Oct202014

As personal finances improve, debt collectors come calling

Lenders didn’t collect on bad debts during the recession when borrowers were broke, but now that personal finances are improving, lenders want their money.

Most borrowers who defaulted on debts during the recession waited anxiously for their lenders to come after them for the bad debt. When lenders didn’t pursue collection on bad debts at the time, most borrowers blithely assumed they no longer owed this money, but most often that isn’t the case.

Lenders were merely waiting until the borrowers became solvent before pursing them; after all, they can’t get blood from a stone, and they can’t get money from borrowers who are broke — but lenders can get money from delinquent borrowers who now have stable income and savings, so now lenders are ramping up collection efforts.

Americans face post-foreclosure hell as wages garnished, assets seized

By Michelle Conlin, October 14, 2014

NEW YORK (Reuters) – Many thousands of Americans who lost their homes in the housing bust, but have since begun to rebuild their finances, are suddenly facing a new foreclosure nightmare: debt collectors are chasing them down for the money they still owe by freezing their bank accounts, garnishing their wages and seizing their assets.

By now, banks have usually sold the houses. But the proceeds of those sales were often not enough to cover the amount of the loan, plus penalties, legal bills and fees. The two big government-controlled housing finance companies, Fannie Mae and Freddie Mac, as well as other mortgage players, are increasingly pressing borrowers to pay whatever they still owe on mortgages they defaulted on years ago.

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.

The laws regarding debt collection vary widely by state.

Using a legal tool known as a “deficiency judgment,” lenders can ensure that borrowers are haunted by these zombie-like debts for years, and sometimes decades, to come. Before the housing bubble, banks often refrained from seeking deficiency judgments, which were seen as costly and an invitation for bad publicity. Some of the biggest banks still feel that way.

But the housing crisis saddled lenders with more than $1 trillion of foreclosed loans, leading to unprecedented losses. Now, at least some large lenders want their money back, and they figure it’s the perfect time to pursue borrowers: many of those who went through foreclosure have gotten new jobs, paid off old debts and even, in some cases, bought new homes.

Nobody who reads this blog should be surprised by this. I warned about this in 2011 (See: Zombie debt: the legacy of the housing bubble) and twice in 2013 (See: Lenders ambush newly solvent borrowers seeking old bad debts, and Zombie debt collectors are gorging on former loan owners)

“Just because they don’t have the money to pay the entire mortgage, doesn’t mean they don’t have enough for a deficiency judgment,” said Florida foreclosure defense attorney Michael Wayslik.

That’s fine. Banks will take whatever they can get.

Advocates for the banks say that the former homeowners ought to pay what they owe. Consumer advocates counter that deficiency judgments blast those who have just recovered from financial collapse back into debt — and that the banks bear culpability because they made the unsustainable loans in the first place.

That’s a compelling argument. (See: Lenders Are More Culpable than Borrowers)

“SLAPPED TO THE FLOOR”

Borrowers are usually astonished to find out they still owe thousands of dollars on homes they haven’t thought about for years.

And that’s exactly why I’ve written about this so many times. People don’t realize lenders can still pursue these bad debts because borrowers lapse into willful ignorance and denial.

In 2008, bank teller Danell Huthsing broke up with her boyfriend and moved out of the concrete bungalow they shared in Jacksonville, Florida. Her name was on the mortgage even after she moved out, and when her boyfriend defaulted on the loan, her name was on the foreclosure papers, too.

She moved to St. Louis, Missouri, where she managed to amass $20,000 of savings and restore her previously stellar credit score in her job as a service worker at an Amtrak station.

But on July 5, a process server showed up on her doorstep with a lawsuit demanding $91,000 for the portion of her mortgage that was still unpaid after the home was foreclosed and sold. If she loses, the debt collector that filed the suit can freeze her bank account, garnish up to 25 percent of her wages, and seize her paid-off 2005 Honda Accord.

“For seven years you think you’re good to go, that you’ve put this behind you,” said Huthsing, who cleared her savings out of the bank and stowed the money in a safe to protect it from getting seized. “Then wham, you get slapped to the floor again.

Borrowers exposed to bad mortgage debt should have declared bankruptcy immediately after they quit paying. Seven years has passed since she quit paying, and if she had filed bankruptcy, she would have permanently extinguished the debt and rebuilt her life on solid ground. Instead, she is exposed to debt collectors who can ruin her rebuilt life.

