Defaulting on secured loans
Bernie Cosell
so-called "underwater" mortgages. The article didn't say, but it seemed to
imply that you can just walk away from a loan like that and be free and
clear of it: the bank takes over the property on foreclosure and you're
otherwise home free. I *thought* that for secured loans [which includes
mortgages] you were responsible for the *entirety* of the loan, even if you
default... and if you do default the lessor can/will come after you for the
difference [which you would still owe]. Does defaulting on a mortgage
actually discharge the obligation or is that part [that you end up having
to deal with the "underwaterness" after the repossession] just not
mentioned. If it *does* discharge the debt, are there other "secured"
loans that work similarly? [e.g., that hefty car loan you're paying off on
the Cadillac Escalade or the H2 Hummer -- can you just walk away and
"stick" the loan company with the underwater-ness of the security?]
/bernie\
--
Bernie Cosell Fantasy Farm Fibers
ber...@fantasyfarm.com Pearisburg, VA
--> Too many people, too few sheep <--
Mike Jacobs
> I *thought* that for secured loans [which includes
> mortgages] you were responsible for the *entirety* of the loan, even if you
> default... and if you do default the lessor can/will come after you for the
> difference [which you would still owe].
The debtor's liability for the entire debt is a given, whether
_or_not_ it is secured by collateral, unless some term in the secured
loan contract itself says that the debtor is _not_ responsible for
more than can be recovered by seizure of the collateral. The latter
type are so-called "non-recourse" loans - meaning, the lender has "no
recourse" to recover his money, other than to seize the collateral
(repo the car, foreclose on the house, bring movers to take back the
TV, appliances or furniture, etc) and sell it for whatever he can
get. However, just to be clear, not all "secured" loans are "non-
recourse" loans - "non-recourse loans" are a wholly included subset of
the category "secured loans."
Even those debtors who do not have a "non-recourse" loan may in some
circumstances be tempted to walk away from an upside-down mortgage or
car payment (where they owe more than the value of the collateral).
The creditor may or may not actually come after them for the balance,
depending on the creditor's best guess whether there is any real
chance of collecting. You can't squeeze blood from a turnip, so the
creditor may choose to concentrate his efforts on collecting from
those defaulted debtors who _do_ have other assets, or a steady job.
But legally, of course, the creditor has the _right_ to go after an
upside-down debtor whose loan terms did not include a "no recourse"
clause, whether or not the creditor actually chooses to do so.
> Does defaulting on a mortgage
> actually discharge the obligation
Yes, _IF_ it is a non-recourse loan. That would depend on the terms
of the contract. Read it. Some kinds of Federally-guaranteed home
loans are required to be non-recourse. However, that law still just
means the term is required to be included in such a loan contract,
which is the first place one should look to see if his particular
mortgage loan is non-recourse, or the other kind.
> or is that part [that you end up having
> to deal with the "underwaterness" after the repossession] just not
> mentioned.
If nothing is mentioned, the debtor always owes the debt as a personal
obligation, period, whether or not the collateral is sufficient to
secure the entire obligation, or whether or not there is any
collateral at all. The personal obligation part is what comes
_first_; the "security" part of a secured loan is _extra_ frosting on
top, an extra layer of protection for the secured creditor that gives
him _some_ concrete means of reassurance his loan will be repaid other
than merely relying on the honesty, industry and diligence (i.e.
personal creditworthiness) of the borrower (as all creditors must do,
on any "unsecured" loan).
> If it *does* discharge the debt, are there other "secured"
> loans that work similarly? [e.g., that hefty car loan you're paying off on
> the Cadillac Escalade or the H2 Hummer -- can you just walk away and
> "stick" the loan company with the underwater-ness of the security?]
