Reuters Money

Underwater mortgage? The book banks and Fannie hope you won’t read

A mortgage is a contract. Maybe that’s why Brent White has drawn so much attention in the red-hot national debate about the ethics of strategic default on mortgages.

White, a law professor at the University of Arizona, is outspoken on strategic default—the notion that it’s okay for homeowners who are underwater on mortgages to simply walk away, even if they can afford to pay.

But White’s analysis of  strategic default doesn’t start with ethics. From where he sits, it’s just a matter of contract law.

“In contract law, if someone breaches you’re not entitled to punitive damages,” White says. “You get that if a moral wrong is committed. A contract treats a breach not as a moral wrong but as an economically efficient thing to do. All you need to do is compensate the other party for losses. Because the parties understand there are no punitive damages, they often decide in advance what the consequences will be — especially sophisticated parties like banks or large corporations. Banks decide up front on what their compensation will be. They understand homeowners have an option to default. So that’s the deal that the bank understands it is making.”

White has just published a book aimed at helping underwater homeowners cast off the emotional baggage surrounding strategic default, and also to walk them through the numbers and possible long-range financial impact. Here’s the core of White’s argument, from Underwater Home: What Should You Do if You Owe More on Your Home than it’s Worth?

What’s really at issue is who bears the primary burden of the housing collapse, financial institutions or underwater homeowners. You shouldn’t just accept the story that preventing people from defaulting on their mortgages is about saving the economy. The main players advancing this theory are allied with financial institutions, which are primarily concerned with protecting themselves from losses. Moreover, all this talk about the economy collapsing if homeowners default obscures one simple point: people wouldn’t have to default if banks were willing to voluntarily modify mortgages. It boils down to a question of fairness. Who should have to bear the burden of the housing collapse? You or your bank? You may be willing to share the burden with your bank, but your bank wants it all on you.

White reserves a good deal of his wrath for Fannie Mae, which has threatened to penalize strategic defaulters by locking them out of Fannie-backed mortgages for seven years, and go after them in court. “We all know Fannie bears a large amount of responsibility for the housing bubble, the burst and the current crisis,” he said. “But rather than saying they’ll step in and share the burden, they want to punish them.”

How to help underwater homeowners

Keith Gumbinger is vice president of HSH.com, which publishes mortgage and consumer loan information. The views expressed are his own.

An estimated 11 million homeowners – perhaps 25 percent of all homeowners – are “underwater”, a situation where their mortgage exceeds the present value of their home. Many are making their payments faithfully each month, and virtually all would benefit from a chance to refinance. Since they are “underwater”, they cannot.

The majority of these homeowners have done nothing wrong, save for purchasing a home at the wrong time, at or near the peak of the market. Be it bad luck or bad timing, they are trapped in the mortgages they chose. In this poor economic climate, and with increases in incomes weak, the best and perhaps only way to substantially improve a household balance sheet is through refinancing.

Underwater homeowners have watched as various initiatives and programs have been rolled out to support failing homeowners. Of course, these programs are only available to those who have already failed (or are in danger of failing) to meet their obligations. Some offer interest rates as low as 2 percent for up to five years and also pay down mortgage balances by up to $1000 per year over that time. Under existing programs, a homeowner can realize great benefit if they fail to live up to their obligations, and to date, most of them have been expensive and ineffective in stabilizing the housing market.

However, current-but-underwater homeowners can find no relief. They cannot access today’s record-low interest rates to help ease their burden, and all the while are being asked to pick up the tab for any number of housing supports and bailouts for others. Our good-but-trapped homeowners get nothing but the bill. We propose a program for underwater homeowners who make their payments on time and expect to continue to do so — a reward for doing the right thing.

There have been half-hearted attempts to help these underwater folks. These’s the HARP program, but you loan has to be held entirely by Fannie Mae or Freddie Mac and you must find a lender who will work you into the program. There’s also the new FHA Short Refi, a voluntary program that requires the loan’s owner to forgive at least 10 percent of the loan’s principal; this creates a substantial loss for someone who also did nothing wrong except lend money to someone who wanted to buy a home. Finally, there have been calls to have Fannie and Freddie simply write new mortgages for these homeowners, but this instantly transmits billions more in losses to the GSEs, and ultimately to the taxpayer.

Instead of these, HSH.com’s idea is to involve the federal government as a guarantor of the difference between the amount of the existing mortgage and the present value of the home, in a program we call the ValueGap Refinance. Once this differential is established through an appraisal process, the homeowner would obtain a new loan at 100 percent of the property’s current  value and at today’s market interest rates.

