Monday, March 22, 2010

"Ruthless Default", 'Walk Away Risk", "Strategic Default Incentive" - What Are The Strategic Default Predictors and Who Really Cares?

It now begins in earnest as analysts, academics, investors, politicians, US Treasury, HUD, mortgage backed security holders, and the Federal Reserve start to analyze the strategic default phenomenon. There are various metrics, variables, models, algorithms, equations, and good ole fashion graphs being put to use to come up with a strategic default predictor.

This is our current list of strategic default predictors:

1. The difference between the value of the property and the mortgage balance. Essentially "How Underwater Is The Property?". At the surface? Below the surface? Or down in the dark deep?

2. The rate of depreciation or appreciation for a property.

3. The type of mortgage loan - fixed rate vs. adjustable rate vs. option (adjustable rate mortgage) arm vs. negative amortization.

4. The existence of a second mortgage or HELOC (Home Equity Line of Credit).

5. Borrower's current income and savings. This involves considering the increase or decrease of available cash and the increase or decrease in savings.

6. Borrower's time horizon as it relates to staying in the home. When does a borrower intent to move or relocate.

7. Other debt carried by the Borrower such as credit cards, auto loans, personal loans and/or business loans.

8. The cost to rent vs. the mortgage payment for a similar property. Basically, the amount of cash saved from renting. This relates to the tax savings/benefits, such as mortgage interest deduction and depreciation, derived from owning a home as opposed to a renting.

9. Morality/Frustration effect or in other words ..."if my friends and neighbors are doing it, why can't I." or "The biggest corporations do it, why can't I" or "The banks got bailed out, so why can't I." or "I feels wrong to do it, yet the banks got bailed out, so why can't I:.

There will be a time when there will be somewhat accurate predictors of the propensity to strategically default. For now, it's fair to say the we are in the beginning stages of this, so it will be some time to understand the full rational for a strategic default. Suffice to say that the primary rationale is cash flow and savings preservation and protection.

The following two articles shed some light on the desire to quantify and qualify those individuals who intend to strategically default.

The article Who, in the End, Will Strategically Default? written by Linda Lowell from points out the desire by large investors to determine who is likely to strategically default. She writes "The topic long been a serious concern among MBS analysts as well. Last week, for instance, analysts at J.P. Morgan Securities 'put pencil to paper' to get beneath vague generalizations that suffice for most discussions of walk away risk, to compute strategic default incentive for ever agency and non-agency securitized loan."

A Financial Times article entitled US Housing Market Hit By Walkaways raised the issue of the importance in profiling a strategic defaulter.
  • "a close look at mortgage payment trouble spots shows that the higher the negative equity, the higher the rate of non-payments."
  • “Negative equity is a big challenge. It contributes to higher delinquency and redefault rates,” Seth Wheeler, senior adviser at the US Treasury, told a conference this month.
  • “The housing problems run very deep, but so far policies have just kicked the can down the road,” says Laurie Goodman, analyst at Amherst Securities, a broker that specializes in mortgage investments. “To get an economic recovery you need to fix the housing problem. And to fix the housing problem, you need to fix the negative equity problem.”
  • "As well as banks, investors owning the mortgages that were repackaged in the last decade are also concerned that there will be further losses on many of these bonds that have already fallen in value."
This is only the beginning as strategic default continues to spread like wildfire. This most certainly raises the "money loss hairs" of asset backed security holders, government officials and investors. Expect some form of government "intervention" to put an end to the "dishonest" strategic defaults.

Until then keep learning.

Friday, March 19, 2010

Ten Facts About Mortgage Debt Forgiveness...

The IRS has posted Ten Facts About Mortgage Debt Forgiveness in order to provide clarity when mortgage debt is forgiven. Debt forgiveness means the lender agrees to cancel the debt and give up it's rights to collect on the debt. When a debt is forgiven, the IRS requires the lender to file a 1099, since the IRS considers forgiven debt as income.