Bankruptcy is one way out for consumers in this rub. But it has serious drawbacks: it can trash a consumer’s credit report for up to ten years, making it difficult to get credit cards, car loans or home financing. …

Most people who declare bankruptcy are offered new credit again almost immediately. As horrible as it sounds, lenders know the borrower can’t declare bankruptcy again for seven years, lenders can charge usurious rates, and lenders want to keep the debt addicts on their product, so they offer them credit almost immediately. Bankruptcy is made to sound bad because lenders want the deterrent effects, but the reality is less problematic than most realize — plus, what many consider a “problem,” limited access to debt, is actually a blessing because it’s an opportunity to get off the debt treadmill.

“A CURSE”Three of the biggest mortgage lenders, Bank of America, Citigroup, JPMorgan Chase & Co and Wells Fargo & Co. , all say that they typically don’t pursue deficiency judgments, though they reserve the right to do so. “We may pursue them on a case-by-case basis looking at a variety of factors, including investor and mortgage insurer requirements, the financial status of the borrower and the type of hardship,” said Wells Fargo spokesman Tom Goyda. The banks would not comment on why they avoid deficiency judgments.

Often these banks will sell this bad debt to another company that doesn’t mind using questionable collection tactics because the large banks don’t want the bad press.

Perhaps the most aggressive among the debt pursuers is Fannie Mae. Of the 595,128 foreclosures Fannie Mae was involved in – either through owning or guaranteeing the loans – from January 2010 through June 2012, it referred 293,134 to debt collectors for possible pursuit of deficiency judgments, according to a 2013 report by the Inspector General for the agency’s regulator, the Federal Housing Finance Agency. …zeuz_repayment

Andrew Wilson, a spokesman for Fannie Mae, said the finance giant is focusing on “strategic defaulters:” those who could have paid their mortgages but did not. Fannie Mae analyzes borrowers’ ability to repay based on their open credit lines, assets, income, expenses, credit history, mortgages and properties, according to the 2013 IG report.  “Fannie Mae and the taxpayers suffered a loss. We’re focusing on people who had the ability to make a payment but decided not to do so,” said Wilson.

That sounds reasonable, but it’s a fiction designed to scare borrowers into paying. In reality, it’s difficult to identify strategic defaulters from people who lost everything then regained their footing.

But homeowner-defense lawyers point out that separating strategic defaulters from those who were in real distress can be tricky. If a distressed borrower suddenly manages to improve their financial position – by, for example, getting a better-paying job – they can be classified as a strategic defaulter.

I first began writing about strategic default back in 2008 in the post Should you walk away from home debt?. Many people faced a cost of ownership greatly exceeding the cost of a comparable rental, and with declining prices, they were sinking underwater and had no realistic hope of future equity; therefore, on a purely financial basis, borrowers who strategically defaulted were wise because the shortest path to equity was to walk away from the huge debt, save money, and wait until the credit scores improved enough to repurchase again at lower prices.sucks_to_be_you

I gave that advice frequently from 2008 through 2011, and as it turned out, borrowers who strategically defaulted early on made the best choice. Borrowers who strategically defaulted avoided repayment of a huge debt, and up through 2013, the government didn’t require them to pay taxes on the forgiven debt income.

Even if Fannie and Freddie can identify voluntary defaulters, the inspector’s reports admit that actually collecting can take months or years. It’s far easier for the government to get a billion dollars out of the banks in settlements than it is to get $20,000 from 50,000 borrowers, many of whom are still insolvent, and many of whom forgot about those debts long ago.

Whatever you believe about the morality of strategic default or the desirability of punishing them to prevent moral hazard, the practical problems of identifying and pursuing strategic defaulters makes the task too costly and difficult to be effective. Should lenders attempt collection from strategic defaulters? I don’t think so, but that isn’t stopping many zombie debt collectors from trying.

Dyck O’Neal works with most national lenders and servicing companies to collect on charged-off residential real estate. It purchases foreclosure debts outright, often for pennies on the dollar, and also performs collections on a contingency basis on behalf of entities like Fannie Mae. “The debt collectors tend to be much more aggressive than the lenders had been,” the National Consumer Law Center’s Walsh said.

How aggressive are they? If they plan to get anything out of these people, they will likely resort to heavy-handed tactics.

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