What do you think of lenders pursuing deficiency judgments against defaulting homeowners?

[mhendo]

Last year, we had a few threads on the SDMB about people who owed more on their house than it was worth, and who were deciding to walk away from their mortgages.

Some were in Great Debates: http://boards.straightdope.com/sdmb/showthread.php?t=546983Is walking away from your mortgage unethical?

Some were in the Pit: House worth less than I paid for it? Why, I might just stop paying my loan!

Rather than dredge up either of those threads, i thought i’d start a new one to talk about a Wall Street Journal article published over the weekend: House Is Gone but Debt Lives On.

According to this story:

Forty-one states and the District of Columbia permit lenders to sue borrowers for mortgage debt still left after a foreclosure sale. The economics of today’s battered housing market mean that lenders are doing so more and more.

<snip>

Lenders still sue for loan shortfalls in only a small minority of cases where they legally could. Public relations is a limiting factor, some debt-buyers believe. Banks are reluctant to discuss their strategies, but some lenders say they are more likely to seek a deficiency judgment if they perceive the borrower to be a “strategic defaulter” who chose to stop paying because the property lost so much value.

The general topic for debate, i guess, is what people think about this, and whether you draw any distinction between “strategic defaulters” and regular defaulters, or between people who default on their residence and those who default on vacation or investment properties. The previous threads, linked above, show quite a range of attitudes on the subject.

In previous debates, i found myself defending strategic defaulters, and based quite a bit of my argument on a research paper written by University of Arizona Law Professor Brent White. White argues that homeowners should look at a mortgage as a financial decision, not a moral one, and should make decisions based on a rational examination of their situation, not on social pressures to keep paying. He argues that mortgages have a mechanism for default, and that, if you stop paying, the agreement says that the bank gets to keep your house.

Now, White’s article focused mainly on non-recourse states, where lenders can only take back the property, and cannot sue the borrower for the difference between what they owe and the sale price of the house. As the WSJ article says, though, 41 states don’t fall into this category, and lender often have years to decide whether to sue defaulting borrowers for the balance of the loan.

I still feel for people who lost their jobs and their homes during the economic downturn, and i still find much of White’s article very compelling, but i also find myself somewhat troubled (in a different way) by some of the cases described in the WSJ articles.

For example:

In July 2005, Mr. Reilly took out a $223,000 mortgage to build a vacation home here, about 160 miles from his primary home in Odessa, Fla. He was laid off just as construction was being completed.

Mr. Reilly says he is current on the loan on his primary residence but couldn’t afford the vacation home’s $1,200-a-month loan payment. Great Western Bank, which is owned by National Australia Bank Ltd., foreclosed on his house in Lehigh Acres in July 2010.

Mr. Reilly, who was a mortgage broker before his layoff, says he knew that deficiency judgments were possible after a foreclosure but didn’t expect to face one because he doesn’t have any financial assets, and you can’t get “blood from a stone.”

So, the house in question here was a vacation house. He’s current on his primary home mortgage. Should this guy be treated differently from someone who defaults on their one and only house?

Another case:

Mr. Falero, 37, says he was about nine months behind on his loan when the bank foreclosed. Before it did, he bought another home in Minneola, Fla., where he now lives and where he says he is up to date on mortgage payments.

This guy fell behind on one mortgage, and when the bank foreclosed was able to get another one. Should the lender on the first mortgage have to eat the difference?

Third case:

Julia Ingham invested in four Lehigh Acres properties in June 2005, hoping to “drum up some real money for retirement.”

All have since been foreclosed on by lenders, says the 62-year-old retired programmer for International Business Machines Corp.

A credit union, after selling one of the foreclosed houses for less than the debt on it, obtained a deficiency judgment against Ms. Ingham for $181,059.54. She worries she could face such judgments on the other properties, too.

Ms. Ingham says when she bought them, she misunderstood how much her investments put her on the hook for. Her builder, she says, promised she could invest $10,000 in four properties and then flip them for a profit. Ms. Ingham says deficiency judgments punish borrowers who were taken advantage of by lenders and builders.

Four homes, all investment properties.

As i said in previous threads, i think the financial institutions need to shoulder some of the hurt in all of this. They were giving 100% loans, giving loans to people who shouldn’t have them, and relying on the unrealistic assessments of continuing price growth. When the bubble burst, they were left in a situation where many of their borrowers owed more than the houses were worth. If the banks end up getting screwed on these cases, they are at least partly to blame.