So keep these the ten facts in mind when negotiating a short sale, loan modification, principle reduction, and/or deed in lieu.

The following is the text from the IRS web pageyour mortgage debt is partly or entirely forgiven during tax years 2007 through 2012, you may be able to claim special tax relief and exclude the debt forgiven from your income. Here are 10 facts the IRS wants you to know about Mortgage Debt Forgiveness.

1. Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.

2. The limit is $1 million for a married person filing a separate return.

3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

6. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.

7. If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

8. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more details about these provisions.

9. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.

10. Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit A good resource is IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments. Taxpayers may obtain a copy of this publication and Form 982 either by downloading them from or by calling 800-TAX-FORM (800-829-3676).

Monday, March 15, 2010

Plan To Be Followed When You Walk Away From Debt

As the economy continues to weaken, the number of individuals and businesses deciding to “walk away” or strategically default from debt continues to grow. Lenders have taken notice. Lenders are taking a long term outlook when it comes to collecting debt. Bottom Line: Lenders understand that a debtor who is unable to pay now may be able to pay later. In the case of a strategic default, where a debtor intentionally stops paying even though they possess the ability to continue paying a lender is keenly aware that it can most likely collect in the future. Lenders are developing classifications for debtors to determine the likelihood of collecting from that debtor in the future. It's important to understand that a lender has several options when a debtor walks away or strategically defaults from debt.

That said, let’s review the various options a lender has at its disposal to collect unpaid debt. This article is divided into two sections. The first section generally discusses the two main options available to a lender to collect a debt. The second section contains links to various national online news sources with stories about everyday people deciding to strategically default and walk away from debt and the ensuing consequences.

Lenders Have Two Main Options to Deal With Unpaid Debt:

1. A lender can obtain a judgment for the entire amount of the unpaid debt or a deficiency judgment on the difference between what it is owed and what it collects. For example, if a lender is owed $250,000 but collects $100,000 the $150,000 difference is considered a deficiency debt. The lender can make an application with a court to turn the deficiency debt into a deficiency judgment. If a lender gets a deficiency judgment, the lender can garnish wages, place a lien on a bank account, or place a lien on personal, business, and real estate assets. In some states a deficiency judgment can stay valid for as long as 20 years. A lender may sell the deficiency to a third party debt collector.

2. A lender can forgive the entire debt or forgive the difference between what it is owed and what they collect. In the same example described above a lender can forgive the $150,000 deficiency debt. If a lender decides to forgive the debt, it can file a 1099. Basically, forgiveness of debt is considered income by certain states and the IRS. In some cases, forgiven debt will not be considered income, if a debtor meets certain requirements.

No matter what a lender decides any unpaid debt is reported to the credit bureaus. For a comprehensive discussion on deficiency debt, debt forgiveness, and debt obligation click here.

We have to put together a collection of articles throughout the nation talking about the strategic default trend and how lenders are viewing this situation.

Mortgage, Tax Bills Ultimately Come Back To Haunt Walkaways by Greta Guest of Freep.Com writes:

"Lenders are hiring collection agencies. They also are getting deficiency judgments -- court orders that allow banks to collect on mortgage balances. Once an order is in place, lenders can garnish wages, tap bank accounts, seize tax refunds and put liens on other assets to satisfy the debt. These judgments also show up on credit reports."

Underwater Homeowners Leave Behind Mortgages, But Lenders Can Still Come Calling by Hubble Smith and Valerie Miller of the Las Vegas Review Journal writes

"People are walking away from their mortgages by the thousands, making a financial decision that it's better to take the hit on their credit score than try to recover $300,000 of negative equity on a $600,000 home purchased at the peak of the housing bubble. They're called "strategic defaults."

"As a recourse state, Nevada leaves the door open for lenders and collection agencies to pursue homeowners with deficiency judgments, going after assets and income years after a foreclosure or short sale, or bank-approved sale for less than the mortgage owed."

