Why Banks should Renegotiate Loans Rather than Foreclose
Personal tragedies aside, foreclosures are expensive for lenders. Keeping the loan alive helps keep the community alive.
Palm Coast, Florida – January 8, 2009 – I get calls on a daily basis from people who never thought they would face possible foreclosure. Only recently has the concept of "walking away from a loan" entered their mind. These are not paycheck to paycheck people. They are, or once were, medium to high net worth individuals. They paid their bills on time. They had good credit scores. They didn’t need subprime loans. Now they face hard financial choices; bankruptcy, foreclosure, deed in lieu of foreclosure, perhaps loss of the accumulation of their life’s work.
Let’s give this person a name – Bob. At the height of the real estate feeding frenzy, Bob bought a piece of property in a "luxury" community. His purchase may have been driven by a desire to live in the community once the "world class" amenities were completed or when he retired. It was more likely driven by a desire to participate in the wealth creation cycle of those times. He was going to flip his purchase. Regardless, when the music stopped, not just one chair was missing. All the chairs were gone. Bob was left standing with no buyers available at anywhere near his outstanding loan balance. And now, Property Owners Association (POA) fees, club deposits and club dues were kicking in. The balloon or ARM loan could not be refinanced because of the loss in property value. And Bob’s recent stock portfolio account statements have not been encouraging.
By the time they call me, most of the Bobs have stopped paying their club dues and POA fees. Several have already received foreclosure notices. Most lenders will not consider a "short sale" because Bob has too many other assets. The lender wants dibs on these. Likewise, the existence of Bob’s other assets makes bankruptcy problematic. Bob faces limited options; among them are foreclosure and deed in lieu of foreclosure.
Meanwhile, the communities suffer. Neither the POA nor the club receives enough revenue to cover expenses. If they are maintained, it is through developer subsidies and the support of dues paying property owners. The more the Bobs fail to cover their obligations, the more the community suffers. Property values reflect this with continuing declines. People are reluctant to begin building a home.
The likely way this cycle plays out is with Bob ruined (or at least severely damaged) financially. Those property owners who honored their obligations (not that Bob is not honorable, just that he ran out of liquidity) are left holding the bag of increased assessments and dues. Amenities may be closed or service levels reduced. The long term viability of the community is at stake. And in the end, it’s the lenders who own much of the property. Besides the high cost of foreclosing, they suffer by the reduced property values magnified by their own actions, not to mention the effect on their balance sheets and reserve requirements.
When Bob doesn’t pay his dues and POA fees, he devalues his own property. He creates a self-fulfilling prophesy. I realize that for some, payment of dues and fees is not an option. But I know others whose failure to pay is a protest. It’s the wrong way to protest. Pay if you can afford it. It will enhance the value of your investment
Let’s look at an alternative scenario. This time, Bob talks to his enlightened lender (there are some). The lender realizes that Bob is still able and willing to make reduced payments and that a more prosperous community and a performing loan is in the lender’s best interest. The loan is renegotiated, perhaps with a lower interest rate, perhaps a longer amortization period and/or a slight reduction in principal. One requirement of the renegotiated loan is that Bob continues to pay his POA obligations. The community is in better shape. Property is more easily sold. The price decline is ended.
This is non-traditional thinking, but trillion dollar bailouts and subprime loans are hardly traditional. It’s time for everyone, including lenders, to think outside the box. This concept is not limited to luxury properties. It should be considered in any situation where the borrower has the willingness and ability to pay at a reduced monthly amount. Keeping the loan alive helps keep the community alive. Please – I’d like to see some comments from lenders. And if you are already doing this, let us know who you are.
Let the free market work
"Bob" made a contractural promise to the lender. When contracts are broken, significant penalties (in this case financial liquidation of "Bob’s" other assets)are warranted unless he seeks protection under current bankruptcy laws. Once the banks start forgiving principal, all property owner’s will want the same treatment. While extremely painful, if politicians will allow the markets to work freely, the market will balance itself out (not stating that values will return, but at least stabilize once all the "Bob’s" have been worked through the system).
Am I a lender? No, I am a "Bob" whom acquired a lot in 2005 to "resell" after 3-5 years and instead have had to renew a note (twice). My plans are to pay down the note until I reach equilibrium on market price or work until it is paid off and leave it for my daughter. Smart investment – No. Keeping a contratural obligation- Yes.
The banks are the problem
Toby,
You are absolutely correct. But banks are not doing what is in everybody’s – including their own – best interests. Comments like the preceeding may sound noble, but are naive, to say the least.
We deal with both homeowners and investors all day that are being thrown into bankruptcy just trying to pay off a mortgage and fulfill their obligations.
First of all, the idea of letting your kids starve or depleting their college fund or your retirement money just to salavage a worthless piece of dirt is simply ludicrous.
But what about the moral issue?