A car loan _can_ be written as a non-recourse loan - there is no legal
prohibition on including such a term in a car loan contract - but in
practice, I think very few of them are, since a car, unlike a house,
_depreciates_ as soon as it is driven off the lot, so _most_ car loan
debtors are "upside down" from the moment they buy the car, until
quite late in the loan repayment period (when the remaining unpaid
principal on the loan is finally less than the repo-sale value of the
depreciated car). I imagine a debtor would have to pay a hefty
premium in the form of increased interest rate, to offset the
additional risk to the creditor that this represented, if he wanted to
negotiate a non-recourse clause in his car loan. This may in fact be
what some dealers catering to low-end (i.e. poor credit) car buyers
routinely do - charge them high interest in return for a no-recourse
clause - but I don't know it for a fact. Plenty of "inner city"
dealers do _not_ offer such terms, though, which I can see every time
I'm at a "cattle call" trial date in an urban small claims court along
with a dozen or so other cases on the same morning docket, many of
which are inevitably those brought by auto lenders against defaulting
buyers, to get a personal judgment for the balance still due after a
repo and forced sale of the car.
Another valuable tool to keep in mind, in the car loan context, is
"gap insurance," which I recommend as a _very_ good idea, not just to
poor-credit borrowers but to _all_ car-loan borrowers (unless they
have a non-recourse loan). Such coverage pays the outstanding balance
on a car loan in the event the car is totalled in a wreck or stolen,
since otherwise the owner would still owe the lender for the remainder
of the unpaid principal even though he no longer owns the car he took
out the loan to buy.
--
This posting is for discussion purposes, not professional advice.
Anything you post on this Newsgroup is public information.
I am not your lawyer, and you are not my client in any specific legal
matter.
For confidential professional advice, consult your own lawyer in a
private communication.
Mike Jacobs
LAW OFFICE OF W. MICHAEL JACOBS
10440 Little Patuxent Pkwy #300
Columbia, MD 21044
(tel) 410-740-5685 (fax) 410-740-4300
David Spencer
>I was reading about "strategic defaults" -- homeowners walking away from
>so-called "underwater" mortgages. The article didn't say, but it seemed to
>imply that you can just walk away from a loan like that and be free and
>clear of it: the bank takes over the property on foreclosure and you're
>otherwise home free. I *thought* that for secured loans [which includes
>mortgages] you were responsible for the *entirety* of the loan, even if you
>default... and if you do default the lessor can/will come after you for the
>difference [which you would still owe]. Does defaulting on a mortgage
>actually discharge the obligation or is that part [that you end up having
>to deal with the "underwaterness" after the repossession] just not
>mentioned. If it *does* discharge the debt, are there other "secured"
>loans that work similarly? [e.g., that hefty car loan you're paying off on
>the Cadillac Escalade or the H2 Hummer -- can you just walk away and
>"stick" the loan company with the underwater-ness of the security?]
It depends on the jurisdiction. Broadly, the states fall into three
categories:
1. No limit on recovery of a deficiency, that is, the lender can
enforce his security, and, if that does not pay the debt in full,
sue for the remaining debt as an unsecured creditor
2. Election of remedies, that is, the lender can recover by enforcing
its security, or by suing on the debt as an unsecured creditor, but
not both.
3. Non-recourse, that is, the lender can only recover by enforcing its
security interest.
In many states, the rules for a security interest in real estate (ie,
a mortgage) are different from those for security interests in
personal property (such as a car). Security interests in personal
property are governed by the Uniform Commercial Code, which permits
recovery on a deficiency. However, that may be limited by other law
or doctrine, particularly for security interests in consumers'
property.
--
dhs spe...@panix.com
Stuart A. Bronstein
> I *thought* that for secured loans [which includes mortgages] you
> were responsible for the *entirety* of the loan, even if you
> default... and if you do default the lessor can/will come after
> you for the difference [which you would still owe]. Does
> defaulting on a mortgage actually discharge the obligation or is
> that part [that you end up having to deal with the
> "underwaterness" after the repossession] just not mentioned.
It depends on the laws of the state were the loan was made. In
some states (e.g. California) a foreclosure of a purchase money
loan for a property of four residential units or fewer
automatically discharges any deficiency balance. In other states
(e.g. Nevada) it does not.
> If it *does* discharge the debt, are there other "secured" loans
> that work similarly? [e.g., that hefty car loan you're paying
> off on the Cadillac Escalade or the H2 Hummer -- can you just
> walk away and "stick" the loan company with the underwater-ness
> of the security?]
Some loans by their terms are non-recourse. That means that the
creditor's only recourse is to the security, not to a judgment for
a deficiency balance. These loans are rare, and only given when
there is a particular reason (e.g. family member). There are
adverse tax implications for non-recourse loans that are security
by other than real property, which is one reason for their rarity.