But some of the people in the story seem like gamblers who are happy to throw their money in when everything seems great, but who also want to be saved from their own mistakes when things collapse. The people who are now crying for relief and blaming the banks or the real estate agents would probably be singing a far different tune if their investments had paid off. If Ms. Ingham’s four investment properties were now worth twice what she paid for them, and were bringing in a rental income of thousands of dollars a month, i’m sure she’d be sitting back and waxing lyrical about her savvy business sense.

So i’m a bit ambivalent about the whole thing. On the one hand, plenty of people have suffered over the past few years, and many of them have been real victims of circumstance. On the other, though, as someone who doesn’t own a house of his own, i find it hard to muster a huge amount of sympathy for people who were buying vacation homes and investment properties and who now find themselves on the hook for the loans that they agreed to.

It will be interesting to see how this all proceeds. According to the article, there are now debt-buying companies getting into the game in an effort to cash in on deficiency judgments:

The increase in deficiency judgments has sparked a growing secondary market. Sophisticated investors are “ravenous for this debt and ramping up their purchases,” says Jeffrey Shachat, a managing director at Arca Capital Partners LLC, a Palo Alto, Calif., firm that finances distressed-debt deals. He says deficiency judgments will eventually be bundled into packages that resemble mortgage-backed securities.

Because most targets have scant savings, the judgments sell for only about two cents on the dollar, versus seven cents for credit-card debt, according to debt-industry brokers.

Silverleaf Advisors LLC, a Miami private-equity firm, is one investor in battered mortgage debt. Instead of buying ready-made deficiency judgments, it buys banks’ soured mortgages and goes to court itself to get judgments for debt that remains after foreclosure sales.

Silverleaf says its collection efforts are limited. “We are waiting for the economy to somewhat heal so that it’s a better time to go after people,” says Douglas Hannah, managing director of Silverleaf.

[TriPolar]

@mhendo

So i’m a bit ambivalent about the whole thing. On the one hand, plenty of people have suffered over the past few years, and many of them have been real victims of circumstance. On the other, though, as someone who doesn’t own a house of his own, i find it hard to muster a huge amount of sympathy for people who were buying vacation homes and investment properties and who now find themselves on the hook for the loans that they agreed to.

Many of these former homeowners were in a sense, defrauded by real estate agents, banks, and appraisers, but nothing will happen to those institutions, their actions were usually legal. And if not, the debtor is in the worst possible position to challenge them.

But if you don’t pay a debt, you should expect someone to try and collect it. I think the solution is to give bankruptcy courts the ability to dismiss or mitigate these debts exclusively when the situation warrants. People could be required under these terms to pay back some of the mortgage without having to liquidate or have their other creditors affected by the mortgage debt.

[Terr]

@TriPolar

Many of these former homeowners were in a sense, defrauded by real estate agents, banks, and appraisers, but nothing will happen to those institutions, their actions were usually legal. And if not, the debtor is in the worst possible position to challenge them.

But if you don’t pay a debt, you should expect someone to try and collect it. I think the solution is to give bankruptcy courts the ability to dismiss or mitigate these debts exclusively when the situation warrants. People could be required under these terms to pay back some of the mortgage without having to liquidate or have their other creditors affected by the mortgage debt.

I’d love to find out exactly how you think these former homeowners were “defrauded”.

Did the real estate agent tell them that the value of the property is only going to go up and they believed it? Is that what you call “fraud”?

Appraisers usually look at similar properties and their sales values - during the bubble, the appraisals will definitely be bubble-high - is that “fraud”?

Banks - I have signed mortgage documents 3-4 times in my life, they are usually a mile long, spelling everything - EVERYTHING - in minutest detail. How “fraud” could squeeze in there I have no idea.

[mhendo]

@TriPolar

But if you don’t pay a debt, you should expect someone to try and collect it. I think the solution is to give bankruptcy courts the ability to dismiss or mitigate these debts exclusively when the situation warrants. People could be required under these terms to pay back some of the mortgage without having to liquidate or have their other creditors affected by the mortgage debt.

Interestingly, Brent White, in the article i linked in my OP, notes that some economists have made a similar argument. He says:

Eric Posner and Luigi Zingales have suggested changing federal bankruptcy law to allow “prepackaged,” or streamlined, mortgage cram-downs under Chapter 13 of the Bankruptcy Code. Under Posner and Zingales’ intriguing proposal, any homeowner who lives in a ZIP code where the median home price has dropped by more than 20 percent from its peak would have the right to submit a “Chapter 13 prepack.” This prepack “would simply contain a new mortgage amount that is equal to the old mortgage amount discounted by the percentage decline of the median house price for the ZIP code. Monthly payments would decline by the same percentage; the term of the mortgage would not be changed.” The creditor would not have the right to oppose the prepack, but would be entitled to a percentage of the home’s appreciate upon sale equal to the percentage reduction in the principal pursuant to the prepack.