5 ways to avoid foreclosure limbo

Homebuyers who have been hoping to score a good deal by buying a foreclosed property have been left in limbo by the recent rash of foreclosure freezes. Reports that many recent home seizures were based on faulty documentation have prompted big lenders like Bank of America to suspend foreclosure activity. Title insurance powerhouse Old Republic National Title has stopped covering some foreclosures. Class action attorneys are readying lawsuits and attorneys general in most states are calling for a massive investigation of whether what happened was fraud or simply sloppy paperwork.

It could take weeks or many months to resolve, leaving would-be buyers without any clear guidance or solutions. “Depending on where you are in the process it could either be mildly annoying or incredibly disruptive,” says Keith Gumbinger of HSH.com, a mortgage research firm. “You may have upended your life and made plans for moving, and have them come to a grinding halt.”

Here are five tips from people who were on the buy side of the latest real estate mess:

Pick up the phone. If you’ve already contracted to buy a home, don’t panic. There’s a good chance the paperwork will be resolved, albeit on a slower schedule than you were expecting, says Rick Sharga of RealtyTrac Inc., a research and listing service. He’s expecting that most of the homes affected by the paperwork problems were legitimately seized, and it’s more a matter of cleaning up the documentation than it is seeing the whole repossession reversed.

But cover yourself: Call the bank that owns the property and find out whether it has a clean title. Get a title search done. And do not even think about going to settlement without making sure that you are getting title insurance. If problems arise later, the title insurance company would most likely cover it.

Stay away from the courthouse steps. Don’t buy any real estate at auction right now, says Sharga. In the first place, you’ll have to pay cash, and it is unlikely to come back to you if problems arise. You can’t as easily ascertain whether the title is clean while you’re standing in front of the courthouse, either.

Wait for a bargain. Regardless of the state of their paperwork now, the vast majority of these homes will come to market eventually; their owners were typically in actual default. And with other folks afraid to handle foreclosures, stalwarts who keep shopping may find the right deal if they don’t rush, says Ethan Roberts, a Jacksonville real estate analyst and agent who specializes in foreclosures.

Don’t hold your breath on home appreciation

You may see two full moons in a month before home prices start rising again across the U.S. The rip tide of a huge home inventory, increasing foreclosures, unemployment and more bank woes continue to roil the housing market in most regions.

If you think you’ll see a profit from selling your home or hope to get a home-equity loan based on recent appreciation, you may have to wait a while — maybe a few years.

A host of demons continue to bedevil the U.S. home market. The worst of these gremlins is unemployment. Home sales and prices are directly linked to the number of people working. A jobless rate around 10 percent doesn’t spur home sales.

Nobody is in a hurry to buy homes. According to a recent report by Ned Davis Research, housing prices may not begin to appreciate until the jobless rate goes to 7 percent or lower.

Once the jobless rate gets to about 6 percent, the firm estimates that home prices may begin to rise roughly 2 percent annually or track the historical level of inflation.

“Yes, there is a light at the end of the dark housing tunnel,” writes Joseph Kalish, the report’s author, “but it will take at least two years and possibly more to get there.”

Complicating any housing rebound scenario is the fact that there are millions of unsold homes on the market and more are being acquired and resold by banks through foreclosures.

Breaking up (with your mortgage) is hard to do

As the housing market continues to take a beating, the number of strategic defaults is rising, triggering a strong reaction among Americans.

The following is an excerpt Psych Yourself Rich: Get the mindset and discipline to build your financial life by Farnoosh Torabi, excerpted with Permission of FT Press, an imprint of Pearson:

Here are some of the factors our experts say are extremely important to consider before deciding to walk away from this specific money relationship. And in any sticky situation like this, you may want to get legal help from a bankruptcy attorney.

Your bank won’t help. The bottom line is, banks don’t want to go through another foreclosure process. It takes time and money. But if playing scared and saying you desperately need to modify your loan or else fails to earn you any material help, consider it a sign you have to take matters into your own hands, which may require walking away.

And before you do, make sure your bank also has no plans to chase you down and sue you for “deficiency” claims, says Gerri Detweiler of Credit.com, which, depending on your situation, could end up costing thousands and thousands of dollars. Some states, such as California and Florida, now prohibit deficiency claims, and in other states some lenders are choosing not to go after defaulted borrowers because they’ve got too much else on their plates. But, “until the statute of limitations is expired, I wouldn’t think I was in the clear,” says Detweiler.

“The lenders may come after you in a couple of years after taking a deep breath.” Some attorneys recommend getting a signed letter from your bank stating it won’t sue you for deficiency claims. You’re not able to save or address your other immediate money relationships. Of the 5,000+ members (at the time of this writing) who’ve so far signed on to YouWalkAway.com, many have decided to forgo their mortgage because they say they’re no longer able to save any money. “They see [their home] as a major drain to their savings and cash flow in general. They don’t want to keep bleeding, basically,” says CEO Jon Maddox.