The SF Chronicle is predicting a $30 billion “mortgage time bomb” set to go off in the San Francisco Bay Area in 2010 as the popular “Option ARM” loans written near the tail end of the housing bubble start to reset. With 20% to 28% of Bay Area mortgages having the “option ARM” pay feature, and an astounding 94% of borrowers with these loans making the minimum payments, the consequences of this, well, they can’t be good. Follow the above article link to read more about this slow moving train wreck.
The San Francisco Chronicle is reporting that a recent study estimates that more than $30 billion in so-called “option ARM” resets in the Bay Area are due to hit the foreclosure stats next year. (If the above link has expired, I have uploaded a reprint here.) If you are one of the borrowers who fit into this difficult spot, you probably already know it. For those who don’t, here’s a brief primer.
An “Option ARM” is an adjustable rate mortgage that includes a feature which allows the borrower to decide whether he is going to pay just the interest or interest and principal. There may be other flavors, variations or exotic trim packages, but that’s the basic idea: Borrower gets to choose the payment that they will make in any particular month. The problem with most of them is that they usually include a negative amortization (or “neg am”) risk, meaning that, if the borrower elects to make the minimum payments, the amount of the outstanding principal actually increases over time. So with housing prices declining and loan balances increasing, you have the perfect storm for a home loan disaster. Whether it’s a whole new home loan disaster or just a continuation of the one we’re already in, well, I’m not sure that we need to slice it that thin. In short, more bad news coming.
The Chronicle article, written by Chronicle staffer Caroline Said, lays the problem out nicely, and does a good job of showing what’s on the horizon. It’s not pretty.
To wit, the following frightening statistics:
So what does all this mean? It’s pointless to try reading tea leaves with information like this, but it seems pretty clear that the Bay Area has a long way to go before our housing market is completely out of the woods. It’s very hard to believe that all of these loans are going to cure without some very painful side effects, like bankruptcies, foreclosures and other “rip cord” type solutions, hitting a higher income bracket than ever before. People who borrow a half-million dollars aren’t used to the word “bankruptcy” being in their day-to-day lexicon.
And what if you’re a homeowner who falls into this picture? Well, that’s beyond the scope of this little blog. But the question that presents itself is the same one that has been presenting to many, many other folks in the last couple of years: How underwater are you, and how long do you want to keep dumping good money after bad? To me, in most instances, the problem isn’t much more complicated than that. The hard question isn’t what to do, it’s more a matter of when to do it and whether there are planning steps that can or should be considered.
There is no on-size-fits-all solution to this problem, and your strategy is going to have to depend on a very careful and detailed analysis of your total financial picture.
Do you need to see a lawyer? Maybe, but I wouldn’t start there. I’d start with an accountant and an appraiser to get the best picture of your exposure. The legal decisions after that are easy. In fact, the legal decision will probably be obvious once the true facts are known. What do you have? What do you owe? What do you want to do about it and are there any timing issues that need to be considered?
My clients get tired of hearing me say it, but if the mantra for real estate values is location, location, location, then the mantra for bankruptcy petition and schedule preparation is disclose, disclose, disclose. This isn’t Chicken Little screaming about the sky falling; it’s real and it can have real consequences. The 8th Circuit Court of Appeals recently [...]
My clients get tired of hearing me say it, but if the mantra for real estate values is location, location, location, then the mantra for bankruptcy petition and schedule preparation is disclose, disclose, disclose. This isn’t Chicken Little screaming about the sky falling; it’s real and it can have real consequences.
The 8th Circuit Court of Appeals recently decided the case of In re Barrows. In that case, the debtors borrowed money from their 401(k) just before their bankruptcy petition was filed, and deposited the funds into their bank account. They didn’t tell their lawyer about it. On their bankruptcy schedules, they disclosed–under penalty of perjury–that their combined bank balance was $325 on the day of filing. The trustee requested bank statements, and those statements revealed the additional funds. When their lawyer sought to amend the exemption schedules to include the additional funds apparently mistakenly omitted, the Court denied the amendment and the debtor’s appealed. They lost the case and, therefore, their $13,000.
The Court of Appeal reasoned that, because the debtors signed their schedule under penalty of perjury, such omissions can’t be cured by simple amendments. The Court upheld the lower court decision, and the debtor’s lost the $13,000.
The most painful–and truly absurd–irony of this tale, however, is that, because the money was borrowed from the debtor’s 401(k) retirement account, and would have been exempt if either a) They had waited until after filing to borrow the money, or b) Correctly disclosed the bank balance and source of the funds. The important issue for the Court of Appeal wasn’t whether the funds would have been reachable by the creditors or the trustee, but the debtor’s “bad faith” in failing to be truthful in the schedules. In other words, the doctrine of “no harm, no foul” doesn’t apply. This kind of stuff drives me nuts because it is so easily avoidable.
