Friday, February 29, 2008

New York Times article: Facing Default, Some Walk Out on New Homes

This article describes a growing trend in real estate:

Facing Default, Some Walk Out on New Homes

Published: February 29, 2008

When Raymond Zulueta went into default on his mortgage last year, he did what a lot of people do. He worried.

In a declining housing market, he owed more than the house was worth, and his mortgage payments, even on an interest-only loan, had shot up to $2,600, more than he could afford. “I was terrified,” said Mr. Zulueta, who services automated teller machines for an armored car company in the San Francisco area.

Then in January he learned about a new company in San Diego called You Walk Away that does just what its name says. For $995, it helps people walk away from their homes, ceding them to the banks in foreclosure.

Last week he moved into a three-bedroom rental home for $1,200 a month, less than half the cost of his mortgage. The old house is now the lender’s problem. “They took the negativity out of my life,” Mr. Zulueta said of You Walk Away. “I was stressing over nothing.”

You Walk Away is a small sign of broad changes in the way many Americans look at housing. In an era in which new types of loans allowed many home buyers to move in with little or no down payment, and to cash out any equity by refinancing, the meaning of homeownership and foreclosure have changed, economists and housing experts say.

Last year the median down payment on home purchases was 9 percent, down from 20 percent in 1989, according to a survey by the National Association of Realtors. Twenty-nine percent of buyers put no money down. For first-time home buyers, the median was 2 percent. And many borrowed more than the price of the home in order to cover closing costs.

“I think I could make a case that some borrowers were ‘renting’ (with risk), rather than owning,” Nicolas P. Retsinas, director of the Joint Center for Housing Studies at Harvard University, said in an e-mail message.

For some people, then, foreclosure becomes something akin to eviction — a traumatic event, and a blow to one’s credit record, but not one that involves loss of life savings or of years spent scrimping to buy the home.

“There certainly appears to be more willingness on the part of borrowers to walk away from mortgages,” said John Mechem, spokesman for the Mortgage Bankers Association, who noted that in the past, many would try to save their homes.

In recent months top executives from Bank of America, JPMorgan Chase and Wachovia have all described a new willingness by borrowers to walk away from mortgages.

Carrie Newhouse, a real estate agent who also works as a loss mitigation consultant for mortgage lenders in Minneapolis-St. Paul, said she saw many homeowners who looked at foreclosure as a first option, preferable to dealing with their lender. “I’ve had people say to me, ‘My house isn’t worth what I owe, why should I continue to make payments on it?’ ” Mrs. Newhouse said.

“You bought an adjustable rate mortgage and you’re mad the bank is adjusting the rate,” she said. “And sometimes the bank people who call these consumers aren’t really nice. Not that the bank has the responsibility to be your friend, but a lot are just so uncooperative.”

The same sorts of loans that drove the real estate boom now change the nature of foreclosure, giving borrowers incentives to walk away, said Todd Sinai, an associate professor of real estate at the Wharton School of Business at the University of Pennsylvania.

“There’s a whole lot of people who would’ve been stuck as renters without these exotic loan products,” Professor Sinai said. “Now it’s like they can do their renting from the bank, and if house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren’t any worse off than renting, and you got a chance to do extremely well. If it’s heads I win, tails the bank loses, it’s worth the gamble.”

In the boom market, homeowners took their winnings, withdrawing $800 billion in equity from their homes in 2005 alone, according to RGE Monitor, an online financial research firm.

Since the Depression, American government policy has encouraged homeownership as an absolute good. It protects people from increases in rent and allows them to build equity as they pay off their mortgages. And it creates stability in communities, because owners are invested in their neighbors.

But new types of loans like interest-only mortgages and cash-out refinance loans mean buyers do not pay down their mortgages. And adjustable rate mortgages, which accounted for 39 percent of mortgages written in 2006, expose owners to rent-like rises in their housing costs.

