Most borrowers who walk away from their homes, agree to short sales, or get pushed out in foreclosure assume that is the end of the matter. They are wrong.
Irvine Home Address … 29 ANTIQUE ROSE Irvine, CA 92620
Resale Home Price …… $1,350,000
I was blown away.
What could I say?
It all seemed to make sense.
You've taken away everything,
And I can't deal with that.
I try to see the good in life,
But good things in life are hard to find.
Daughtry — It's Not Over
It all seemed to make sense; leave the house and leave the debts behind. How could property debt follow a borrower once they left the property? Well, just because a debt was secured by property doesn't mean that debt is extinguished when the borrower leaves the property. In particular, many borrowers who naively agreed to short sales thought they were avoiding liability for the outstanding debt. They were tragically mistaken.
California is a non-recourse state. This means that any debt used for the purchase of real estate is secured only by the real estate itself, and lenders cannot pursue deficiency judgments or otherwise attempt to collect on any shortfall at sale. However, these recourse protections currently apply only to purchase money mortgages. Any borrower who refinanced their original mortgage gives up their non-recourse protections. Any HELOCs opened or used after the purchase do not enjoy non-recourse status. Since many purchase money mortgages were refinanced, and since many HELOCs were added to the purchase money mortgages, many California borrowers have lost their non-recourse protections.
By Dina ElBoghdady
Washington Post Staff Writer
Wednesday, June 16, 2010
After the bank foreclosed on Fernando Palacios's Gainesville home in March, he thought he was done with what he described as the most stressful financial situation of his life.
The bank sold the home for far less than Palacios owed on it, as often happens with foreclosures. What Palacios did not see coming was the letter from his lender demanding that he pay the shortfall: $148,064.02. "I really thought I was through with this house," said Palacios, who fell behind on payments when the economy soured and his cleaning business stumbled.
How would you like to get that letter? How many people live in fear of that letter? How many people live in blissful ignorance of the fact that a collection letter like that one is coming soon?
Over the past year, lenders have become much more aggressive in trying to recoup money lost in foreclosures and other distressed sales, creating more grief for people who thought their real estate headaches were far behind.
In many localities — including Virginia, Maryland and the District — lenders have the right to pursue borrowers whose homes have sold at a loss to collect the difference between what the property sold for and what the borrower owed on it, also called a deficiency.
Before the housing bust, when the volume of foreclosures was relatively low, lenders seldom bothered to chase after deficiencies because borrowers had few remaining assets to claim and doing so involved hassles and costs. But with foreclosures soaring, lenders are more determined to get their money back, especially if they suspect borrowers are skipping out on loan they could afford, an increasingly common practice in areas where home values have tanked.
The threat of collection is the only remaining defense lenders have against strategic default. It is a good defense.
The people who will be most harmed by collections are those borrowers with assets. People who walk away, agree to short sales, or are pushed out in foreclosure are going to get calls from collections. Why would a lender take a $100,000 loss when the borrower has assets they can take?
Palacios said he was committed to staying in his house, which he bought in 2005. He sunk $20,000 into improving it and hoped to raise his children there. But his lender refused to modify his loan, he said. To avoid personal liability for the deficiency, Palacios is filing for bankruptcy protection, as many people do who are in similar situations, said Nancy Ryan, his bankruptcy attorney.
"I am definitely seeing more people come through my door who walked away from houses a year or two ago and thought they were as free as the dead," Ryan said. "They're stunned when they realize they're not."
I am surprised that people think its over when they leave the house. When people stop paying on car loans and either give back the car or get it repossessed, there is a widespread understanding that they still owe on the loan. The presence of non-recourse laws in some states has convinced people that they don't owe on a house even when they do. Perhaps there is also an optimistic denial because the deficiencies are so large that most borrowers know they could never repay the shortfall even if they wanted to.
Several lenders contacted for this story declined to say how often they pursue deficiencies. But many said they try to collect the debt if they conclude the borrower can repay all or part of it.
"Lenders are not going after people who face a hardship," said John Mechem, a spokesman for the Mortgage Bankers Association. "If they can't pay their mortgage because they have a loss of income, there is no point in going after them."
There may not be much point in going after these people today, but once their circumstances improve after the recession, lenders will come looking for that money, and many borrowers who may have long forgotten the house debt are going to be shocked.
Those who had a second mortgage, such as a home-equity line of credit, in addition to their primary mortgage may find themselves particularly vulnerable, especially if they tapped into the equity line for cash.
Second lenders are last in line to get paid when a distressed property is sold. There's usually little or no money left over for them, making it more likely that they will pursue large deficiencies, several attorneys said.
The gold in second mortgage debt is in future collections. These loans have little or no value today — which makes them attractive purchases to distressed debt buyers — but these loans may have considerable value in the future as the financial circumstances of debtors improves. California Ponzis are going to be drained for years by these old debts.
Gretchen Somers said she and her husband understood the risks last year when they completed a "short sale," a transaction that allowed them to sell their Manassas home for about $150,000 less than they owed on it. But they felt they had no other options.
Somers said her family hung onto the house as long as possible. They tried but failed to sell it when her husband was transferred to Arizona for his job in early 2006, just as home prices were softening. They moved back into the house then tried to sell it again in 2008, after their adjustable-rate mortgage reset and their monthly mortgage payment nearly doubled. But home prices had plunged further by then, making it even tougher to sell.
Last year, their first lender and their home-equity line lender granted permission for the short sale. But the second lender reserved the right to come after the couple. Six months later, a collection agency called demanding $85,000 for related losses.