Rich Carreiro
> I was reading about "strategic defaults" -- homeowners walking away from
> so-called "underwater" mortgages. The article didn't say, but it seemed to
> imply that you can just walk away from a loan like that and be free and
> clear of it: the bank takes over the property on foreclosure and you're
> otherwise home free. I *thought* that for secured loans [which includes
> mortgages] you were responsible for the *entirety* of the loan, even if you
> default... and if you do default the lessor can/will come after you for the
> difference [which you would still owe].
That depends on the state. In many states purchase money mortgages
are "recourse loans" and absent you filing bankruptcy the lender can
come after you for any remaining deficiency after they've foreclosed
on and sold the property.
But in some states (like California) purchase money mortgages are
"non-recourse loans" and the lender is stuck with what he can get
from the foreclosure sale -- he can't come after you for the deficiency.
--
Rich Carreiro rlc-...@rlcarr.com
Seth
Bernie Cosell <ber...@fantasyfarm.com> wrote:
>I was reading about "strategic defaults" -- homeowners walking away from
>so-called "underwater" mortgages. The article didn't say, but it seemed to
>imply that you can just walk away from a loan like that and be free and
>clear of it: the bank takes over the property on foreclosure and you're
>otherwise home free. I *thought* that for secured loans [which includes
>mortgages] you were responsible for the *entirety* of the loan, even if you
>default... and if you do default the lessor can/will come after you for the
>difference [which you would still owe].
In some states, purchase-money mortgages may be non-recourse.
In others, they're semi-non-recourse: the bank can either foreclose on
its own (quickly and cheaply), making it non-recourse; or it can do a
judicial foreclosure (slow and expensive, and subject to nasty
defenses like "do you still have all the original paperwork?"), and
have recourse. Typically, the extra cost and time involved are more
than the bank thinks it could collect later from the defaulter.
Seth
Silence DoGood
>Does defaulting on a mortgage
> actually discharge the obligation � � � � �
If the place goes into repossession, you would owe much more than for
being underwater, you would also owe for all the bank's expenses. Of
course that debt is now unsecured, along with any second mortgage or
other liens.
Many people are "working with" their lender to negotiate a "short"
sale. In a typical case, the bank will discharge the loss, but be sure
to read the fine print. Sellers often fail to adequately comprehend
that a short sale on a first mortgage will not discharge a debt on the
second mortgage which now becomes an unsecured, but legally
collectible, debt.
If one owes $22,000 on the Hummer and is $5,000 behind, and it is
repossessed and auctioned off for $12,000, the previous owner may now
owe $10,000 plus expenses.
I'm not a lawyer and I'll be watching this thread, but I'm pretty sure
about what I have said so far, but perhaps someone can answer a
question that remains on my mind.
Suppose a guy paid $250,000 for a house with $180,000 left on the
first mortgage. The bank repossesses and the highest "bidder" at the
foreclosure auction is the bank itself which takes title for $150,000.
And then, let's say, the bank dallies for two years and sells it for
$120,000, meaning after expenses they are netting, say, $85,000.
I believe the original buyer is "off the hook" for the money lost by
the bank after the foreclosure, in contrast with the Hummer where the
original buyer would be responsible for virtually any loss incurred by
the lender.
Of course, there is a problem with collecting unsecured debt, which
can turn into throwing good money after bad. Also, some are
discovering there are judges who read and follow laws and refuse to
issue orders without the signed paperwork.
Mike Jacobs
> Many people are "working with" their lender to negotiate a "short"
> sale. In a typical case, the bank will discharge the loss, but be sure
> to read the fine print.
Always - or at least, have somebody (like your own lawyer) who is
unequivocally on YOUR side and knows what he is doing, read it _for_
you.. But it is surprising how many people don't, perhaps on the
assumption that the lenders are being "fair" and are "looking out for
me" by "working with me" and arranging the short sale in lieu of
foreclosure. Clue - they aren't. They're looking out for
THEMSELVES and if you get screwed in the process, they won't lose any
sleep.
> Sellers often fail to adequately comprehend
> that a short sale on a first mortgage will not discharge a debt on the
> second mortgage which now becomes an unsecured, but legally
> collectible, debt.