Many of these mortgages have been the product of inflated appraisals, kickbacks and illegal schemes between the lender and developer that would make Bernie Madoff blush. This is the primary reason the economy is in the predicament it is in.
Most loans have been diced up and sold off as securities to trusts in what has turned out to be little more than a gigantic Ponzi scheme. Read the newspapers. Our firm is endeavoring to get to the bottom of these securitized trusts and i can assure you that the misdeeds that are being uncovered is truly astounding.
The lenders often cannot pay off their own obligations, due to nothing more than their own greed and malfeasance. If banks were actually lending their own money – rather than that of unknown investors – they would indeed be renegotiating these loans rather than foreclosing.
HOA fees
Toby,
You are forgetting something. Some of these "communities" are charging exorbitant HOA and POA fees from the get go. Managers gave contracts out to their “friends” or brother in laws to provide services. Unfortunately these services cost 2 times what they normally should. Of course they claim that they must maintain a certain “standard.” Sometimes, these Association Managers deem that a central telephone service or security service need to be installed. Of course once again they have their hand in it somehow!
As members we do not have a say because the associations have not been turned over to the members yet.
These associations should be cutting back on expenses and looking for cost saving methods. If these fees are reduced, I really think more people will be able to afford to pay for them. Maybe the vicious cycle will stop and communities can start to get their legs.
I know for sure, paying $400 to $600 per month in HOA fees for a piece of dirt will not attract buyers in the community and will quickly defunct the association.
Associations need to WAKE UP and help the owners decrease their costs and help the community value to be attractive for a buyer!!!!!!
Hilton is right on!
I’ll give you a quick example which is dear and near to my heart because this is exactly what happened to me.
I was underwritten and approved by a popular bank here in the SUNshine state in which many have TRUSTed for years.
My loan docs clearly state that with the with my then current income and debts that I actually had a negative net worth. With that said, I was still approved for a $387,000 loan in Ginn’s Conservatory. I had 10% to put down and reasonable income so I suppose they didn’t have an issue.
A reasonable bank should have said, what are you doing with this lot. Clearly building a house of the magnitude that should go on a $420,000 lot (roughly $2,000,000 home) could never be afforded by someone with my financial standing. So if I’m not going to build a house what are my other options? To sell the lot.
So here we are today, the lot’s true value of roughly $75,000 has been established by the market. I simply can’t cut a $320,000 check to get out from under the property so what else can I do?
They wrote my loan with a 3-year term so they knew darn well I was either going to build or sell. They already knew I wasn’t going to build.
So now they have $42,000 in my down payment plus my interest carry for 3.5 years totaling $84,000 for a grand total of $125,000 I have turned over to the bank!!! That doesn’t even include HOA, club dues, taxes, etc.
I don’t know how they came up with the value they did when they underwrote me and I don’t know why I even got the loan. Sounds a lot like lender fraud to me.
Now they are going to come after the rest of my personal assets AND the IRS is going to hit me with a massive tax bill for the forgiven debt.
Something stinks and it’s the little guy that is getting crushed!!!
Cramdown legislation moving
Citibank Mortgage just agreed to back the proposed federal legislation to allow judges to cramdown the terms for homeowners at the bankruptcy proceedings. That can only be done if the mortgagor has asked the banks to renegotiate the loan prior to filing bankruptcy and were denied. The thought is after all the debts are paid, or resoved for all other things, the homeowners are more qualified to pay an adjusted mortgage. This is for existing mortgages only, and will allow owners to see help is available and they need not leave their home for lack of help. This should slow the short sales and prevent foreclosures. The bill will be voted on by the new 111th congress prior to the February 14 ajournment.
Renegotiate Loans
Agree with Toby. A bank that renegotiates now will be better off in the future. If all the banks would simply refi at the new government forced rate in the 4%-5% range this situation would stabilize. Better for a bank to earn 4% on all loans, than 6% on some loans but lose on many others. I am a free market guy, but since the government has got involved the best answer is to take advantage of the low rates. The problem we have now is the foreclosure homes are setting the prices. Every time a foreclosure house is sold in a 5 mile radius zillow marks to market the value of our house another $10,000 it seems. So stop the overwhelming supply of foreclosures and you stop the ridiculous mark to market mark downs that are occurring.
I am a bob 3 times over. Have not missed a payment YET, but so far the bank is unwilling to negotiate with me. I am deep in the hole on one house and even or slightly ahead on the other two.
Reply to Bob
One side of my brain agrees with you. In fact, I was upside down in my last investment property. When I sold it, I had to show up with a check at closing. I honored my contract and protected my credit. But these are not normal times. The owners who do not pay their dues and POA fees have a negative effect on your investment as well as their own. In the end, if the dues and fees can keep the community and amenities alive, everyone benefits. It’s not fair for everybody, but your carrying their dead weight isn’t fair either.