The government and the mortgage industry have spent a lot of energy trying to figure out how to help homeowners with their underwater mortgages. There are initiatives underway to help homeowners refinance their mortgages or to write down the principal balances for homeowners that would like to stay in their homes at a lower cost. In the case of homeowners that want/need to leave their homes they can do a short sale if they can demonstrate a hardship. These initiatives amount to no more than a wealth transfer from investors to home owners.
But what about the homeowner that needs to sell but can not demonstrate a hardship? Suppose they want to do the responsible thing and keep to their financial commitments but doing so is so painful that they either stay put or they become a reluctant landlord? Admittedly this is a smaller segment of homeowners with underwater mortgages but I can assure you this is a very real group of people. I meet them every day. But guess what? There is no alternative solution for these people.
What would such an alternative solution look like? Suppose the lender said “let’s work out a payment plan for the shortfall in your mortgage once your home is sold”? A lot of would-be sellers would jump all over this because in many cases the interest cost on this shortfall would be less than what they are losing every month on their rental – or it would be worth it to be able to move on.
So why don’t the banks offer this solution? It’s my understanding that it’s because the remaining loan would be unsecured because the collateral has been sold – as if this is any worse than having collateral that is insufficient by the exact same amount as such an unsecured loan! Typical bank logic.
So let’s get this straight. You get a break if you want to stay put or if you want to walk away from your home and your mortgage but if you want to meet your financial obligations and get out of your situation in a controlled manner you are out of luck.
The Deficiency Judgement
The closest thing to the solution I propose is the deficiency judgement but it’s not such a pretty alternative. Home sellers who are involved in a foreclosure or short sale sometimes find themselves subject to a deficiency judgement that basically attempts to collect from them the shortfall, or deficiency, in paying off their mortgage when their home is sold. The problem with the deficiency judgement is that I’ve heard the interest rate can be 8% per year and the collection mechanisms can be quite onerous, including wage garnishment and levying your bank account. The deficiency judgement is really for banks trying to collect shortfalls from people who don’t want to or can’t afford to pay it off.
Such is the topsy turvy world of the mortgage crisis.
The more government tries to fix a problem the worse it gets. Look for more fixes and even worse solutions.
Agree with you. You’d think there would be some private investors who would be willing to take the risk. However, my guess is the premiums they would demand are probably are pretty high given the debt is unsecured.
Until principal reduction is addressed in a meaningful way, this situation is going to continue to drag out.
The funny thing is that this portion of the original mortgage is already unsecured.
Let’s assume that something is done to help the smaller segment of homeowners you mentioned above. Something between your replayment plan and the deficiency judgement that is amicable to most people.
what do you think the effect would be on housing prices? Would they go up because people can now move up or would they stay about the same since people could only afford to upgrade to slightly more home?
It would probably depress prices further since it would allow more people to sell now. However, it would clear out this other “shadow inventory” which will be hanging over the market for years as these potential sellers wait on the sidelines for prices to rise in order to put their homes on the market.