As this dog-tired economy continues to drag on, with no relief in sight and no bounce-back in home prices appearing anywhere on the horizon, the single question I am asked most frequently is “Should I walk away from my mortgage, and if I choose to do that, what are my options?”
Usually it comes in the following form. “We bought our house in 200_, for $_______. It’s now worth less than what we paid, and less than the outstanding loan amount. We’re considering our options, but are not sure what to do.”
Sometimes this question comes up because someone has lost a job, or is in the real estate business and hasn’t been able to generate much commission income in the past 2 to 4 years, although sometimes it’s just the economics themselves that trigger the inquiry.
The question about what to do, however, is less a legal decision than it is an economic decision. Of course, once you decide to walk away, then the follow-through becomes a purely legal act, and should only be undertaken after consulting with legal counsel and obtaining a full understanding of what is likely to happen.
First, should you? That all depends on where you think housing prices are going to go in the future, how long you’re willing to tough it out and what your other housing options look like. Obviously, you have to live somewhere, so if you’re not going to own, then you have to have a good understanding of what your rental options are Example: A family of four, with two teenagers, living in a 1,500 square foot house in an expensive neighborhood is going to be looking at a very different set of concerns than a childless couple living in a 4,000 SF home in an affordable location. That seems obvious, but to many folks it apparently isn’t.
So it’s not a straight dollars and cents analysis. Just because your home is worth 20% less than the balance on your loan, no lawyer can advise you on whether you should keep the house and keep paying, or let it go and brave the consequences. All a lawyer can do is tell you what is likely to happen under any particular course of action.
Next, if you do decide to walk away, what is going to happen? Well, we all know that such a decision is going to cause significant credit problems. It’s inevitable: If you walk away from a home loan, your credit is going to suffer. But what else?Fortunately, we don’t have debtor’s prison, so despite the loss of the house to foreclosure–another inevitability although the timing may vary depending on circumstances–you may get sued. Obviously that’s no fun, and is something that you should try to avoid, but whether that is likely to happen or not is a very good question to take up with a lawyer. We’re lucky in California as there are very powerful anti-deficiency laws, about which I have already blogged rather extensively. (See California anti-deficiency rules and statutes: When can a mortgage lender in California recover a deficiency after foreclosure?, California Mortgage Deficiencies: What is a Purchase Money Security Interest? and Second Mortgages in California: Deficiencies Not Usually an Issue for full treatment of the subject.)
Last, what about staying and trying to complete a mortgage modification? I’m sorry to say that I’m a cynic on this subject. The process seems capricious and arbitrary at best, and since my experience leads me to the unshakable and firm conviction that, as a class of people, consumer bankers are among the dumbest clowns wandering the planet, the percentage likelihood of any one homeowner or family successfully completing a mortgage modification is nearly microscopic. This is especially true here in Northern California where incomes and home prices are among the highest in the country. They’re not much interested in modifying mortgages for people with six figure incomes and seven figure home prices. And of course, whether that is right or not is beside the point, but you need to understand the reality if you’re going to test the water.
The New York Times recently reported on a movement by the California State Legislature to amend California Code of Civil Procedure (“CCP”) §580b. (See “Battles in California over Mortgages.”) For those of you who’ve been following along, CCP §580b is the California statute that prohibits a mortgage lender from obtaining a deficiency judgment on any loan that was used to purchase or construct a residence. Such loans are referred to in the law as “purchase money loans.” I have posted about this a couple of times (See posts: California anti-deficiency rules and statutes: When can a mortgage lender in California recover a deficiency after foreclosure? and Second Mortgages in California: Deficiencies Not Usually an Issue), and it is a very important statute for California homeowners.
On June 3, 2010, the California Senate passed, by a convincing margin of 30 to 4, Senate Bill 1178 which extends the protections of CCP §580b to any loan taken out to refinance a purchase money loan, up to the amount of the original purchase money loan which is refi’d. Here’s how that works: I take out a loan for $500,000 which I use to buy my home. A few years later, I refinance that loan with a new loan for $700,000, $500k of which goes to take out the original purchase money loan, and the other $200k of which I use for other purposes. Under existing law, because the new loan is no longer a “purchase money loan,” but is a refi of a purchase money loan, I would not be protected against possible personal recourse by the lender if it foreclosed and did not recover enough on the sale of the residence to pay off the whole loan. Under the new law–if it passes the California State Assembly–I would still be protected on the refinance loan up to the amount of the original purchase money loan that was refinanced, or in my hypothetical, $50ok. That would leave me exposed on the balance in excess of that refinanced amount. In my hypothetical, up to $200k.
Do we care? Well, maybe some day someone will, but I doubt it.
As usual, the press gets it all muddled up, and everyone jumps on the band wagon to shout about “consumer protections.” It’s actually somewhat comical. If you Google “SB 1178 California” you get a whole raft of folks nattering about the great “consumer protections” it offers. But if you know anything at all about how the economics and law of foreclosure in California actually work in day-to-day reality, a little reflection shows that it doesn’t do anything of the sort.