The value of homeownership, then, has increasingly shifted to the home’s likelihood to rise in value, like any other investment. And when investments go bad, people tend to walk away.

“When people don’t have skin in the game, they behave like they don’t have skin in the game,” said Karl E. Case, a professor of economics at Wellesley College, who conducts regular surveys of borrowers as a founding partner of Fiserv Case Shiller Weiss, a real estate research firm.

Though many states give banks recourse to sue borrowers for their losses, Mr. Case said, in practice it’s not often done “It’s tough to do recourse,” he said. “It’s costly, and the amount of people’s nonhousing wealth tends to be pretty slim.”

Christian Menegatti, lead analyst at RGE Monitor, said the firm predicted more homeowners would walk away from their homes if prices continued to drop, regardless of their financial circumstances. If home prices drop an additional 10 percent, Mr. Menegatti said, 20 million households will owe more than the value of their homes.

“Will everyone walk out?” he said. “No. But there’s been a cultural shift. Buying a house used to be like entering a marriage, a commitment for life. Now, if you see something better, you go back into the dating market.”

When homeowners see houses identical to their own selling for much less than they owe, Mr. Menegatti said, “I wouldn’t be surprised to see five or six million homeowners walk away.”

For Raymond Zulueta, the decision to go into foreclosure, and to hire You Walk Away, brought him peace of mind. The company assured him that in California he was not liable for his debt, and provided sessions with a lawyer and an accountant, as well as enrollment with a credit repair agency. He stopped paying his mortgage and used the money to pay down other debts.

Consumer advocates and others question the value of You Walk Away’s service.

“We are more interested in servicers and borrowers coming to mutual resolutions through loan remediation,” said Kevin Stein, associate director of the nonprofit California Reinvestment Coalition. “Even though we are not seeing good outcomes, we’re not willing to throw up our hands and say people should walk away from their homes based on the advice of a company that stands to profit from foreclosure.”

Jon Maddux, a founder of You Walk Away, said the company’s services were not for everybody and were meant as a last resort. The company opened for business in January and says it has just over 200 clients in six states.

“It’s not a moral decision,” Mr. Maddux said of foreclosure. “The moral decision is, ‘I need to pay my kids’ health insurance or my car payment so I can get to work.’ They made a bad decision, but they shouldn’t make more bad ones just because they have this loan.”

Mr. Zulueta said he felt he had let down the lender, himself, and his family.

“But you got to move on,” he said. “I know in a few years my credit’s going to be fine. If I want to get another house, it’s going to be there. I’m not the only one who went through this. I know I’m working the system, but you got to do what you got to do. There’s always loopholes.”

Copyright (c) 2008 The New York Times Company. All rights reserved.

Tuesday, February 19, 2008

Mortgage and foreclosure update

This month, we’re going to update you on the latest Congressional and judicial developments in the rapidly escalating debate over mortgages and foreclosures.

1. On December 12, 2007, the House of Representatives Judiciary Committee narrowly ordered H.R. 3609, the “Emergency Homeownership and Mortgage Equity Protection Act of 2007” to be reported as amended out of committee for consideration by the full House. The bill would allow bankruptcy judges to modify the terms of a Chapter 13 debtor’s mortgage loan. Among those terms that a judge could tweak are the loan's interest rate, remaining value and maturity.

The substitute bill that was reported out of the committee would limit relief to subprime or nontraditional loans that are in foreclosure or at least 60 days overdue. Judges would also have the authority to determine if debtors qualified for relief under the current means test. The bill applies to existing nontraditional and subprime mortgages originated between Jan. 1, 2000 and the bill's enactment.

Although the compromise bill was nominally bipartisan, only one Republican on the committee voted for the bill. Many opponents of the bill, including The Financial Services Roundtable, argue that the changes could have unintended consequences, by pricing people with poor credit risks out of the mortgage market and causing lenders to require higher interest rates or down payments or both.

