentence themselves to a lifetime of debt servitude.
The next time you read or hear that borrowers who default are being immoral, ask yourself who is really being immoral, the lender or the borrower. In my opinion, it is the lenders who were immoral when they inflated the housing bubble and over-burdened borrowers. The borrower who strategically defaults is behaving morally by doing what’s best for their family.”
This is not an either/or scenario.
The lenders are immoral, the debtor are immoral, and the governmental is immoral for allowing this to be passed off on the tax payors.
Very true. Nobody involved in the transaction is guiltless here.
It’s chain reaction of consequences. A immoral act leads to B immoral acts then to C immoral acts.
Truer words never spoken, IR:
if lenders are given a free pass to make another generation insolvent, then we have failed our children
As IR also points out, our post-2000 insanity includes a massive, new, larger than life size, student loan scam. This lend-a-palooza comes with its own mega-insolvency for the next generation, worsening rapidly, and its own bank-caused boom-crash recession so EVERYONE of the youth is desperate to improve their dismal chances at upper and middle class by going to college, but of course, the jobs are scarce because…they were exported or eliminated due to corporatacracy run amok. Oh, and how about the irresponsible manner of running up a fifteen trillion federal debt, plus doubling the municipal debt in under ten years plus unfunded pensions? My conclusion: Yep, we have utterly, absolutely, irretrievably failed our children. At least they can marry well…well, not without secure jobs and no loan debt and as to California, not with a court system that seems to make many young men feel marriage is an over-risky penalty state of servitude, so don’t do that (and, they aren’t).
And then the banko-politicos want to know where are the new buyers for homes (and especially buyers who qualify for non-subsidized government backed loans). Meaning: IR is correct that either this is not now the time of the housing price bottom in Orange County, or if so by some miracle, that the housing market in Orange County faces fewer and fewer qualified and eager new buyers for the next five years. The trends have been worsening since 2000 and accelerated after the crash.
You know what, I’ve been hearing the economy is “bad” since 1978. No, really.
Bad indeed…… what cost $20 in 1978 now costs about $71.
Meanwhile, US wages as a % of the economy have TANKED since the 70′s.
http://static7.businessinsider.com/image/4fcf9a4c6bb3f7d52c000003-590/in-short–while-ceos-and-shareholders-have-been-cashing-in-wages-as-a-percent-of-the-economy-have-dropped-to-an-all-time-low.jpg
Notice how the ‘things’ began to go downhill right about the time Nixon ended the $ gold-standard in ’71.
The fed will print more money to keep mortgage interest rates falling. QE3 is coming…
Lockhart Says Extending Operation Twist Is ‘On the Table’
Federal Reserve Bank of Atlanta PresidentDennis Lockhart said extending Operation Twist, the program to lengthen maturities of debt on the central bank’s balance sheet, is an “option on the table.”
“There is capacity to do more,” Lockhart said today in response to audience questions after a speech in Fort Lauderdale, Florida. “It is certainly an option. I’m not going to speculate on what the FOMC will do,” he said, referring to the Federal Open Market Committee.
The policy-setting FOMC meets June 19-20 to consider whether more stimulus is needed after the economy added the fewest jobs in a year in May. Fed Vice Chairman Janet Yellen will discuss the outlook for the economy and policy tonight in Boston, and Chairman Ben S. Bernanke is due to testify before Congress tomorrow.
“What Lockhart said today is that he’s certainly on board if that’s what the chairman and the majority of the FOMC want to do,” said Stuart Hoffman, chief economist at PNC Financial Services Group Inc. in Pittsburgh. “He’s not going to stand in the way.”
A big difference between a short sale and strategic default, is that you have to qualify for a short sale. There is no qualification or permission necessary in a strategic default. I don’t know how bad your financial position has to be to qualify for a short sale, but I know you’re not being approved for one if your financials are fine.
“…Without the current tax law, if the bank forgives that amount the borrower is underwater, such as through a short sale, they’d be subject to pay taxes on that forgiven amount, since the Internal Revenue Service regards it as income…”
The key word there is “forgive.” If the bank is not forgiving anything, there is no tax consequence. e.g. In CA, a deficiency resulting from a purchase loan or a non-judicial foreclosure is not “forgiven debt” and therefore the deficiency is not taxable income.
“…Since prices are not rising…”
Hmm, the prices of the Mirabella townhouses in Columbus Square have increased every month for the last year. It’s shocking, but true. The end-units are currently sold out!
If I wanted to do a strategic short sale and the lender didn’t approve me, I would immediately strategically default. I suspect many feel the same. Strategic default is an escape route whether or not the bank approves of it.
BTW, my agent in Las Vegas told me one of his clients from California who had over $1M in liquid savings was approved for a short sale in Las Vegas in 20 days with no recourse. That tells me the approval process is getting much easier.
