Chicago Foreclosure Lawyer Blog

If you live in Chicago and have a mortgage, there is a 47% chance that your home is worth less than the mortgage balance. The most recent projections indicate that the housing market won't begin to recover until 2014 at the outside earliest. Some economists are noting that we may be headed for a double-dip recession. Although some home owners may be able to weather the storm, many are going to be stuck with negative equity for much longer than the next three years.

When a home is underwater, mortgage payments can seem futile -- payments towards principal are merely nudging the property towards a break-even point; they are not building equity. If you believe the media, so-called "strategic default" is a big thing these days. Let's ignore the fact that nobody can properly define the term, and focus on concrete options available to Illinois home owners who are underwater on their mortgages.

1. Keep Paying

If your home is only marginally underwater, and you're in an area that is seeing fewer foreclosures, it may make good business sense to stay put. Home owners best served by staying put likely purchased their homes before the real estate bubble took off and did not refinance their homes during the bubble. This type of home owner will likely have stable income as well.

Obviously, this would be the best option as it avoids any negative impact on the home owner's credit. It also keeps the home owner out of bankruptcy and out of foreclosure.

2. Walk Away

Simply walking away from the property is the diametric opposite of option number 1. When the media discusses strategic default, it seems to be discussing this option. However, it sometimes lumps the other options in with this one.

The walk away is simple. Stop paying the mortgage. Move out of the property. Some people mail the keys to the bank. At some point, the bank will foreclose on the property. The way this option is described, the worst-case scenario is almost always a negative impact on the home owner's credit score.

That is not the case. Simply walking away from a mortgage can have other penalties associated with it. When a property is underwater, it is almost guaranteed that a foreclosure auction will not recover the value of the mortgage. In general, properties sell for less than their market value at a sheriff's sale. If a property's market value is significantly less than the value of the loan, a sheriff's sale will not even come close to recovering the loan's value.

So why should the person who walked away care? Isn't it the bank's problem? Yes, if you live in what is known as a "non-recourse" state, the bank is out of luck.

Illinois is a "recourse" state. This means that the bank can pursue a foreclosed home owner for what is known as a deficiency judgment. This deficiency is the difference between the amount owed on the loan and the amount obtained at the sheriff's sale. Once a bank obtains a deficiency judgment, it can put a lien on other property that you may own. It can proceed to garnish your wages. It can freeze your assets while it determines just how much of your money it can obtain to satisfy its judgment.

Suffice it to say that walking away in Illinois is not as hassle-free as it may seem.

3. Deed In Lieu of Foreclosure

The deed in lieu of foreclosure is a remedy available to Illinois home owners. The deed in lieu is created by the Illinois Mortgage Foreclosure Law. You can find the statutory language at 735 ILCS 5/15-1401. Some federal programs like HAFA also provide a deed in lieu option. Some lenders may also make this option available to home owners in states without a statutory version of the remedy.

A deed in lieu of foreclosure avoids the filing of a foreclosure lawsuit. Although the borrower may be in default, or close to defaulting, it is nothing like simply walking away from the property. The deed in lieu of foreclosure protects the home owner from the negative credit reporting associated with a foreclosure lawsuit. It also protects the owner from a potential deficiency action on the underlying loan. The deed in lieu wipes out the entire debt obligation.

The deed in lieu may not be a great option for underwater home owners. While some underwater homes may only have one mortgage, many have multiple mortgages. The presence of a second or third mortgage makes a deed in lieu of foreclosure all but unattainable.

If there is only one mortgage on the property, most lenders require that the property be listed for sale for 90 days before granting a deed in lieu. The lender will also want to see financial disclosures that demonstrate a financial hardship. If you are able to make your mortgage payments, but simply do not see the sense in paying off negative equity, you may not be eligible for a deed in lieu of foreclosure.

4. Consent Foreclosure

In a consent foreclosure, the home owner has been sued by the lender. However, instead of proceeding forward with the foreclosure lawsuit, the lender and home owner agree to settle the matter. The home owner files a stipulation of consent to foreclosure. In return, the lender takes back the property and agrees to waive the right to later pursue the home owner for a deficiency judgment.

This remedy is very similar to a deed in lieu of foreclosure. It is also created by the Illinois Mortgage Foreclosure Law. You can find the entirety of the statute section at 735 ILCS 5/15-1402. There are some key differences.