However, the bill gained the support of the National Association of Federal Credit Unions, since the definition of a “nontraditional” loan would be limited to interest-only mortgages and adjustable-rate mortgages with payment options that can lead to negative amortization. Credit unions don’t typically provide these types of loans.

On October 3, 2007, Sen. Dick Durbin (D-IL) introduced S. 2136, the “Helping Families Save Their Homes in Bankruptcy Act.” It would allow bankruptcy court judges to reduce the remaining values, interest rates, and maturities of existing mortgages. Specifically, the bill allows cramdowns for principal residential mortgages for homeowners in Chapter 13 bankruptcy. During proceedings, judges would have the discretion to fix the APR over a 30-year period. The bill also exempts the debtor from the requirement for credit counseling if the court receives certification that the home has been scheduled for a foreclosure sale. In addition, any prepayment penalties can be waived. Another provision in the bill prohibits a bankruptcy judge from allowing a claim that is subject to any remedy for damages or rescission due to failure to comply with the Truth in Lending Act or any other state or federal consumer protection law. The bill has been the subject of hearings in the Senate Judiciary Committee.

Look for closely contested floor votes on these bills this spring.

2. In In re Maisel, No. 07-43324-JBR (Bankr. D. Mass. 11/15/07), Wells Fargo Bank was allegedly the current holder of the note and mortgage and filled a motion for relief from the automatic stay. However, the Bankruptcy Court called upon the lender to prove that it was the holder of the note and mortgage. At the hearing, Wells Fargo presented an assignment of the documents dated four days after Wells Fargo’s motion was filed.

The Court observed that Section 362 of the Bankruptcy Code plainly limits motions for stay relief to parties in interest and that Federal Rules of Bankruptcy Procedure 9011 requires movants to make factual assertions that have evidentiary support. In this case, Wells Fargo was unable to provide evidentiary support for its assertion that it was a party in interest when the motion was filed because it did not yet have a colorable claim to the property.

Judge Rosenthal wrote:

“Today, more and more homeowners turn to the bankruptcy system for protection when facing financial hardship or impending foreclosure. It is this Court's responsibility to ensure that these debtors receive the full protection of the Bankruptcy Code, including the benefit of an automatic stay, for as long as they are entitled to it. Unfortunately, concomitant with the increase in foreclosures is an increase in lenders who, in their rush to foreclose, haphazardly fail to comply with even the most basic legal requirements of the bankruptcy system. It is the lenders' responsibility to comply, and this Court's responsibility to ensure compliance. with both the substantive and procedural requirements of the Bankruptcy Code. Compliance with these rules is not difficult and this Court will require it in order to preserve the rights of debtors. Any motion filed with the Court must be true and have support as of the date of the motion. For example, a movant cannot state that it is the ‘current holder’ of an instrument if it is not. Similarly, this Court has seen motions for relief that state that a debtor is in postpetition default where the last payment was due prepetition, or allege that the debtor will be In default by the time of any hearing; these types of allegations are unacceptable to this Court. Lenders must take care in their haste to obtain relief from stay to ensure that the factual statements they make in their motions are true, have evidentiary support and support their claims.”

Although Wells Fargo did not have standing. the court granted the relief because the debtors intended to surrender the property.

Judge Rosenthal’s decision follows in the footsteps of In re Foreclosures Cases, a case decided last fall in the U.S. District Court for the Northern District of Ohio, Eastern Division, in which Deutsche Bank claimed to hold the notes and mortgages for properties it was attempting to foreclose on. The cases were dismissed without prejudice.

The lesson to be learned from these cases is that if a client is the target of a foreclosure action, it is incumbent upon counsel to review the mortgage and note and verify that the party making the motion for relief from the automatic stay or foreclosure is the party that owns those instruments and has standing to commence the action.

For the latest news on real estate and bankruptcy, please contact Shenwick & Associates.

Monday, February 11, 2008

Debt Relief Can Cause Headaches of Its Own

It wasn’t supposed to work this way.