10 yr US treasuries hit 1.619% yesterday. A record. Unreal.
http://www.forbes.com/sites/afontevecchia/2012/05/30/record-low-treasury-yields-a-harbinger-of-coming-bond-market-collapse/
The reason why the strategic short sellers are still paying on time, as agreed? They want to buy again in 24 to 36 months with an FHA insured loan. The Government (through FN/FRE) bought the loan, they backstopped some of the servicers losses when the short sellers got out of Dodge, and in time they will insure the borrowers new loan against a future default. What a tangled web is weaved once the Feds get involved.
I get plenty of calls from ready and willing buyers who had a short sale / foreclosure suddenly able to put 25-30% down after what should have been a personal asset base disaster. What was the source of this sudden wealth? The reader already knows – it was stuffed away somewhere as the buyer claimed financial ruin to convince the bank to cut the principal on their cash out refinanced loan. Wash, rinse, repeat. The cycle will never end it seems.
During the next housing bubble, people will open foreign bank accounts and put all their HELOC booty away in these hidden havens. When prices crash, they can cry poor and after the taxpayers eat the losses, the money can come back from overseas to buy houses at the bottom. Nifty way to steal from taxpayers, don’t you think?
If you believe cash out from equity will flow to European banks, I’ve got a bridge for sale I’d like you to take a look at. Are there any good places to put cash other than hard assets now?
Larry Miller needs to hawk a few mattresses with safes built in. He’d do gangbuster business.
I suppose that’s true. Perhaps everyone will buy gold coins, or they will become doomsday preppers and load up on booze and feminine hygiene products.
…of note, assets that are unattached (no liabilities) and movable will generate the highest returns/values.
I think it’s time we start another gold rush “reality” in Alaska. I just need a loader and tracker. I have the south box. Who has a tracker?
Well, IR, look at the Irvine+Tustin+Foothill Ranch market right now, the next housing bubble is here already. This will be spreading to other areas like wildfire.
I don’t get why anyone would do a short sale. Why voluntarily give up your rent-free house? Why not milk it for everything you can, stay there until they drag you away? You don’t gain anything at all with a short sale, there’s no equity in it for you.
The only thing I can think of it might be less of a black mark on your credit vs foreclosure. But aren’t even those who have been foreclosed on finding they repair their credit rating in short order?
The benefit of staying and squatting is the biggest hurdle banks face in convincing more loan owners to short sell. For those who have already strategically defaulted, there isn’t much point in a short sale.
As the article pointed out, and as SGIP pointed out above, many who short sell are still paying the mortgage. For those people, a short sale makes sense because they get out from under the debt, and they will be able to buy back in sooner.
Yes, a short sale gets them out from under the debt, but foreclosure does too… from the point of view the homeowner (loanowner) it would still make more sense to have the bank foreclose rather than do a short sale.
To me, it’s a wonder that more homeowners underwater keep paying their mortgage. The banker/government propaganda is working.
Once bitten by the housing bug, some buyers are ready for a second nip. A foreclosure puts you out of the buyer pool for 7 years. If you still pay on your loan during a short sale it’s 2 to 3 years before you can buy again. These “boomerang buyers” are clamoring to re-buy even though renting might make more sense. It’s a true mania. I wish I could tape some of the conversations that reflect just how desperate some recent SS or FC loan owners are to re-buy again. You wouldn’t believe the passion of these people.
“I wish I could tape some of the conversations that reflect just how desperate some recent SS or FC loan owners are to re-buy again. You wouldn’t believe the passion of these people.”
It wouldn’t surprise me at all. Once you had an ATM machine with unlimited funds, it’s pretty hard to go back to earning your spending money.
Not to mention some people view renting as being lower on the socio-economic scale even if it makes sense financially. There is also lots of family pressure. Baby boomer parents did great in California real estate, junior should be able to do the same. Then there is also the strong female nesting instinct, it’s difficult to establish a nest when the landlord might not renew your lease.
Then there is also the new fangled reason to be a homeowner, as witnessed the government treats homeowners much better than renters in every given way! More and more people are becoming aware of this daily.
“Then there is also the new fangled reason to be a homeowner, as witnessed the government treats homeowners much better than renters in every given way! More and more people are becoming aware of this daily.”
That is the biggest change that came from the housing bubble. The disparity between how loan owners were treated and how renters were treated is appalling.
I know what you’re talking about – the passion or hysteria to buy again. Know some folks like that myself. I know some that go through the slow, slow foreclosure process – stop paying the mortgage and bank it with the idea of using it for the next down. Makes sense, let the house you are paying on go back to the bank. It will not be worth what you owe on it for the next decade at least, then buy one down the block for 30% less.
But, I’ve also read where many who have been foreclosed on have been able to have their credit ‘repaired’ in a matter of months. Of course, they are people with good incomes, but still it seems like the penalty for foreclosure can be minimal.