The first major difference is that a consent foreclosure causes a judgment to be entered against the home owner. This will have a more adverse credit impact than a deed in lieu. However, it is entirely possible to obtain a consent foreclosure, even with other mortgages on the property.

The second and third position lenders can object to the consent foreclosure, but if the property is significantly underwater, their position won't be much different than if the property went to sale normally. This is because there will not be any funds remaining to pay the second and third mortgages. It is important to note that the consent foreclosure only protects the home owner from liability as to the first mortgage. Any second or third mortgage may still pursue the home owner for the balance due on those loans.

If you anticipate opting for a consent foreclosure, it is best to request on as soon as you are served with a summons. If you are represented by counsel, make sure your attorney send the request as soon as possible. This way, you avoid being denied a consent foreclosure because the lender has too much money invested in the foreclosure process.

5. Bankruptcy

The U.S. Bankruptcy Code affords home owners the opportunity to surrender a property as part of a bankruptcy. Under Chapter 7 or Chapter 13, the home owner may elect to surrender the property. One also gets the benefit of discharging other consumer debts.

Chapter 13 may afford underwater home owners the opportunity to strip second and third liens off the property, paying them back as if they were repaying a credit card debt. This tactic may restore equity to an underwater property.

Before considering a Chapter 13 bankruptcy as a means of lien stripping, it is important to consult with a bankruptcy attorney in your area. Different courts allow different things, and lien stripping may not be available to you.

Conclusion

No matter how you proceed, there are many options that could be defined as "strategic default." Aside from lien stripping, the end result is always the same -- the bank ends up in possession of the property. Ignore the people that claim mortgages are a moral obligation. At the end of the day, the only true difference is that most reasonable options involve a minimization of home owner liability, while a true strategic default can result in judgments against the home owner. Those judgments have a rather lengthy shelf-life and can be collected upon in several ways.

It is likely a good idea to consult with a licensed attorney before seriously pursuing any of the above options. Know your options and the possible impact before you act.

This article at Bloomberg.com has me a bit confused. The headline, "'Squatter Rent' May Boost Spending As Mortgage Holders Bail on Payments," and the article itself both leave me unsure what message the good people at Bloomberg.com are trying to send.

On one hand, it's impossible for a homeowner who has defaulted on his mortgage to be a squatter. I'll chalk the term "squatter rent" up to poetic license. On the other, it makes it sound like people are robbing Peter to pay Paul. I think the reality is somewhere in the middle. While being unable to make mortgage payments may free up some funds for people who could make a partial payment, I highly doubt many people are choosing to default on their mortgages in order to afford shiny new toys. There are always people who will exploit the system, but they are about as common as Cadillac-driving welfare queens.

Could the upswing in consumer spending be the result of people in foreclosure not making mortgage payments? Sure. Are people not making mortgage payments in order to help drive up consumer spending? I highly doubt it.

The longer I practice in foreclosure defense, the more I wonder if this "strategic default" phenomenon is more of a macguffin created by the financial sector than it is an actual widespread movement.

Not too long ago, I mentioned a recent law review article about the morality of strategic default. I am only halfway through the article; I won't get into its main arguments.

What interests me is that the article, and Adam Levitin's response to it, highlight two competing views of contract theory. Quite simply, is a contract a moral obligation or an economic bargain?

Read on for my take on it.

Continue reading "Are Contracts A Moral Obligation?" »

FICO recently released data which indicates that 35% of U.S. mortgages are in strategic default. FICO determines a strategic default by looking at the status of a borrower's other credit accounts. If other payments are current, but the mortgage is in default, FICO declares it a strategic default. This is not too shocking -- the strategic default movement is growing as more homeowners discover that their homes are underwater.

On a related note, FSU College of Law Professor Curtis Bridgeman has published an interesting article entitled, "The Morality of Jingle Mail: Moral Myths About Strategic Default." Adam Levitin has a decent write-up over at Credit Slips. I will provide my own thoughts on the article once I've had a chance to read it. For those interested in contract theory, it's supposed to be a real page-turner.

Thirty-eight percent of mortgages are underwater. Many people may be wondering whether they are one of the homeowners below sea level. Other home owners may be facing a foreclosure lawsuit and want to know whether their homes are worth keeping.

