The Foreclosure Crisis Hits Close to Home, Part 2

I've already told one story about how the current foreclosure crisis has hit close to home for us. Here's another one.

In the process of selling our current home, we were looking at comparative homes near ours that were for sale and ones that had sold -- so we could set the price for our place. One of the homes for sale was previously owned by good friends of ours, a wonderful, honest, trustworthy family that had moved to Colorado this past summer. They had previously had their home listed in the low 200's, but now it was down to $189k.

I said I was surprised that they had gone so low since I thought their plan was to see if they could get a higher price, even if it meant that they were letting it sit for awhile. Then I noticed some red lettering on the listing and asked our agent what that meant. She said, "Oh, that means the place is now owned by a bank. It was probably foreclosed on."

What? How could this happen -- and to good friends of ours? We had no idea!

And just to be clear, we still have no idea what has actually happened (my wife has talked to the other wife a couple times and nothing's been mentioned -- and my wife is hesitant to ask, for good reason). In fact, despite our agent's claim, they still have a neighborhood boy cutting their grass and the home is listed with the same agent, both of which might indicate that they still own the home. That said, if they did go into foreclosure, here's the likely scenario that played out:

• They knew they were going to move, so they had their home fixed up. They painted, put in new carpeting, and had some other major work done to make the house look as good as possible.

• They set the price they wanted to get out of the house -- not at the going market rate.

• While they waited for their home to sell (and assumed they'd get $XXX price for it), they bought a new place in Colorado. While we don't know the price on the new home, we do know the following specifics:

• It was a home in foreclosure.
• It wasn't finished. It still needed some drywall, etc. They had a relative in that area that was going to fix it up for them before they moved out.
• As such, they had to put a decent amount of money into the new place to get it livable.
• It had several bedrooms (six or seven, I believe) and 10 acres of land.
• Somehow we got the idea that the house was in the $500k price range (though this could be way off). What I do know is that they "stretched" to afford this place (the husband told me so a few weeks before they moved.)
• The land had stables, so they bought a couple horses and a few motorcycles/ATVs to really enjoy the place.

• Their home here didn't sell. It's an older home and the market is tough anyway -- and they wouldn't/couldn't move the price down much (though they did some.)

• It got to the point where they were underwater on the home and they simply walked away -- giving the home (and their debt) to the bank. This is speculation, but if the house is bank-owned now, it's the most plausible explanation of what happened.

So, in other words, they bought a new home and some goodies while their credit was good, then dumped the old house for the bank to handle. I'm sure it wrecked their credit (or will soon), but they already have their new loan secured -- so they're "fine."

If this is the case, I'm shocked in many different ways. Shocked that they were in such financial trouble, shocked that they bought such an expensive place given that they couldn't really afford it, shocked that they were dishonest and simply walked away from a financial commitment, and so on. I'm shocked, shocked, shocked!

I did a bit of Google research and it turns out that this practice (called "buy and bail") is rather common (see The Wall Street Journal, ABC News, About.com, and Yahoo). Still, I see it as pretty dishonest. And I'm shocked that people we knew so well and considered honorable did something like this.

Comments

[anna]

Don't be too too hasty to judge them: you don't know excactly what happened yet. Your version of the events may be the right one, but it's just speculation right now.

If you are right, and that's what they did, then you still don't have evidence they could have handled the situation in a different way (perhaps desperation instead of dishonesty at work here?) You don't know if they sold the second house & the rest of the stuff and are living in an apartment.

These are friends of yours...you called them honest and trustworthy at the top, but dishonest and shocked at them near the bottom. They are not just your friends, but your very good friends...can you give them the benefit of the doubt? At least find out what

[FMF]

Anna --

That's why I wrote this piece with phrases like "we still have no idea what has actually happened" and "if this is the case" -- because we don't know. Did you miss those parts?

As far as finding out what really happened, I'm not sure how to do that -- it's not a topic you bring up easily, even with good friends.

[Todd]

Why are you suprised? So many people in my area (metro Detroit) are doing the exact same thing. Home prices are so depressed right now that you can buy what used to be a $220K house for $150K or less. So if you had a house that was worth $150K but you know you can only get $110K for it--They just buy another house for $150K(which is really worth $220K)--No change in payment and let the first house get foreclosed. My friends and I have talked about doing it(for financial reasons only!) but can't do it because of moral and ethical reasons. Just another easy way out for most people.

