Recently, Fannie Mae (FNMA), the giant secondary mortgage market purchaser, declared war on borrowers who engage in “strategic defaults.” In their view, these are the borrowers who can afford to pay, but voluntarily choose not to. It appears that in some instances, these decisions stem from reliance on some states’ laws that say a lender may not pursue personal liability against borrowers for certain loan “deficiencies.” A deficiency is the difference between what the lender recovers in a foreclosure, and the remaining amount due under the borrower’s promissory note.
In some states, such as Oregon, lenders are prevented from recovering a judgment against their borrowers for deficiencies arising after foreclosure of a first mortgage used to acquire their primary residence. These anti-deficiency laws arose out of the 1930’s depression era, when banks pursued borrowers for repayment even after taking the home in foreclosure. In 2010 Oregon passed another law (House Bill 3656) that extended anti-deficiency protection to borrowers who also took out second mortgages to pay the remaining purchase price. These loan programs, sometimes known as “piggy-backs,” were designed by lenders to provide 100% of a borrower’s purchase price. In the vernacular, borrowers had no “skin in the game.” But that was OK to the banks. They believed, like most, that if they ever had to foreclose, they could simply resell the home, perhaps at an even higher price. Piggy-backs were not only offered, they were actively promoted, by many lenders during the 2005 -2008 period. This was when credit was cheap, interest rates low, and real estate prices were skyrocketing. Piggy-backs often came in the form of two simultaneous loans, the first mortgage (or in Oregon, the “trust deed”) for 80% of the purchase price, and another – the second mortgage or trust deed – for the remaining 20%.
Now, with property values at 40%-50% of their original purchase price, borrowers are realizing that after months of unsuccessful negotiations with lenders to modify their loans or consent to a short sale or deed-in-lieu of foreclosure, under certain circumstances it may be best to permit the home to be foreclosed. Keep in mind that by the time borrowers reach this point of frustration, they have already provided the lender with reams of financial information about themselves, their finances, and the hardships that drove them to this point.
Why lenders would be surprised that borrowers may be frustrated is a surprise in itself. In my experience, most borrowers initially try to work within the system. That is, seeking permission rather than foregiveness. But after a year or more of dealing with the one, two, three or more, bank negotiators who change the rules on a whim, they finally call it quits. (I submit that this is the reason why the re-default rate on loan modifications exceed 30% or more. It is also the reason that some lenders refer to the modification programs as “extend and pretend.”) As a result, for many borrowers, the foreclosure alternative becomes a “last resort.”
With the banks’ realization that borrowers are securing the protection afforded them by state anti-deficiency laws, they are now crying foul. They are labelling these defaults “strategic” in order to portray an entirely legal act as something reprehensible. Apparently, using laws for their intended purpose, such as Miranda warnings, the Fifth Amendment right against self-incrimintation, bankruptcy, and other legal protections lawfully created and used, is now “strategic” – which in banker-speak, means “bad.” This is like labeling the lenders’ acceptance of TARP money as “strategic” and therefor reprehensible. However, as the banks know, at some point, tough decisions are based less on choice, and more on survival. If that is “strategic” then so be it.
FNMA’s appoach is fundamentally flawed. It ignores the fact that at the inception of the transaction, both borrower and lender struck a deal: “If you pay your loan, I cannot foreclose. If you don’t pay your loan, I can foreclose.” Neither the promissory note nor the trust deed signed by Oregon borrowers, included language saying: “You must pay your loan, no matter how burdensome it is, and no matter how financially foolish it would be to continue paying for an asset worth half the sum used to acquire it.” During the credit bubble, banks were notorious in making freewheeling loans – sometimes with no verification of income or other credit information. The bargain that was struck between lender and borrower did not address whether the borrower could “afford” the loan; whether they could pay the higher interest rate when it reset; or whether they must pay the bank first before putting food on the table. The bargain between lender and borrower did not factor in an economic downturn, unemployment reaching and exceeding 10%, or whether borrowers were obliged to dip into their retirement savings to repay a losing mortgage.
Criticizing borrowers for doing exactly what the law permits – and the bargain allowed, is no more reprehensible than a lender foreclosing a family out of their home because the can’t pay. It is simply the deal that was struck – and the banks, not the borrowers, understand this risk better than anyone.
Posted in Legislation - Oregon, Market Conditions, Miscellany, Real Estate General, Real Estate/Distressed |
Tagged Banks, Deed-In-Lieu, Distressed Transactions, Foreclosure, Liability, Market Conditions, Modification, Oregon, Piggy-Back Loans, Promissory Notes, Short Sales, Trust Deeds