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.
Like everyone else, when I’m reading the various ads in the real estate section, I see quite a few ads for properties being sold “as is.” The suggestion behind this phrase seems to be that this little two-word phrase absolves the seller (and the listing broker) from any responsibility or liability for existing physical defects with the property, or for the need to tell the buyer that certain things that might go awry somewhere down the line. As though it’s a legally sanctioned form of the old “caveat emptor,” or “buyer beware,” which basically puts all of the due diligence job on the buyer. While there is a (very) small grain of truth to this, it is by no means a blanket absolution for a seller regarding known defects.
So then what does this “as is” designation really mean? Resisting, of course, the flippant philosophical observation that almost everything in this world is sold “as is,” as opposed to “as it is not” or “as it might be if all our dreams and fantasies came true.”
California law requires that a seller of real property disclose in writing all conditions and problems that the seller knows or should know to exist. The means by which this is customarily accomplished is through a document called a Real Estate Transfer Disclosure Statement. As far as a seller’s disclosure duties, this is where the rubber hits the road. For those readers who like to read the actual statutes, the language and scope of this disclosure requirement is set forth in California Civil Code section 1102.1. This is a written disclosure, the format of which is specified by law, which requires a seller to go through an exhaustive list of attributes and characteristics and state whether there are any known problems, past, present or reasonably likely to occur in the future.
An “as is” clause does NOT exonerate the seller from the obligation to provide the Civil Code 1102 written disclosures to the prospective buyer, nor from the obligation to disclose known conditions that would affect the purchasing decision of the reasonable purchaser. Also covered are problems that a seller “should” know to exist. What does this mean? It means that even though the seller may not have set foot on the property for 15 years and thus have no idea that the floor boards are rotting to the core, if he or she “should know” that such problems exist, they must be disclosed. Intentionally blind eyes are no excuse.
From the buyer’s side, legally, all an “as is” clause does is put the buyer on notice that the sale is made without warranty, and that the property is accepted in the condition as it appears to a reasonably diligent inspection. As a matter of sound business practice, however, an “as is” clause should alert a prospective purchaser to the possibility of problems and the realization that your inspections should be extra diligent.
So, an “as is” clause is not an “anything goes” pass that allows a seller to dodge disclosure requirements. It is, however, a flag for the buyer that she should look extra carefully because there may be problems of neglect or inattention that a “reasonable inspection” will discover.
I frequently hear from clients and prospective clients telling me that they have “rearranged” their financial affairs through the use of so-called “quitclaim deeds” or other contractual mechanisms by which title to property–and by extension–liability for a mortgage, is transferred. The most common appearance of this tends to be in the marital dissolution and property settlement context, where two divorcing spouses have divided the marital assets by “giving” property to each other, and one or the other has “assumed” liability for the mortgage. In concept this is a great idea. In reality, however, if there is a mortgage, it’s not all that useful. In fact, it is usually pointless.
This is simply because the lender’s rights are fixed as of the time of execution of the loan documentation, and the borrower can’t get out from under a repayment obligation simply by deeding the property to someone else. I won’t bore you with the legal language that is usually contained in the deed of trust, but suffice to say that, once on a loan, always on a loan until the loan is repaid or the lender specifically releases the borrower from the liability. Further, as a general legal principle, the loan obligation follows the property no matter who is on title.
An example might be in the case where the family owns two houses, a primary residence and a rental property, both of which are subject to mortgages, and both of which have both spouses’ names on title. When they divorce, the husband takes one and the wife takes the other as part of the marital property settlement. That’s great as long as the mortgages are being repaid. But if one of the parties gets into financial trouble, it will not be possible to inoculate the other from the consequences of a bankruptcy or default, because both parties are on the loans. Once on a loan, always on a loan until the loan is repaid or the lender specifically releases the borrower from the liability.
Of course this doesn’t mean that there aren’t solutions, but the quitclaim deed and assignment without the lenders’ consent are not real solutions.
Last year I posted on the subject of deficiency judgments in California. I’m not going to repost the same lengthy and technical post on the subject, but because I keep seeing this problem and questions about it all over the web, I thought I’d chime in one more time.
A deficiency is what is left on the debt after a lender forecloses. Simple example: House worth $250k, debt of $450k, there’s going to be a deficiency of $200k. It can be principal and interest on the specific loan that was actually foreclosed, or it can be a completely different loan, like a second or third deed of trust. California is highly unusual and is very pro debtor in this regard. More often then not, deficiencies are barred due to the generous anti-deficiency rules.
Here are those rules in a nutshell:
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.
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 the blank one below. I think you’ll agree that this is pretty clear.
3. Most deficiency risk that remains after the weeding out of the two above rules can be discharged in bankruptcy.
Together, Rules one and two take care of about 80 percent of the deficiency concerns in California. These days, Rule 3 covers a large chunk of what’s left.
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.
Following on the heels of my post the other day on the Option ARM perfect storm that’s brewing in the San Francisco Bay Area, the LA Times recently ran a piece on the growing phenomenon of“strategic defaults”, by which is meant the intentional defaulting on a mortgage loan by a borrower despite an ability and the wherewithal to make the payments. In other words, just walking away.
Why would someone do this? Simple: The debt far exceeds the value of the collateral by such a margin that continuing to make the payments can no longer be justified by sound economics or abstract moralizing, guilt, sense of duty or any other non-economic reasoning. In other words, the numbers just don’t crunch any more.
The Wall Street Journal Economic Insight Blog also recently ran a piece on the subject in June, called “When is it cheaper to walk away?” The answer, according to the writers of that piece is 10%. When the balance of the loan is more than 10 greater than the value of the property, economically, it makes more sense to just walk away rather than keep making the payments.
The WSJ articles was, in turn, based on a very thorough paper prepared jointly by the University of Chicago School of Business and Northwestern’s Kellogg School (under the auspices of the Financial Trust Index). The paper, called “WHEN HOMEOWNERS WALK AWAY: NEW RESEARCH REVEALS MORE THAN 25 PERCENT OF MORTGAGE LOAN DEFAULTS ARE STRATEGIC” concludes about 25 percent of foreclosures are “strategic,” meaning intentional and driven by larger economic considerations than merely the borrowers’ ability to make the payments, and that…
Homeowners start to default at an increasing pace, and walk away massively after decreases of 15 percent and more. In fact, 17 percent of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50 percent of the value of the house.
As for “strategic bankruptcy,” this is just the next step after the “strategic default.” (I wrote about this last year in an only-partially tongue-in-cheek “Top 10” list for why bankruptcy is the “ultimate mortgage modification tool.” I won’t repeat myself here.)
What does all this mean? Well, for one thing, it means that what we’ve known all along is now starting to attract the attention of economists and journalists.
As for what it might mean for an individual or family? Probably not much frankly. It seems to be giving an academic gloss to what people tend to know at a gut level anyhow: That we’re not out of the woods yet, there are lots more foreclosures and bankruptcies to come, and the housing market probably has a few more bumps in the road awaiting it before things smooth out.
As to whether this data or these reports can help you or anyone you know as you wrestle with difficult decisions: whether to default, whether to file bankruptcy, what other options you have, it probably can’t. Everyone’s situation is unique. Just like everyone else’s as the old saying goes. But before you decide that you’re going to “strategically default,” or file a “strategic bankruptcy,” you should consult bankruptcy counsel. There are lots of moving parts, and the amount of your home loan and the value of your house are just two pieces or a much larger puzzle.