[John_Mace]

I guess my original opinion only changes inasmuch as this new information about the law is relevant.

Where no law exists, you have no obligation to pay the bank anything if you don’t want to, and they can foreclose on your home, taking your house.

Where laws do exist, make your decision based on what your risk assessment says. But be aware that you may end up on the wrong side of the law. I wonder, though, if you can get out of that sort of mess by declaring bankruptcy.

As for people with vacation homes vs people with only a primary residence, I don’t see the distinction. The banks knew what they were getting into, and the customer has no obligation to that bank beyond what the loan specifies and what the laws of that state say.

[Frylock]

I don’t claim this is what Tripolar was talking about and I don’t know what to do about the situation I’m about to describe, but I do want to describe what I’ve found over the last couple of years of teaching critical thinking and logic to mostly low income minority students.

It turns out that many, many generally competent adults are simply incapable of reading and understanding a legal document, much less one that goes on for pages and pages and spells out everything in detail.

(I use “incapable” in a loose sense–in my experience almost all these adults can learn the skills involved. But that requires having a good teacher and knowing one needs to learn–both of which are hard to come by.)

They don’t know the formalities that help one organize one’s reading of the document, and they don’t know how to read things for their strict literal meaning, and they don’t understand how to read off implication relations between sentences and longer passages.

And moreover, they have no idea that they don’t know how to do these things. They think they’ve read and understood documents which they have completely failed to comprehend.

This leads to a larger discussion about education, (and let’s not even bring up basic math abilities) but nevertheless, the fact remains–many, many people are signing documents every day which they not only don’t understand, but can’t understand, and can’t see that they don’t understand.

Having seen this for myself semester after semester, I find myself having a lot more sympathy for prospective homebuyers who are in over their heads. Getting in over your head is sometimes blameworthy, but sometimes you genuinely have no way of knowing the waters are rising til they’re already over the top.

[Terr]

@John_Mace

As for people with vacation homes vs people with only a primary residence, I don’t see the distinction. The banks knew what they were getting into, and the customer has no obligation to that bank beyond what the loan specifies and what the laws of that state say.

I agree.

But changing the laws retroactively (doing “mortgage cram-downs”, for example) is ridiculous and will cause enormous damage to the financial climate.

[Terr]

@Frylock

This leads to a larger discussion about education, (and let’s not even bring up basic math abilities) but nevertheless, the fact remains–many, many people are signing documents every day which they not only don’t understand, but can’t understand, and can’t see that they don’t understand.

Having seen this for myself semester after semester, I find myself having a lot more sympathy for prospective homebuyers who are in over their heads. Getting in over your head is sometimes blameworthy, but sometimes you genuinely have no way of knowing the waters are rising til they’re already over the top.

First of all, the legal principle (I presume, IANAL) is if you signed it, and you are a competent (in legal sense) adult, you are certifying that you read it and understood it.

Education aside, this can lead to the discussion of what mental competency is, whether there are grades to it, and whether those at the lower grade should be prevented from signing legal documents that their grade says they cannot understand.

[Oakminster]

@Terr

How “fraud” could squeeze in there I have no idea.

Lots of ways especially in the sub-prime market where many erstwhile homeowners are considerably less than sophisticated–and some are barely literate. Lenders tell borrowers one thing, the paperwork says something entirely different. Lenders conceal or fail to explain variable rates and/or balloon payments. Lenders actively falsifying loan applications to be able to approve loans for borrowers that should not have qualified–the incentive being the lenders were going to sell the notes almost immediately, so they had nothing to lose.

[Frylock]

@Frylock

(and let’s not even bring up basic math abilities)

That should be stricken–I didn’t make my meaning clear there…

[Terr]

@Oakminster

Lots of ways especially in the sub-prime market where many erstwhile homeowners are considerably less than sophisticated–and some are barely literate. Lenders tell borrowers one thing, the paperwork says something entirely different. Lenders conceal or fail to explain variable rates and/or balloon payments. Lenders actively falsifying loan applications to be able to approve loans for borrowers that should not have qualified–the incentive being the lenders were going to sell the notes almost immediately, so they had nothing to lose.

But (and I cannot emphasize it enough) the document that the borrower signed spells out, in excruciating detail, everything that the borrower is taking the obligation to do, every variable rate applied, and every balloon that’s coming.