"Homeowners who feel relieved to have the burden of debt lifted may be surprised to receive a letter from a collection agency two or three years down the road demanding payment on their old mortgage."

To Walk Away or Not To Walk, Is That The question? By Paul Owers of the Sun-Sentinel writes:

"But borrowers have to weigh several practical considerations of so-called strategic default. They risk being sued by the lender for the unpaid mortgage balance for up to 20 years. Their credit will take a huge hit, making it difficult to get a credit card or a car loan. And the poor credit rating could affect future employment and mean higher auto insurance rates...'Those who walk away and let their homes fall into foreclosure can expect to see their credit scores drop...Foreclosures stay on borrowers’ records for 10 years, and they won’t be able to get other mortgages for at least two or three years...There may be tax issues, too. If lenders forgive the mortgage debt, borrowers who walk away from investment properties risk having to pay federal income taxes on the forgiven amount. Forgiven mortgage debt through 2012 is not taxable income on a primary residence as long as the debt was used to buy or improve the house."

Thursday, March 11, 2010

Strategic Default Employed By Manhattan Condo Owners Seeking To Get Loan Modifications

In a recent Real Deal article entitled "New Manhattan Condos See Rise in Foreclosures". The essence of strategic default techniques employed by condo owners are contained in the following quotes. Mind you that these are high end luxury condominiums presumably owned by upper income individuals. The article points out that investors own many of the properties that are now in distress. In other words, the properties were purchased to rent and flip for a large profit. Now these owners are strategically defaulting in order to get a loan modification.

Let's look at the relevant quotes from the article briefly describing the strategic default strategies:

  1. They intentionally fall into pre-foreclosure to encourage the bank to lower their interest rate, which can shave thousands of dollars off their monthly payments. Several owners contacted for this story said they successfully used this tactic and are no longer technically 'in foreclosure.'"
  2. Sometimes an owner will not pay the mortgage for several months as a strategy to encourage the bank to modify the terms of their loan, by "proving" the loan can't be paid under the original terms, but could be under better terms.
  3. And the foreign investor at the Cipriani Club who owns several units in pre-foreclosure claimed that he is intentionally not paying the mortgage so the bank will modify his loan, said a source within the building.
  4. An owner of another apartment at the Downtown Club with a lis pendens filed against it, said he 'took a break' from paying the bank and was able to negotiate his monthly mortgage payment down from $3,300 per month to $2,000 per month. "I own a construction company and business went down. I own several properties," the owner said last month during an interview at his apartment, explaining that for a time he couldn't make payments on all of his properties at once, but knew the bank would cut him a deal. Ultimately, he said "the bank agreed to move his unpaid balance to the principal and reduce his interest rate from 6.2 percent to 3 percent...It's a shame that a lot of people let their units get foreclosed on without knowing they can do something."
  5. Others are not so lucky, like a creative professional who said he'd probably lose his apartment at be@Clinton West...Records show he purchased his studio apartment in 2007 for $507,000 -- 25 percent more than the previous owner paid three months earlier -- with almost zero equity by taking out two mortgages. The owner says in the article, "My one loan is about 8 percent interest only and the other is 13 percent interest only," said the owner..."I was told by an associate at [lender] SunTrust...that this is probably the only way I could get a mortgage and that I could refinance a little down the road with equity...I knew going in that it was a ridiculously high interest...But I thought I would live tight for a year or so and then refinance based on the equity, which at the time seemed like a great plan. I'm not saying I was coerced, but I was excited to buy my first place". Unfortunately, his business declined along with the economy, leaving him with no money to put toward equity. He said the bank has refused to modify the terms of his loan.

Of course, there is not much sympathy for investors who lost out on their bets for quick profit. However, most individuals who purchased properties did so to make a profit over time.

Is it right for an investor to strategically default in order to improve their investment?

What do you with a property that has no equity and requires high monthly payments that draining cash and savings?

At this time the answers appears to be "Yes, strategic default is an effective business and financial tool"