Joseph A. Mullaney, a consumer affairs lawyer in New Jersey, was once a victim of a debt settlement company.

Credit card companies have long seduced customers with “buy now, pay later,” hoping they would pay at least a minimum amount month after month but never pay off their debts. Now, though, with the economy slowing and houses no longer easy sources of cash, a growing number of consumers cannot pay even the minimums.

In December, revolving debt — an estimated 95 percent from credit cards — reached a record high of $943.5 billion, according to the Federal Reserve. The annual growth rate of this debt increased steadily in 2007, reaching 9.3 percent in the last quarter, up from 5.4 percent in the first quarter.

The amount of debt that is delinquent — in which minimum payments are late but the accounts are still open — also appears to be on the rise. The Federal Reserve found that 4.34 percent of the credit card portfolios of the 100 largest banks that issue cards was delinquent in the third quarter of last year, up from 4.07 percent in the previous quarter. Charge-offs — accounts closed for nonpayment — also grew in that period, and banks expect charge-offs to keep rising in 2008.

“It’s not that card debt is unmanageable for everyone,” Adam J. Levitin, a credit expert and an associate professor of law at Georgetown University, wrote in an e-mail message. “Rather, it is unmanageable for some (and a growing group, it seems).”

What can borrowers do to extricate themselves?

If belt-tightening suffices, one option is a debt management repayment plan in which interest rates, but not balances, are reduced.

Ronald J. Mann, a law professor at Columbia University and a credit expert, describes credit industry practices as intended to enslave borrowers in a “sweat box.” He recommends a Chapter 7 bankruptcy that wipes out most credit card debt.

Many consumers, however, are loath to file for bankruptcy protection, said Mark S. Zuckerberg, a bankruptcy lawyer in Indianapolis. And others may find that they cannot qualify for a Chapter 7.

Then there is debt settlement, when a debtor and creditor agree that payment of a negotiated, reduced balance will be payment in full. Debt settlement generally works best when consumers can offer a lump sum, the experts said. But consumers may face taxes on the amount the creditor has forgiven.

“Done correctly, it can absolutely help people,” said Cyndi Geerdes, an associate professor at the University of Illinois law school who also runs a consumer debt clinic.

Consumers can arrange debt settlement themselves, and many Web sites offer advice. Consumers can also hire a lawyer or use debt settlement companies, many of which advertise online and on television. The experts agree, however, that “buyer beware” is the best advice when considering debt settlement companies.

A thousand such companies exist nationwide, up from about 300 a couple of years ago, estimated David Leuthold, vice president of the Association of Settlement Companies, which has 70 members and is based in Madison, Wis.

Deanne Loonin, a senior lawyer with the National Consumer Law Center in Boston, has investigated them. “It’s possible there are honest ones,” she said, “but I assume they aren’t until proven otherwise.”

Travis Plunkett, legislative director of the Consumer Federation of America in Washington, said distressed borrowers who cannot produce lump sums to settle with creditors were the most vulnerable to dishonest companies. In some cases, these companies tell consumers to stop paying monthly minimums, explaining that they will negotiate a settlement when borrowers have saved enough. Meanwhile, they take hefty monthly fees directly from clients’ bank accounts.

Creditors will not negotiate reduced balances with consumers who are still making monthly payments. But when they stop paying, total balances swell with fees and interest rates. And depending on the law in states where debtors live, creditors can attach wages and property to satisfy the new total owed.

“Many debt settlement companies never explain these risks clearly,” said Joseph A. Mullaney, a consumer affairs lawyer in Voorhees, N.J.

According to Ms. Geerdes, whether a creditor takes legal steps depends on its analysis of each debtor.

Mr. Leuthold said his association’s members served consumers who had already stopped making payments and had no better options. And his members must pledge to inform clients of risks and spell them out in contracts, he said.

David Johnson, senior vice president of ByDesign Financial Solutions, a nonprofit charity in Commerce, Calif., says he advises consumers to avoid companies that charge large fees upfront or through payments.

