SHOULD YOU DEFAULT ON YOUR LOAN?

The Second Great Depression?

A dilemma many home-owners face today is the call from bankers and government to “Do the right thing” and continue to pay on an “underwater” mortgage. There is also the stigma implicit in the implied unethical action of not fulfilling the terms of a contract. The consequences contained in the mortgage contract as well as the societal pressures of shame and guilt placed on borrowers can seem overwhelming.

In addition to the terms and conditions contained in a mortgage contract, home-owners face other issues. Borrowers need to consider all personal financial obligations when deciding upon the best course of action when faced with the prospect of continuing to pay for a piece of property that will probably never be worth what was paid for it. The very real consequences of “strategic default” cannot be ignored, but those consequences need to be put into context with retirement, college education for children, unemployment, future property value, etc. All need to be included in any overall financial decision.

An honest assessment of the country’s current economic condition and financial situation of the home-owner is imperative to be able to have an intelligent discussion on the options available.

Currently, the economy stinks. Many economists believe the US has entered a second Great Depression. Compared to July 2009, the July 2010 sales figures show that existing home sales dropped by 27%. Without rampant hyperinflation (a very real probability but one that comes with far greater problems than we are currently experiencing), real estate values will never recover the unsupportable heights achieved in 2005 and 2006.

Those inflated real estate prices were fueled by greed, fraud and irresponsible cheap money borrowed by the Wall Street TBTF (Too Big To Fail) banks from the Federal Reserve. In some states, real estate prices DOUBLED in a year or two’s time, reaching their peak in 2006. This surreal escalation in prices (with no supporting increase in the general public’s incomes) started to correct itself slowly at first. But the real collapse starting in 2008 as the sub-prime real estate loans started to default. Lenders had thrust no-document, interest only, variable rate loans with teaser rates upon millions of unqualified borrowers. The lenders did not care if the borrower had any ability to repay the loans as long as the lenders received their fees and commissions. Then, instead of a “junk bond” rating these mortgages deserved, the TBTF banks had “AAA” ratings slapped on these bundled (toxic assets) mortgages and sold them to patsies who were stupid enough to believe the TBTF Wall Street banks had any honesty or integrity in their business dealings.

Irrespective of baseless pronouncements of “Green shoots” and the “Summer of Recovery” from economic, government, and media shills, the national economy is not recovering. Unemployment exceeds 21% when compiled using the same methodology used in the early 1990s. The headline number for unemployment of 9.6% is a fraud perpetrated by the federal government with the help of a lazy or complicit media. Trillions of dollars have been thrown at the Wall Street banks and the government bureaucracy but nothing has been fixed. There is no recovery, nothing but a short term “sugar” (money printing) high that is now wearing off. Real estate prices have been artificially supported by the manipulation of the real estate market by the Federal Reserve and federal government so the TBTF banks would not have to recognize the loses and be closed because of their insolvency.

The largest commercial property owners are never accused of immoral or unethical behavior when they walk away from an investment. As reported in the Wall Street Journal on 8/26/2010, “…some of the largest commercial property owners are defaulting on debt and surrendering buildings worth less than their loans…These companies all have piles of cash to make the payments. They are simply opting to default because they believe it makes good business sense.” When commercial property owners “strategically
default”, the companies are usually rewarded with a rise in stock prices because of ditching a losing investment.

Lenders do not want to foreclose. An existing mortgage, (even a delinquent one), can remain on the books as an asset of the bank with an inflated value that makes the bank look more financially stable than the bank really is. On the other hand, a foreclosed home has to be written down in value on the lender’s books. Enough write-downs will bankrupt the lender. Thus, lenders have a vested financial interest to convince a home-owner to continue to make some kind of mortgage payment no matter what the current value of the property, the financial situation of the borrower, or the ongoing national economic collapse. With the help of a qualified attorney, this is leverage a home-owner can wield in renegotiating their mortgage under the threat of a “strategic default”.

A mortgage is not an ethical document. It is a legal, binding contract prepared by the lender. The lender’s legal team includes in the mortgage document the terms, conditions, remedies, and consequences the lender requires of the borrower for the lender to make the loan. The sole purpose of these clauses is to protect the lender’s interest. By signing the mortgage, the home-owner agrees to abide by the conditions contained within the four corners of the document, not some additional, implied, one-sided obligation that the lender wishes to thrust upon the borrower after the signing. You can be assured that the lender did everything in its power to make the document favor the bank and not the borrower. The bank was not concerned about the borrower’s “well-being” when the mortgage note was prepared by the lender. The only contractual items a borrower needs to consider are included in the document the lender prepared and the borrower signed at closing. The borrower can decide to consider other things, but those additional considerations are at the borrower’s sole discretion.