If you think most people are not mentally competent to sign such documents, maybe there should be a law that certain gradations of mental competency should be assigned to people (maybe based on some kind of exam) and the document levels adapted to those grades.

[Frylock]

@Terr

First of all, the legal principle (I presume, IANAL) is if you signed it, and you are a competent (in legal sense) adult, you are certifying that you read it and understood it.

But like I said, a lot of people think they’re understanding things they don’t actually understand.

Education aside, this can lead to the discussion of what mental competency is, whether there are grades to it, and whether those at the lower grade should be prevented from signing legal documents that their grade says they cannot understand.

A more “freedom-minded” response would be to face the education problem head on, (like I said, I’ve yet to meet the student who I thought couldn’t learn this stuff–the problem was they were supposed to have gotten this in grade school but didn’t).

And also find ways to make these legal documents more accessible, probably through (affordable) mediation of some kind.

[Oakminster]

@Terr

But (and I cannot emphasize it enough) the document that the borrower signed spells out, in excruciating detail, everything that the borrower is taking the obligation to do, every variable rate applied, and every balloon that’s coming.

Not necessarily–again, especially in the sub-prime market, it is not particularly unusual to find loan documents that had blanks when the borrower signed them, with outrageous figures added after the fact.

[Cheesesteak]

@mhendo

But some of the people in the story seem like gamblers who are happy to throw their money in when everything seems great

Just pointing out here that the people in this story did not have money to throw in. They had an idea, but no money. So they asked a loan professional to give them a humongous pile of money to fund their project, and the loan professional said “You Betcha!” If their idea was nothing more than gambling, then the loan professional should have been a bit more circumspect with the money he was handing over.

That said, if the law says they have recourse, then they have recourse, and the borrowers are rightfully on the hook, especially if they have robust enough finances to pay into that remaining debt. If the law says no recourse, the banks can suck it.

I’m willing to listen to a modest amount of whining by borrowers who are being sued, since they are not loan professionals, they may have unwittingly gotten in over their heads. I do not accept any such complaints by banks, they know the law, they write the contract, they provide the funds, they live with the consequences.

[Terr]

@Oakminster

Not necessarily–again, especially in the sub-prime market, it is not particularly unusual to find loan documents that had blanks when the borrower signed them, with outrageous figures added after the fact.

Who can be idiotic enough to sign blank checks?

[Voyager]

@Terr

But (and I cannot emphasize it enough) the document that the borrower signed spells out, in excruciating detail, everything that the borrower is taking the obligation to do, every variable rate applied, and every balloon that’s coming.

If you think most people are not mentally competent to sign such documents, maybe there should be a law that certain gradations of mental competency should be assigned to people (maybe based on some kind of exam) and the document levels adapted to those grades.

So, if a mortgage professional tells someone who barely graduated from high school, and for whom English might not be a first language, something different from what is buried inside a 70 page document, it is the customer’s fault? No fraud at all?

I think someone should bury a clause giving intellectual property rights for anything written using an office suite inside the license agreement. I’m sure you read every word of these, right?

[John_Mace]

@Terr

I agree.

But changing the laws retroactively (doing “mortgage cram-downs”, for example) is ridiculous and will cause enormous damage to the financial climate.

Not sure what you mean. Did some of these 41 states that the OP mentions pass laws retroactively? Can they even do that?

[Voyager]

As for the OP, the law is the law. It would make sense for the law to protect a purchaser of a primary residence, probably not for a vacation home, and certainly not for investment properties. I can see a social good in supporting home ownership, but none in pushing risk from a business operation onto a bank. That is what bankruptcy laws are for.

[Voyager]

@John_Mace

Not sure what you mean. Did some of these 41 states that the OP mentions pass laws retroactively? Can they even do that?

I believe mortgage cramdowns are rules requiring banks to renegotiate balances with borrowers, perhaps in return for a share of any gain in value from the property. They are retroactive since no one thought them necessary when the loans were made.
However, the banks managed to do immense harm to the financial environment all by themselves, causing the drop in value that make cramdowns useful.

[Tastes_of_Chocolate]

If you feel that the existance of a default mechanism in a mortgage makes it alright, and maybe even preferred, for a borrower to walk away from a mortgage, than why doesn’t the same thing hold true for the lender?

The mortgage and the law clearly call out what will happen if the borrower choses to stop making or is unable to make payments. Just because the borrower decides not to spend the $300-500 that it costs to hire a real estate lawyer (and learn what is in that mortgage) does not exempt them from being bound by contracts that they sign.