“It certainly would seem likely that there would be less incentive to push to settle quickly,” Mr. Johnson wrote in an e-mail message. He recommended that consumers look for services that charge after settlement, about 20 percent of the amount of the negotiated reduction in balance.

Desperate consumers may turn to debt settlement, Mr. Mullaney says, because “they usually want to pay their debt” but are also “intrigued with the proposition of getting out of it without the dishonor of declaring bankruptcy and with the prospect of compromising the actual principal that they owe.”

And company employees can be smooth talkers, said Susan Block-Lieb, a law professor at Fordham University and a consumer affairs expert. “You’ve got these really convincing, calm people with a really complicated formula, who are saying, ‘Don’t worry.’ ”

Katherine Taylor, the maiden name of a white-collar worker in Austin, Tex., who did not want to be further identified because she is a supervisor, said she realized last summer that she and her husband would soon be unable to make monthly minimums on their $59,000 in credit card debt. After seeing a television advertisement, Ms. Taylor said she typed “Christian debt settlement” into her computer. “I wanted an agency with high ethics,” she explained.

On the first phone call with one based in Austin, she agreed to let the company take $676 from her bank account for five months, then $416 for the next 13. “I was told that if I stopped making payments and saved up almost $24,000 on my own, in 48 months I would be free and clear and my credit score would improve,” Ms. Taylor said.

Late last year, unable to reach the settlement company by phone and getting constant calls from collectors, Ms. Taylor contacted a local Better Business Bureau office. She was advised to close her bank account immediately and file a complaint.

Offered a partial refund by the service, she is considering her options.

Mr. Mullaney himself was a victim of a debt settlement company. He was determined, he said, to avoid bankruptcy, a black mark for lawyers. But after starting practice in 2003, he said he realized that he would not be able to afford both student loan payments and the minimums on his $33,500 in credit card debt. He searched online for a debt settlement company run by a lawyer, and by phone closely questioned one based in Anaheim, Calif.

As instructed, Mr. Mullaney stopped paying his credit cards, started paying monthly fees and saved aggressively, he recalled. But without warning, three of Mr. Mullaney’s four creditors took legal action. “Finally, the cloud of irrational belief in the concept disappeared, and I realized the scam I’d fallen for,” he said.

On Oct. 17, 2005, the last day before changes in federal bankruptcy law made it harder to obtain a Chapter 7, Mr. Mullaney filed for bankruptcy protection and eliminated his credit card debt. “I’ve found redemption, through using my legal degree and what I’ve gone through, in counseling others who sit before me ashamed and in tears,” he said.

Marc S. Stern, a bankruptcy lawyer in Seattle, said most consumers should not negotiate for themselves. “It’s too emotional, and a lawyer can say things about clients that they never will, like he’s a deadbeat and you’re never going to get any more from him,” Mr. Stern said.

Experts agreed that deals may be struck with many original creditors for 50 to 80 cents on the dollar, while debt buyers, who paid 20 cents or less on the dollar, may settle for a lower amount.

Debt settlement companies are regulated by state attorneys general and the Federal Trade Commission, but they are rarely prosecuted. To improve regulation of this interstate business, the Uniform Law Commission, sponsored by state governments and based in Chicago, is promoting a model law that covers credit counseling and debt management companies. It was in force in four states last year, and an estimated five state legislatures will vote on it this year, said Michael Kerr, the commission’s legislative director.

Mr. Leuthold says his association welcomes regulation but has reservations about the model law, including its volume. “Some say it is long and complicated, 80 pages, and a lot of states don’t want that level of detail,” he said.

Until the states or Congress act, credit card holders are “naked in the world,” said Elizabeth Warren, a law professor at Harvard and a bankruptcy expert. “Unscrupulous debt counselors have built their business models around taking advantage of desperate people.”

By Jane Birnbaum. Copyright 2008 The New York Times Company. All rights reserved.