Walking away from your mortgage just got a lot scarier

We've been touting the benefits of walking away from an underwater mortgage here for years.

Of course, as we noted, there's one catch: "recourse debt." The laws vary greatly by state, but often (as in California, I believe, but I'm not a lawyer, so consult one) purchase loans are non-recourse while refinance loans are recourse. Recourse debt means the banks can sue you many years after a foreclosure for the loss they took.

For a while, it looked like this recourse risk was only theoretical, as the banks were overwhelmed with an operational deluge and political pushback on targeting the poor. Now, it seems, that has changed.

Joseph Reilly lost his vacation home here last year when he was out of work and stopped paying his mortgage. The bank took the house and sold it. Mr. Reilly thought that was the end of it.

In June, he learned otherwise. A phone call informed him of a court judgment against him for $192,576.71.

It turned out that at a foreclosure sale, his former house fetched less than a quarter of what Mr. Reilly owed on it. His bank sued him for the rest.

The result was a foreclosure hangover that homeowners rarely anticipate but increasingly face: a "deficiency judgment."


The increase in deficiency judgments has sparked a growing secondary market. Sophisticated investors are "ravenous for this debt and ramping up their purchases," says Jeffrey Shachat, a managing director at Arca Capital Partners LLC, a Palo Alto, Calif., firm that finances distressed-debt deals. He says deficiency judgments will eventually be bundled into packages that resemble mortgage-backed securities.

Because most targets have scant savings, the judgments sell for only about two cents on the dollar, versus seven cents for credit-card debt, according to debt-industry brokers.

Silverleaf Advisors LLC, a Miami private-equity firm, is one investor in battered mortgage debt. Instead of buying ready-made deficiency judgments, it buys banks' soured mortgages and goes to court itself to get judgments for debt that remains after foreclosure sales.

Silverleaf says its collection efforts are limited. "We are waiting for the economy to somewhat heal so that it's a better time to go after people," says Douglas Hannah, managing director of Silverleaf.

Investors know that most states allow up to 20 years to try to collect the debts, ample time for the borrowers to get back on their feet. Meanwhile, the debts grow at about an 8% interest rate, depending on the state.

If you have a recourse mortgage, you're probably better off trying to short-sell the house and getting the bank to release your deficiency liability in writing. Banks will do this in a short sale but you have to ask.

The best strategy of all for deeply underwater homeowners is to take advantage of the FHA's great new FHA "Bail and Buy" program. Under FHA Bail and Buy, you short-sell your underwater house, then you get a 3.5% down, taxpayer-guaranteed loan to buy another house at current market prices. WINNING!!!

1 comment:

Anonymous said...

The recourse risk was never theoretical in Florida. Lenders began suing, albeit in limited numbers, after the first short sales for the balance.

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