There must be more to this story. In early 2006, prices were not softening, they were at the peak. If they were going to sell at that time, they must have owned for a while meaning they had equity to lower price and close the sale if they wanted to. The only reason someone could not sell would be due to greed and foolishness. Since they were paying on a time-bomb toxic mortage due to explode two years later, failure to sell the home reveals just how foolish they were.
In hindsight, Somers said she and her husband should have just walked away from the house. "We took care of the house because we wanted it to sell," Somers said. "If they were going to come after us anyway, we shouldn't have done them the favor of making sure it looked good and cutting the grass even after we moved out, We should have mailed them the key and said: 'Here you go.' "
I have never understood why people bother with short sales. Their credit is already trashed, and most short sale agreements have language slipped into them where the borrower agrees to repay the shortfall thus giving up any non-recourse protections. I don't see the upside of a short sale. Lenders are hoping to utilize short sales to increase their loan loss recovery. If underwater owners fail to see a benefit, there will be fewer short sales and more foreclosures.
Carlos Cortez and his wife managed to escape that fate after their second lender came after them for $70,000 when their short sale was completed on his Manassas Park townhouse in 2008.
Cortez knew that was a possibility, but he went through with the sale because his real estate agent said the lender was engaging in scare tactics.
This guy took legal advice from his realtor? It is foolish to take investment advice from a realtor, but it is even more foolish to take legal or tax advice from one. It amazes me that realtors get away with this behavior.
James Scruggs, an attorney at Legal Services of Northern Virginia, said the lender appears to have backed off after Cortez argued that that the loan officer falsely qualified him and his wife for a home-equity line by fabricating key details about their finances.
Liar loans to the rescue….
A handful of states do not allow lenders to pursue deficiencies, nor does a federal program that took effect April 10. Lenders participating in that initiative are paid for approving short sales and as a condition, they cannot go after outstanding debt.
In many states, lenders can go after deficiencies, though laws vary widely, said John Rao, an attorney at the National Consumer Law Center. Some states limit how long the banks have to file a claim or collect the debt. Others may calculate deficiencies based on the fair-market value of the house, Rao said. For instance, if a home sells for $200,000 yet its fair market value is $250,000, "the borrower who owes $240,000 on the mortgage would not have a deficiency," he said.
Borrowers should get a waiver in writing from their lenders to protect themselves, said Diane Cipollone, an attorney at the nonprofit Civil Justice. "Nobody should assume the deficiency is forgiven," she said.
Nobody should assume a deficiency is forgiven, but almost all borrowers make that assumption.
I can foresee circumstances were new converts to financial prudence are punished for their good behavior. Many people will dutifully save for that 20% down payment that is now required only to see that money taken away by a collection company in the future.
People who default on recourse debt should also declare bankruptcy to make sure the slate is wiped clean. Denial of the debt problem will only serve to create more problems later.
Bought late, squeezed out a few bucks, and squatted
- This property was purchased on 11/3/2005 for $1,434,000. The owners used a $1,145,000 first mortgage, a $143,800 HELOC, and a $145,200 down payment.
- On 1/4/2007 they refinanced with a $1,293,750 Option ARM, and a $86,250 stand-alone second.
- On 1/31/2007 Washington Mutual gave them a $250,000 HELOC as a third mortgage. No wonder WAMU bit the dust.
- Total property debt is $1,630,000.
- Total mortgage equity withdrawal is $196,000.
- Total squatting time is at least 11 months.
Recording Date: 09/02/2009
Document Type: Notice of Default
Irvine Home Address … 29 ANTIQUE ROSE Irvine, CA 92620
Resale Home Price … $1,350,000
Home Purchase Price … $1,434,000
Home Purchase Date …. 11/3/2005
Net Gain (Loss) ………. $(165,000)
Percent Change ………. -11.5%
Annual Appreciation … -1.3%
Cost of Ownership
$1,350,000 ………. Asking Price
$270,000 ………. 20% Down Conventional
4.80% …………… Mortgage Interest Rate
$1,080,000 ………. 30-Year Mortgage
$273,201 ………. Income Requirement
$5,666 ………. Monthly Mortgage Payment
$1170 ………. Property Tax
$300 ………. Special Taxes and Levies (Mello Roos)
$113 ………. Homeowners Insurance
$142 ………. Homeowners Association Fees
$7,391 ………. Monthly Cash Outlays
-$1448 ………. Tax Savings (% of Interest and Property Tax)
-$1346 ………. Equity Hidden in Payment
$495 ………. Lost Income to Down Payment (net of taxes)
$169 ………. Maintenance and Replacement Reserves
$5,261 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$13,500 ………. Furnishing and Move In @1%
$13,500 ………. Closing Costs @1%
$10,800 ………… Interest Points @1% of Loan
$270,000 ………. Down Payment
$307,800 ………. Total Cash Costs
$80,600 ………… Emergency Cash Reserves
$388,400 ………. Total Savings Needed
Baths: 5 full 1 part baths
Home size: 4,100 sq ft
($329 / sq ft)
Lot Size: 6,949 sq ft
Year Built: 2005
Days on Market: 15
Listing Updated: 40332
MLS Number: P737893
Property Type: Single Family, Residential
Exquisite model perfect home in gated Northwood II. Highly sought after floorplan with fully built loft on third floor; perfect for a home office, game room or additional bedroom. Large kitchen with granite countertops, stainless appliances and center island that opens to welcoming family room with fireplace. Crown moulding, custom paint, window shutters, thick upgraded carpet and gorgeous travertine flooring throughout the downstairs. Spacious backyard is perfect for entertaining with a built in BBQ, relaxing patio with fire pit, lush landscaping and upgraded hardscape. Association amenities include clubhouse, park area and exercise facilities. Excellent location near great schools and shopping.