Good point.
> If one owes $22,000 on the Hummer and is $5,000 behind, and it is
> repossessed and auctioned off for $12,000, the previous owner may now
> owe $10,000 plus expenses.
Correct.
> I'm not a lawyer and I'll be watching this thread, but I'm pretty sure
> about what I have said so far,
I don't see anything glaringly inaccurate in what you said. I think
you got it right.
> but perhaps someone can answer a
> question that remains on my mind.
I'll try.
> Suppose a guy paid $250,000 for a house with $180,000 left on the
> first mortgage. The bank repossesses and the highest "bidder" at the
> foreclosure auction is the bank itself which takes title for $150,000.
Well, that's the first issue. A bank which "re-buys" the property it
already has a security interest in, is almost always going to do so
for the full amount of the outstanding principal - in your example,
$180,000. Why? This insures no other bidder will come in and bid
(in your example) $151,000 and walk away with a cheapo fire-sale deal
on a $250,000 house. For the bank, bidding the balance due as the
starting point means that any other bidder who wants the house will
have to pay more than that, so the bank will be fully paid off, and
there will even be a little bit left over to pay to the defaulting
borrower (representing his equity in the property). Now, if it is an
upside-down situation (let's say, the home is actually only _worth_
$150k in an arm's-length, fair transaction between strangers who have
had no prior dealings) the above rationale may not apply, but that is
not what your example said.
> And then, let's say, the bank dallies for two years and sells it for
> $120,000, meaning after expenses they are netting, say, $85,000.
The original foreclosure sale is the only one that counts, in terms of
setting how much balance is still due from the original borrower, _IF_
it was a recourse loan (of course, for a non-recourse loan the
foreclosure sale wipes out any remainder personal debt).
> I believe the original buyer is "off the hook" for the money lost by
> the bank after the foreclosure,
Sure. Whatever the buyer (bank) does with the property after they
buy it, and whether they later sell it at a profit or at a loss, is no
concern of the (former) owner's. The purchaser at foreclosure bears
the entire risk of what might happen to the property after that, both
physically (risk of casualty loss) and in terms of fluctuating market
value.
> in contrast with the Hummer where the
> original buyer would be responsible for virtually any loss incurred by
> the lender.
I'm not sure what you meant by "virtually any loss." The
repossessing lender still needs to sell the repo'd vehicle in a
"commercially reasonable" manner, which usually means an open auction
(attended mostly by car dealers) and the price he gets at the repo
sale determines how much of a remaining balance is still owed by the
defaulting borrower, just as in the home foreclosure situation.
> Of course, there is a problem with collecting unsecured debt, which
> can turn into throwing good money after bad.
That's true. It's up to the creditor to put his collection resources
where he thinks they will do him the most good, not waste time trying
to squeeze blood from people who don't have two nickels to rub
together.
> Also, some are
> discovering there are judges who read and follow laws and refuse to
> issue orders without the signed paperwork.
I'm not sure what that dig means either - I remember your hobby horse
threads about perceived judicial misconduct - but yes, _most_ judges
do read and follow the law. Note, however, that in my experience as
a back-bench observer (while waiting for my own cases to be called),
the typical, busy urban or inner-suburban small-claims court has
lawyers for 2 or 3 lenders show up on an average trial day with half a
dozen cases each of defaulting car borrowers whose vehicles have been
repossessed and sold, and from whom the plaintiff lenders are seeking
deficiency judgments for the remaining principal balance (plus repo
costs). There does appear to be a cookie-cutter quality to most of
those judgments, especially if the defendant borrower is also in
default of answering the complaint, and fails to appear.
The judge in such cases, after calling the case in turn, basically
asks the lender's lawyer how much Debbie Debtor owes on her repo'd
Hummer, and signs a judgment for that amount - the whole trial takes
about 1 minute each (as a particular lender's lawyer is standing at
counsel table, one after another of the cases he represents is called,
saving him and the court the time it would take him to walk back and
forth from the gallery each time. Then, it's the next collection
lawyer's turn). If a borrower claims he has a defense to the debt,
though, and shows up to contest it, of course he is given fair
opportunity to do so, the trial takes longer, and the outcome is _not_
a foregone conclusion - I did not mean to imply otherwise.