You have touched on one of the dilemmas faced by bankers. They want to make the punishments for strategic default and foreclosure high in order to provide a deterrent. However, bankers need these buyers to absorb all the foreclosures, so they try to strike a balance.
IR,
“When a loan owner is underwater and making payments far larger than the cost of a comparable rental, they are throwing their money away on mortgage interest to support a depreciating asset. That’s pretty stupid.” Throwing their money away. You turned the table on the normal RE babble of throwing their money on rents!
Short sale are for those that want to get back in the game in 2 to 3 years or in recourse states or with recourse loans. Know one who short sold after bring $7000 to the closing table after half year of no payments but the banks reported it as a FC in a recourse state. She was trying to get if fixed. I don’t know if it was resolved.
It’s really wonderful that loan defaults can get the income tax free without working, but the working stiffs get a 10% CA tax plus 25% Federal tax on earned income.
It makes more sense to by with 4% down with the option of a walk away plus free rent (or rental income) for 1 to 2 year. Why work?
Why does there need to be a law related to ‘forgiveness’ reducing the balance of a long-term loan?
1) Capital Gain: Resolution of a long-term contract resulting in a gain due to forgiveness should be a ‘long-term capital gain’
2) Capital Loss: The Short Sale for less than the cost basis of the asset (purchase price or refinancing price) results in a ‘long-term capital loss’.
In Year 2008:
House purchased for $559,000 fully loaded with closing costs [Cost Basis for the Long Term Asset]
Mortgage balance [Cost Basis for the Long Term Debt Contract] = $559,000
For simplicity let’s call it an interest only loan and the home owner keeps up with these payments. With a principal contribution of $0.00 the Cost Basis will not change over time.
In Year 2012:
House is Short Sold for $200,000 fully loaded [Cost Basis] which is turned over to the lender. Wouldn’t the treatment for the home owner/victim be:
1) Capital Gain: $559,000 Debt Contract ended – $200,000 Cash Contributed = +$359,000 GAIN
2) Capital Loss: $200,000 Cash Received for Asset – $559,000 Tax Cost = -$359,000 LOSS
1040 Schedule (D) (for FY 2012)
+ $359,000 GAIN
-$ 359,000 LOSS
= $0 Taxes due on Capital Gain/Loss for Long Term activity on the house related financial transactions.
Admittedly it wouldn’t neatly resolve to $0 in a real world transaction. However, a good sized chunk of any forgiveness “gain” should wash the with the “capital loss”.
If Personal Tax law for some bizarre reason doesn’t allow this…. Would it be possible to form a shell company contributing the Mortgage and House in the formation process and then resolve the Short Sale under Corporate Tax law? Admittedly, this would have to be done carefully to avoid provoking the IRS, so ask a lawyer if you want to try this route.
I’m a renter so this is entirely theoretical for me.
What you are overlooking is the distribution of gains and losses. The $359,000 loss is not born by the loan owner, it’s born by the lender. The lender gets the write off, but that becomes a gain to the loan owner.
You are correct that the Lender has a -$359,000 LOSS they can recognize. However, that is a different loss from the one being recognized by the House seller.
I think I made it a tad confusing when I tried to simplify the case. It may help to think of it as two totally separate transactions for the:
A) Fixed Asset (the House)
B) Financial Asset (the Loan)
From the Lender’s perspective:
Fixed Asset : Lender never took possession of the House, so they have no involvement in Cost Basis workout of that asset.
Financial Asset: Long Term Loan on their books as a performing asset. When they write off the Loan their situation is:
+$200,000 Cash Received – $559,000 Cost Value of Loan cancelled = -$359,000 LOSS
Does this make the situation more clear?
Short sale or default – I do not believe either is immoral. But I do seriously question the framing as one of either harm to the lenders’ bondholders or to the borrower’s family. If a purchaser was prepared to spend, say, $400,000 on a particular house and they proceeds to pay off the credit that allowed them to make the purchase, what harm has fallen to the borrower’s family? The borrower paid what they wished to and got the property they wanted. You might argue that there is an opportunity cost associated with not taking the opportunity to push a notional loss off on another party, but should that truly be considered harm? I don’t think so or, rather, it is only a harm to the extent that the borrower should never have entered into the contract to begin with.
[...] are weaker, it is probably wise for those looking right now to be patient and wait for lenders to cajole more short sellers or release more REO in the fall and [...]
I have a new definition for strategic defaulters –
Someone who sold their home at the top of the market and didn’t find out about it until the bottom of the market.
Think about it.
LOL!
I may use that one. Thank you.
I just noticed this underhandedness change on Redfin (at least for Las Vegas). The agents have updated the MLS listings to the (higher) price in the contract even though the transaction hasn’t completed. They want to show the higher price in the contract rather than the listing price which is lower. So rather than waiting 3 months for the new price to show up, the agents figured they can raise the prices right away as soon as they got the contract in.