The only way morality or ethics should enter into a discussion of “strategic default” is when looking at the borrower’s family finances, not just under the current economic conditions, but over the longer term. Continuing to make mortgage payments just to default or declare bankruptcy in the future is thoughtless, unethical and immoral to your family. Making payments for years only to default later (which for many borrowers is a very real possibility especially if the real estate market continues to decline), extends the length of time necessary to financially recover and wastes all the mortgage payments that could have been used to restore the home-owner’s credit. A borrower’s first responsibility is to his or her family and to their well-being.

The president announced a plan on Friday whereby homeowners who are “underwater” will have part of their prinicipal paid off by the federal government. This plan will ostensibly help stop the wave of foreclosures by keeping people in their homes and thereby stabilizing the market. The gruesome reality is, this plan will do nothing to correct this massive problem. The government has already tried a trillion dollar stimulus, using money that simply did not exist, with results that only delayed the inevitable, while doing little, if anything, to help small businesses and employment.

This latest plan will do little more than give more and more taxpayer money to the irresponsible banks, enabling the banks to avoid bankruptcy for a little while longer (at least until after the November election), while the country gets more and more into debt. It is simply a matter of math:
• The government has pledged $15 billion to pay principal to the banks for underwater homeowners.
• Currently, according to Robert Shiller, a well-respected economist and Yale Economics professor, 14.7 million US homeowners currently have $770 Billion in underwater equity.
• Fifteen billion dollars is enough for each of those 14.7 million US homeowners who are “underwater” to reduce their mortgage principal by $1,000.
• If only 1 million underwater homeowners are assisted through this program (as the government is stating), then $15 billion is enough for each of the 1 million homeowners to reduce their principal by $15,000.

Homeowners are not losing their homes to foreclosure because they are $15,000 underwater. And what about the other 13.7 million homeowners who are currently underwater who would not be helped by this plan? And what happens to the other $755 billion dollars in unpaid underwater equity? How much of this $15 billion program will be absorbed by the federal government bureaucracy that will be created to implement this plan? Either very little of the $15 billion will actually be used for principal reduction, or this plan will cost American taxpayers a lot more than $15 billion. This plan is insulting to the American taxpayer, AND to the struggling homeowners who will stay in their homes for a little while longer, hoping to be saved.

This new plan should be about as successful as the government’s last great mortgage “re-negotiating” plan (costing American taxpayers $75 billion), known as HAMP (Home Affordable Modification Program). The majority of homeowners who applied for this plan either didn’t “qualify”, or found the new “terms” to be totally useless for their situation. Every home owner I talked to who applied for this plan described the process as horrendous. The paperwork sent in by the borrower was continually “lost” by the bank processor and had to be sent in numerous times. Many homeowners said that they were instructed to make temporary “lower” payments to show good faith while their applications were being reviewed, only to be told after months of prompt payments that they did not qualify for HAMP. The banks managed to get four, five or six more months of payments out of these homeowners, only to then start foreclosure procedures. In some cases, the borrowers’ “new” improved plan changed their loan terms from 30 to 40 years, but their payments were actually higher than before (or only very slightly lower) due to an increased principal balance to cover processing fees, late fees, and missed interest payments. The bottom line as to the success of HAMP in rectifying our housing problem is this: a large percentage of homeowners who qualified for, and accepted, the HAMP “help” have already defaulted on their “new” loans.

The magnitude of this collapsing real estate market is almost unfathomable to much of the American public and few people will escape its impact. Many of the homeowners who are currently struggling with this “moral” decision as to whether or not to default on their mortgages are, in fact, struggling with the "strategic default" decision because they were conscientious borrowers who never dreamed they would be in their current financial position. They were not sub-prime borrowers. When they purchased their property, these home-owners were financially qualified to repay the mortgage debt and had every intention of doing so. Many were responsible borrowers, who put down twenty percent, who had high credit scores and now feel shame at possibly contributing to the foreclosure crisis and its effect on other homeowners. But this is a problem that will continue to worsen (a lot) before it gets better. The price of real estate, commercial and residential, will continue to fall until the prices represent utility value, not financial speculation. Roughly, real estate could lose another 20 to 50% of value. Emotions and misplaced morality have no place in determining the advisability of “strategically defaulting” on a property with enormous negative equity and simply "walking away". This is my opinion, not advice. Whatever your decision, there will be very real and significant consequences to you and your family. Before doing anything, consult with your CPA and an attorney who specializes in this field of law.

Bill Willkomm
9/05/2010

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