Seth
Mike Jacobs <mjaco...@gmail.com> wrote:
>On Oct 28, 1:06 pm, Silence DoGood <Silence_DoG...@angelic.com> wrote:
>> Also, some are
>> discovering there are judges who read and follow laws and refuse to
>> issue orders without the signed paperwork.
>
>I'm not sure what that dig means either - I remember your hobby horse
>threads about perceived judicial misconduct - but yes, _most_ judges
>do read and follow the law.
Since this started with mortgages, in the current climate, there have
been a lot of cases where a mortgage was originated by a storefront
operation which later went out of business, and sold through several
intermediaries before being packaged up with a number of other
mortgages and various slices and dices sold off. Then, when someone
goes to foreclose, the original paperwork can't be found.
Some judges have ruled that since a bank was willing to pay $400K for
this mortgage to a packager, it must have been valid, so the paperwork
isn't required. Others have said that without the paperwork, the
entity attempting to foreclose can't prove that it's the valid owner.
Seth
Stuart A. Bronstein
> Since this started with mortgages, in the current climate, there
> have been a lot of cases where a mortgage was originated by a
> storefront operation which later went out of business, and sold
> through several intermediaries before being packaged up with a
> number of other mortgages and various slices and dices sold off.
> Then, when someone goes to foreclose, the original paperwork
> can't be found.
Anyone who pays for a note secured by a mortgage but does not get the
original paperwork (or at least a good copy) is foolish. The
transfer of paperwork should be routine, if for no other reason than
to prove that the purported mortgagee is actually the one entitled to
be paid. Normally a copy will be allowed in evidence if there's a
good reason for not supplying the original.
One of my clients, a private person, once purchased a mortgage from a
bank - and received all the original paperwork along with a signed
assignment of the rights of the lender. If he hadn't, it would have
been really, really foolish.
Stuart A. Bronstein
> Mike Jacobs <mjacobs...@gmail.com> wrote:
>
>> Well, that's the first issue. � A bank which "re-buys" the
>> property it already has a security interest in, is almost
>> always going to do so for the full amount of the outstanding
>> principal - in your example, $180,000. �Why? � This insures no
>> other bidder will come in and bid (in your example) $151,000
>> and walk away with a cheapo fire-sale deal on a $250,000 house.
>
> result from anything less than a full credit bid.
Waiver? How would paying market value be considered a waiver?
The rule in California is exactly the opposite. When the sale of a
foreclosed property is made, anyone who wants to can attend and
bid. The highest bidder gets the property - considered market
value under the circumstances. If someone pays the full amount,
the bank is paid off in full and the debtor owes nothing.
So if the bank makes a full credit bid, it's as if they are paying
themselves the entire outstanding balance. So it's in that
situation that they are unable to sue for a deficiency balance -
they are paid in full. The sale that counts is the foreclosure
sale, not what the bank sells the property for later.
Seth
Stuart A. Bronstein <spam...@lexregia.com> wrote:
>se...@panix.com (Seth) wrote:
>
>> Since this started with mortgages, in the current climate, there
>> have been a lot of cases where a mortgage was originated by a
>> storefront operation which later went out of business, and sold
>> through several intermediaries before being packaged up with a
>> number of other mortgages and various slices and dices sold off.
>> Then, when someone goes to foreclose, the original paperwork
>> can't be found.
>
>Anyone who pays for a note secured by a mortgage but does not get the
>original paperwork (or at least a good copy) is foolish.
I agree.
When has there ever been a shortage of foolish people?
Seth
Seth
>
>> Well, that's the first issue. � A bank which "re-buys" the property it
>> already has a security interest in, is almost always going to do so
>> for the full amount of the outstanding principal - in your example,
>> $180,000. �Why? � This insures no other bidder will come in and bid
>> (in your example) $151,000 and walk away with a cheapo fire-sale deal
>
>It also avoids a waiver of the deficiency balance that could result
>from anything less than a full credit bid.
I don't understand.
If the mortgage balance was $180,000, the bank foreclosed and sold the
property for $180,000 to the high bidder (which happened to be itself,
but so what?), then there is no deficiency balance, waived or
otherwise.
Seth