[Kay]

What makes me most upset is that I live in a neighborhood (Southeast Michigan) with 12 CURRENT foreclosures out of 191 houses. That does not include those foreclosed on and sold already within the last year. We know many have done this "buy and bail". We have a mortgage, pay every month on time and watch our house value go down, down, down because others are taking the "easy" way out.

We couldn't even refinance if we needed to because of the value of our home (bought at $230, value $175). When housing prices come back up, it doesn't seem fair that my neighbor will make money with the "buy and bail" and I will be lucky to realize the price I paid.

[Kevin]

Karma's a bitch, pardon my french. It will come back around to them at some point.

[Tim]

I'm sure this practice of "buy and bail" is one reason why getting a loan is so difficult these days. Even for those with pretty good credit. This is something I would absolutely not do myself and I think it is completely wrong.

[Todd]

Kay I feel your pain. Bought my house in 05 for $135K and put $20K down. Put another $8-$10 into the house. It is probably worth somewhere in the neighborhood of $110K. I've had 7 foreclosures on my street alone!!!! People are buying the houses next to me for anywhere from $66-95K. Thought I was doing good buying a house in my low-mid 20's but I guess not. Should have stayed with my parents or rented an apartment.

[rwh]

Not only is this practice ethically wrong, but it would be extremely stressful. One would have to know that a foreclosure will eventually create big problems in the future. It simply delays the day of reckoning.

But, maybe failure to consider the consequences is what created this problem in the first place.

[Troy]

Exactly what is "dishonest" or "unethical" about walking away from your mortgage?

I am serious.

See, as part of the mortgage paperwork there is a note and deed of trust, and in that note and deed of trust there is a default clause that spells out exactly what happens if the borrower defaults. This is a written contract. You pay, you stay. You don't, the lender gets the collateral back.

There is nothing about that that is dishonest or unethical. Unethical would be for the lender to take the house even though you are current on payments.

Unethical would be you getting to keep the house after failing to make payments, leaving the lender with no recourse.

However, there is recourse. That is the entire point of the note and deed. It is not unethical or dishonest because it was agreed upon BEFOREHAND the terms of the contract. Breaking the contract is an option that all parties to that contract have. That is specifically why there are default remedies written into them.

It may be unfortunate, but it is not unethical or dishonest. These are business transactions to banks.

[Kim]

Not only is it unethical and dishonest, it is criminal. If someone knowingly does this, it is considered mortgage fraud and they will be prosecuted. It's a Federal crime, too, so don't think you'll get off with a fine and a few days in County. A Federal judge will throw you in Federal prison for years.

I have to agree with Troy. Kim may be right if they entered into the mortgage with this intent, but if not I think she's wrong. Mortgage fraud typically focuses on the misrepresentation to induce someone to give you a mortgage. Not failure to pay one's mortgage. Assuming there aren't other laws that I don't know of, and assuming the mortgage was obtained by non-fraudulent means in the first place, then it's a matter of contract and I think Troy is right.

[Colin]

Won't this catch up with them at some point? I mean, we know that the credit is going to get trashed. But, after the bank unloads the property, won't it sue them, win, and take a lien against the new property if they don't pay the difference?

[rwh]

I'll clarify:

If they knew they couldn't sell their house for enough to pay off the mortgage, yet went ahead and got a loan for a more expensive home....because they knew the only way they could do this was before their credit rating took a hit from a foreclosure, that sounds pretty unethical to me.

You would have to prove intent, which is often difficult, but a requirement of participating in a valid contract also includes full disclosure. I doubt the second bank would have given them a mortgage on the new place if the situation with the place back in Michigan was disclosed to them.

[Jim]

Its really not known what happened with these people.

Its not even verified that the house is in foreclose.

If they were planning to 'buy and bail' then they wouldn't have upt money into the old house to fix it up first. Nor would they pay someone to mow it. And if this house was foreclosed then why would they still be paying for the mowing?

Its possible they got in over their head and that the Michigan house was foreclosed. But I don't see anything pointing to that being an intentional move or their plan.

Jim

[TLC]

Since you don't have the facts of the matter, doesn't this just amount to gossiping about your so-called friends? And, if they are friends, they may have been aware of your blogging and didn't want to end up as fodder for the blog if they told you what was going on.

