Tuesday, April 15, 2008

Misinformation from Fannie and Freddie on walking away

(Mish's Global Economic Trend Analysis) The San Francisco Chronicle is reporting Fannie warns homeowners who walk away.

The country's two largest sources of mortgage money have a blunt warning for anyone thinking about joining the growing "walkaway" trend, where homeowners stop making payments and months later send the house keys back to their lender: You will feel the pain.

On March 31, Fannie Mae (FNM) sent out new guidelines to lenders intended for walkaways and other foreclosure situations. Fannie will now prohibit foreclosed borrowers from getting another mortgage through the giant investor for five years, unless there are "documented extenuating circumstances." In those cases, the mortgage prohibition is for three years.

Freddie Mac (FRE), Fannie's rival, counts foreclosures as major credit blots for seven years, and a senior official said the company is now aggressively pursuing some walkaway borrowers "to preserve our deficiency rights" where permitted under state law.
My Comment: Walk away borrowers in non-recourse states do not have a problem on the original loan with Fannie's threat "to preserve our deficiency rights". Where permitted by state law is key. California is a non-recourse state.

Furthermore even if a state is a recourse state, that does not imply that every loan in that state is a recourse loan. Consider this answer from Bryan Whipple, Attorney at Law Re: Non Recourse Loan, Recourse State Florida

(1) Just because a state permits recourse loans doesn't mean it forbids non-recourse loans! In general, parties to loan transactions are allowed to agree on whatever terms they are able to negotiate. It's a freedom-to-contract principle.

(2) However, just because a document is stamped "Non-Recourse" doesn't necessarily make it such. A stamp on a document may be part of its terms, or it may be legally meaningless. To be sure the loan is truly non-recourse, I would suggest reading the entire document pretty carefully.


It pays to consult an attorney. Continuing with the article...
The walkaway trend is particularly noteworthy in former housing boom markets - including California, Florida and Nevada - where many homeowners find themselves upside down on their loans, owing tens of thousands more than the current market value of their houses. If they invested little or nothing in down payments, some owners reason, continuing to make payments - even if they can afford to - may be throwing good money after bad.
My Comment: The walk away trend is highest in the bubble areas. Not surprisingly, those are the areas with the largest numbers of walk-aways and those are areas where walk aways make the most sense.
Robin Stout Migala, consumer outreach manager for Freddie Mac, said in an interview that "there are so many bad reasons for walking away" from a home loan. Not only are borrowers' credit standings wrecked - forcing them into excessively high interest rates on any credit they can manage to obtain. But they also face other potential problems, including federal income tax liabilities.

Federal legislation enacted last year allows homeowners who negotiate loan modifications with lenders and have portions of their principal debt eliminated to escape income tax liability for the amount forgiven. Walkaway borrowers, by contrast, have nothing forgiven, and the IRS may demand income taxes on the balance they never paid, according to Migala.
My Comment: In my opinion Robin Stout Migala is spreading misinformation. I leave it to the reader to decide if this is on purpose or though ignorance.

Migala is misrepresenting the Mortgage Forgiveness Debt Relief Act. There is a provision allowing tax free debt forgiveness, even in recourse states, for reasons of insolvency. Note the following question and answer from the IRS.

If part of the forgiven debt doesn't qualify for exclusion from income under this provision, is it possible that it may qualify for exclusion under a different provision?

Yes. The forgiven debt may qualify under the "insolvency" exclusion. Normally, a taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is insolvent. A taxpayer is insolvent when his or her total liabilities exceed his or her total assets. The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real property business indebtedness. If you believe you qualify for any of these exceptions, see the instructions for Form 982.


Inquiring minds may also wish to read Mortgage Workouts, Now Tax-Free for Many Homeowners; Claim Relief on Newly-Revised IRS Form.

The article continues ....

For borrowers who faced genuine financial hardships leading to foreclosure, underwriters are likely to be more sympathetic a few years down the road. But if you walk away, here's the deal: Don't expect to get a new home loan - certainly not one with favorable terms - for five to seven years.

That's no matter what some promoter promised you online.

My Comment: Robin Stout Migala is talking his book. That book is to get you to keep paying your mortgage whether it makes any sense or not. Threats of "preserving deficiency rights" may be hollow.

Anyone who is deep in the hole on a mortgage should do what is in their best interest. That may mean a work out, it may mean bankruptcy, it may mean walking away. Walking away is not the right solution for everyone, and it does have consequences. On that I agree with Migala. However, the picture Migala presented is far from accurate.

I happen to believe the folks at You Walk Away are providing a valuable service at a reasonable price. They have turned down clients attempting to "game the system". There are times walking away makes sense and times it does not.

I have talked about walking away on many occasions. Here is a recap:
In the end, everyone has to decide this issue for himself. However, the one thing that makes absolutely no sense is to struggle for years as a debt slave, attempting to hang on, tapping out credit cars or heaven forbid IRAs, then only to lose the house anyway.

Fannie and Freddie are attempting to stigmatize walking away. Worse yet, they are doing it by spreading misinformation. There is one thing I want to be clear on: I am not promoting walking away for walking away's sake. I am promoting people do what is in their best interest. That may or may not be walking away. Sadly, I suspect walking away makes sense far too often.

Corporations are doing what is in their best interest even if they have to spread misinformation to do it. Why shouldn't people do what is in their best interest and tell businesses where to go? I am sick of seeing people being turned into debt slaves. If walking away makes sense, then by all means do it.

Fannie and Freddie's big threat seems to be if you walk away they will require a big down payment, higher FICO score, and ability and willingness to pay the loan back.

Had Wall Street, banks, homebuilders, the Fed, Congress, GSEs, etc., shown any sense of responsibility in the first place, this never would have happened. Yes, consumers were greedy too, but who bears the lion's share of the blame? Now consumers, especially innocent bystanders, are bearing the brunt of a sinking US$, of low interest rates on CDs, of bailouts of banks, etc.

To hell with em.

California Attorney Chimes In

I have been in communication with "HCL", a California attorney over real estate law in California. HCL writes:
As a California real estate attorney I can tell you this:

1) Mortgage debt, whether its a first or second loan, is nonrecourse if it is "purchase money", used initially to purchase the property;

2) Mortgage debt that exists due to a refinancing and/or to second loan taken out after purchase is recourse, but -- and its a BIG but -- only if the lender elects to file a lawsuit for judicial foreclosure rather than going through the usual foreclosure process;

3) Suits for judicial foreclosure are in my experience of 28 years extremely rare, due mostly to the fact that any buyer at a judicial foreclosure sale has to give the foreclosed-upon party a full year to redeem the property. This of course is a complete deal-killer.

An interesting side-note: California's anti-deficiency law originated during the Depression years, in order to place the burden of properly valuing real property and risk of loss on lenders (who presumably were more sophisticated and able to assess value) rather than buyers. Fast-forward to now, when it turns out that rampant greed prevented lenders from acting rationally in their own self interest. Now they are paying the price with walk-aways and "jingle mail".
If walking away makes sense to you, then by all means do it, just consult your tax advisor first.

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