As a Bay Area real estate and bankruptcy lawyer who lives on the front lines–representing both lenders and borrowers–in these sorts of disputes every day, I’ll go way out on a limb here, and say with confidence, and in my most stentorian tone of voice, that this is a bunch of hogwash. More political window dressing in the face of a crippling inability to do anything meaningful at all. It’s not going to solve a single one of the problems facing California’s real estate industry today, and in practice, its benefits–if any–will be limited to an extremely small group of people who have more money than brains. The investor who made a wrong bet, but who can still afford to pay their debts. (Which, ironically, is the precise subset that everyone who’s anyone in this debacle–from Hank Paulson to Bernard Bernanke to George Bush to the Barrack Obama–has steadfastly maintained they have no desire to help. But I digress.) Legally and economically, this is a red herring brought to you by a band of legislators who are largely powerless to do much more than wave their arms in sturm und drang trying to demonstrate to an increasing angry constituency that they are doing something.
Here’s why this thing is meaningless:
First, in order for this hypothetical to be a real problem, the lender would have to file an action for judicial foreclosure, because under the provisions of CCP §580d, no deficiency is available to a lender who forecloses by trustees sale. If the foreclosing lender has availed itself of the “power of sale clause” in the deed of trust, then no deficiency is allowed. Period, done finished, end of story. That’s what CCP §580d is all about. It doesn’t matter what the money was used for, how it was obtained, from whom, etc. No lawsuit, no deficiency. (A trustee’s sale is when they sell the property by auction on the Courthouse steps, and a judicial foreclosure is when they file a lawsuit in Superior Court seeking a judicial decree of foreclosure and money judgment.)
Second, the California real estate market continues to slog along the bottom of the river, which means that there are very few loans where the bank is going to be interested enough in the borrower to actually spend the time and money to chase a debtor on one of these. The costs of foreclosure are already sky-high, (found by a Joint US Congressional Economic Committee to approach an average of $80,000 (!!!), see Joint Congressional Economic Committee Report on Foreclosure Costs), and the added costs and uncertainties of trying to pursue a deficiency on a mortgage balance in a court only adds more time, expense and uncertainty. Banks–and the regulators who regulate them–hate time, expense and uncertainty when it has to do with a non-performing loan.
The fact is that most lenders are not going to spend the money to launch a judicial foreclosure on a generic breach of contract claim. Which is what this foofaraw is all about. When a borrower defaults on a promissory note by not paying it back it is just a simple, no-brainer breach of contract claim. Mortgage lenders in this sort of hypothetical don’t sue for that. Why? Because it’s a colossal, herculean, humongous and uncertain waste of time and money. And why is that? Because the person they’re chasing either doesn’t have the money to pay them back–which is why they’re not paying in the first place–which means that if they actually get a judgment it will be an uncollectible judgment, i.e., a meaningless wallpaper, and…And here’s the big one, a generic breach of contract claim on a promissory note is completely dischargeable in bankruptcy. The lender can chase the borrower all the way to judgment and the borrower can still squirt out by filing a simple $299 Chapter 7 petition.
The person that they will sue, however, is the scam artist who got the loan by fraudulent means, and there is nothing at all in the revised CCP §580b that is going to protect that scam artist from the consequences of their fraud.
So who is this new and improved law going to help? Here’s the profile: He/she is a borrower who doesn’t want to pay the loan back even though he/she has the money to do so. Further, they’re willing to spend this money that he doesn’t want to spend to avoid the foreclosure to finance litigation. Oh yeah, and one more data point. The National Consumer Law Center recently published a report on average hourly rates for experienced consumer law attorneys, experienced being defined as those with 20 to 30 years experience. Me and my colleagues in other words. (See NCLC United States Consumer Law Attorney Fee Survey) The result? $460 to $475 per hour. So this hypothetical borrower doesn’t want to pay his loan, but he’s willing to pay me or my colleagues $475 an hour to litigate this issue. Total likely fees? $50,000 to $100,000 at those rates. Where is this idiot?
So the new and improved CCP 580b is a pointless public relations stunt, and any blogger, journalist, banker, lawyer, real estate agent or politician who tells you otherwise is a well-intended liar or, more likely, just doesn’t know what they’re talking about. I suspect what they’ll say in response to me, however, is that removing this threat removes a negotiating plank–the threat of a lawsuit–from the lenders’ arsenal.
Last, the new law, if it passes, is likely only to apply to loans made after June 1, 2011.
May 11, 2010 UPDATE since original post: 60 Minutes with Morley Safer did a piece on Strategic Defaults on May 9, 2010 that you may want to check out.
Today’s New York Times is running its latest article on the growing phenomenon of homeowners walking away from mortgages. Check out the article by David Stretfield, entitled “No Help in Sight, More Homeowners Walk Away.” Not that this is news to you if you’re reading this blog, as I’ve posted on this
My favorite take aways in the pop culture contribution department: What used to be called “house poor is now called “house arrest.” And the new phrase for mailing the keys to the lender? “Jingle mail.” Cute.