[kitty]

One thing that I find surprising about this whole thing - assuming you are correct - and this practice of "buy and bail" is that the mortgage contract on the new home didn't have "conditional on prior sale" clause. Just a few years ago when everyone could get loans for any amount, it wouldn't have been a problem. But now, the banks are more careful. So to get a new place without "conditional on prior sale" clause, they must have shown that they are able to afford both places.

At least this was the case in the 90s. I know that when I bought my townhouse the agent did calculations to make sure I could afford carrying costs on both places before he allowed me to have a contract without this clause - I wanted to rent out but wanted to have a bit of time to fix up the new place. So are all these people who do "buy and bail" indeed able to afford two places yet walk away rather than paying or are some banks still not being careful?

[kitty]

Never mind. I just googled for "buy and bail" and found out that people who do it draw up a phony rental contract to satisfy "conditional on prior sale or rental" clause.

Surely this must be illegal? Walking out on one's home is one thing, but lying to the bank that gives them the new mortgage and showing fake papers is a totally different thing. It also shows intent, and it shouldn't be difficult to prove - just find the party who signed the phony rental contract.

I also found this link "http://www.inman.com/news/2008/09/24/fha-limits-buy-and-bail-purchases" which shows that people who do it are actually hurting legitimate buyers who honestly rent out their old place.

[Sara]

How is this possible? Given the current credit crisis, it can't be easy to QUALIFY for a loan on a new home when you are in enough financial distress to consider walking away from your current home. Is this being done by people who are taking advantage of the situation just to get into nicer/bigger houses at a discount?

[Funny about Money]

@ Troy and others who wonder what's dishonest and unethical about walking away from a mortgage: It has to do with that phrase "a note and deed of trust." TRUST is the operative word here. It means someone agrees to trust that you are good for your word.

Going back on an agreement that explicitly entails "trust" defines "dishonest and unethical."

Sometimes you can't avoid it because you run into financial troubles that can't be overcome. In that case, one might be forgiven -- and we don't know but what this is exactly what befell FMF's friends. But the truth of the matter is that defaulting on loans has become a calculated financial strategy for a surprising number of people. It's possible to engineer this strategy so that it has no serious consequences over the long run.

Example: The woman who bought my last house decided that she didn't want to get a job. As home prices ballooned, she cashed in on the increased "value" to keep herself drifting along. She had only put down $5,000 on the $211,000 purchase. By the time she defaulted, she had borrowed $320,000 against the house. She spent the hot summer months loafing in northern California; she took weeks-long trips into Mexico and Central America. She was able to live on the proceeds of these loans for several years, traveling and doing whatever she pleased without so much of thinking about trudging off to work.

After she had run the scam into the ground, she got the bank to agree to accept a short sale of $260,000, forgiving the $60,000 balance; the bank also paid all the Realtor's fees and closing costs. She walked away with NO DEBT. No credit, either? True...but that was no tragedy for her, since she uses pretty much cash only -- doesn't drive a car and so doesn't need a car loan or a credit card to buy gas. She now lives with friends in a kind of latter-day commune in northern California, so need not worry about qualifying for rent or another mortgage.

Meawhile, the rest of us are paying the tab. Stupidity, greed, and dishonesty all the way around -- on the parts of lenders as well as borrowers -- have led to a worldwide economic meltdown that, if it can be reversed (remains to be seen, IMHO), will be paid for by you and me in the form of higher taxes and reduced standard of living.

[John]

The main point being missed here is that one cannot just walk away from a mortgage, get foreclosed on, and deal solely with trashed credit. I'm not a lawyer or banker, and it may vary state to state, but usually after a bank forecloses on a property they have the right to go after a deficiency judgment. This means that if they can't recover enough in a subsequent sale, then they go after your personal guarantee to satisfy the difference. If you have assets, you have something they could then sue for.

Comments from any lawyers/bankers out there would be informative.

[Jim]

As far as I know, there is no deficiency judgement in Arizona, and California. That means the bank cannot go after your other assets. I also heard even the tax on the forgiven deficiency (treated as your income) is also forgiven by new Frederal regulations (not 100% sure, maybe someone can confirm it). But I am sure that if you lived in the house more than two years as your primary residence, you pay no tax if the different is less than $250k for single person and $500k for couples.