I take three lessons from this:
1. Don’t expect post petition amendments to cure material omissions without the threat of some possible consequence.
2. Truth matters. A lot. Innocence alone doesn’t vitiate inaccuracy.
3. If you are untruthful in your schedules, you should expect to be caught.
Here in the Northern District of California, Judge Alan Jaroslovsky of the Santa Rosa Division wrote an Open Letter to Debtors and their Counsel in 1997 with regard to the casual assumption that inaccuracies can be easily cured with later amendments. You can read the original order here.
But to quote the most important message from the 1997 Open Letter, Judge Jaroslovsky says:
Whatever your attitude is toward the schedules, you should know that as far as I am concerned they are the sacred text of any bankruptcy filing. There is no excuse for them not being 100% accurate and complete. Disclosure must be made to a fault. The filing of false schedules is a federal felony, and I do not hesitate to recommend prosecution of anyone who knowingly files a false schedule.
That’s worse than losing $13k.
Now, first off, I know that the title I’ve chosen for this post is about as unsexy and non-juicy as it can be. That’s okay. I can take it. It’s boring. I can hear marketing consultants hollering about how I need to make my title more grabby, sticky, etc. Yawn. What can I say? Trying to [...]
Now, first off, I know that the title I’ve chosen for this post is about as unsexy and non-juicy as it can be. That’s okay. I can take it. It’s boring. I can hear marketing consultants hollering about how I need to make my title more grabby, sticky, etc. Yawn. What can I say? Trying to make this stuff fun and exciting is like trying to turn a root canal into a spectator sport. And besides, if you’re reading this, you didn’t come here to be entertained. Maybe someday I’ll change the title but for the moment it stays.
So, anyhow, on the subject of deficiencies…
Far and away the most common question I get asked by clients and potential clients is whether they will be liable for what’s called a “deficiency” after they let a property go in foreclosure. Please note that the discussion below is limited to California law. If your property is not in California–it doesn’t matter where you are; what matters is where the property is–then the discussion below will not apply to your situation because the laws in each state about foreclosures and deficiencies is unique to each state’s laws.
First, what is a deficiency anyhow?
A deficiency is, simply defined, the difference between what you owe on your loan(s) minus the value of the property at the time of the foreclosure. Here’s an absurdly over-simplified example: You owe $250,000 on the loan. At the time of the foreclosure, the property value is $200,000. If the lender is entitled to a deficiency (and that’s a HUGE “if” in California) then it would be calculated at $50,000 ($250,000 – $200,000 = $50,000)
Lots of people right now are trying to weigh their options about whether they want to let a property go in foreclosure, file bankruptcy, do a “short sale,” try for one of those “deeds in lieu” or even try to work something out with the lender. (Right!) What I am seeing quite frequently is that decisions are being made based on completely wrong information about the extent to which they are at risk for
Next, how do you evaluate the risk of being chased for a deficiency by a lender after foreclosure?
Here are the rules in as simple a way as I can articulate them. Remember: THESE APPLY ONLY TO LOANS SECURED BY PROPERTY IN CALIFORNIA. If you don’t live in California, then these rules DO NOT apply to you.
1. There can be no deficiency on a purchase money loan. Ever. This means that if the loan was used to purchase the property, then no deficiency is possible. It doesn’t matter if the holder of the first, second or third forecloses. If the loan on which a lender is trying to get a deficiency is a purchase money loan, then no deficiency is possible. There are wrinkles in this: A HELOC can be purchase money. A loan taken out to refi a purchase money loan cannot. If you have multiple loans, then you have to think about the purpose of the loan. Let’s say you have a purchase money first, and then you later took out a second. The second, because the loan proceeds weren’t used as “purchase money,” that lender is not barred from pursuing a deficiency in a lawsuit.
2. There can be no deficiency if the lender exercises its power of sale and conducts a non-judicial foreclosure by the mechanism of a trustee’s sale. In order to get a deficiency, the lender MUST file a judicial foreclosure action. That means that they have to sue you in Superior Court. Some people seem confused about whether that piece of paper then got in the mail was a lawsuit or something else. It’s hard to miss: It’s a big 8.5? x 11? document called a “Summons,” and it says in unambiguous writing: “Notice to Defendant….You Are Being Sued By Plaintiff.” See a copy of one on my post “Second Mortgages in California: Deficiencies Not Usually an Issue.”