Websites like Zillow.com are a useful resource for determining a ballpark home value. However, Zillow isn't always accurate. To get a better picture of your home's value, the best practice is to consult with a real estate agent. A real estate agent can give you a valuation of your home based on time on the market as well as comparable properties in the area.

Once you know your home's value, you can make a more informed decision about your options. As always, consulting with a licensed attorney can't hurt either.

The more I hear about strategic default, and the more I see people congratulating themselves for simply walking away from their debts, the more I wonder if I'm the only person writing about foreclosures and the mortgage crisis that finds the whole concept to be unnecessarily risky.

On one hand, the idea of "sticking it to the man" appeals to me. On the other, I know that "the man" can generally stick back about 1000% harder than an individual consumer. Depending on which Huffington Post article you read, next Tuesday's "national meetup" day is either to discuss the mortgage crisis in general, or to share stories of walking away and how easy it was to do.

I am beginning to wonder whether the walking away "movement" will ever have any impact on the bottom lines of the various and sundry major financial institutions. The recent reports of raises for those in the financial sector would seem to indicate that all is well on Wall Street. My main concern is that most evidence of the power of walking away is anecdotal, and based on a fact pattern that remains relatively short-term.

Ten years from now, let's revisit those who walked away from underwater mortgages. For some, they may be in a significantly better position than they are now. Many more may have discovered that a subsequent lawsuit forced them into bankruptcy. Why? That deficiency doesn't go away. Lenders have several years before they lose the ability to pursue borrowers for these debts. Why not wait until a potential defendant is more able to satisfy a judgment for monetary damages?

Perhaps I'm just being a curmudgeon, but I continue to have a bad feeling about strategic default. If you insist on doing so, consult with a licensed attorney before pulling the trigger. Forewarned is forearmed.

UPI recently published an article about strategic defaults. For that article, a leading figure in the strategic default movement was interviewed. One of his quotes stood out as being wildly incorrect.

Here is the statement:

"People need to know a mortgage contract clearly spells out you have two options: You promise to pay and if you don't you'll give the property back to the lender. It's not a solemn oath you're going to pay,"

This statement is not entirely true. While a mortgage is basically an agreement to pay back the loan or surrender the home in the event of a default, the mortgage does not exist on its own. In addition to the mortgage, you also sign a note. This note (or "promissory note") is an explicit promise to repay a loan. This promise is then linked to the mortgage obligations, providing security for the loan. Even if you walk away from the mortgage and the bank takes the property, that note still exists.

That note, which still exists, is enforceable against you as an individual. If the bank sells your home for $150,000, if you owed more than $150,000 you are still liable for the difference. Before you choose to simply walk away from a property, it is wise to consult with an attorney and make sure that you have a plan for dealing with what may be a sizeable deficiency judgment. People selling strategic default packages are salesmen, first and foremost. The information they provide may be useful, but buyer beware. Only an attorney licensed in your state, and preferably one that handles foreclosure matters, can give you legal advice regarding your best options.

On Fridays, I'm sometimes inclined to link to someone else. This article, by Don DeBat, is a good overview of the various Federal programs available to distressed homeowners. He describes the differences between loan modifications, loss mitigation, and the new federally-backed refinance program.

It is worth a read, especially if you are just starting to research your options for a strategic default or a loan modification.

Talk about carrots and sticks. I've already written about Fannie Mae's attempts to prevent strategic defaults by adding penalties for the behavior. Now, we see action from HUD and the FHA that can only be described as a carrot.

A new program, slated to begin last Tuesday, may provide relief for some home owners who are currently underwater on their mortgages. The FHA Short Refinance option is designed to help home owners who are current on their payments, but who have negative equity in their homes. Home owners must have a credit score of at least 500 to be eligible, and the loan to be short refinanced cannot be an FHA loan. The new loan, a FHA-backed mortgage, must have a loan-to-value ratio of no more than 97.75%. Any remaining junior mortgages, when combined with the FHA short refi, must result in a loan-to-value ratio of 115% or less.

This program is entirely voluntary and all lien holders on the subject property must agree to the short refinance. Although this option is brand-new, some observers have noted that the fact that it is voluntary means it will likely have little impact. This is a bit pessimistic, but perhaps just slightly jaded realism. Only time will tell if this program gains traction.

This article in the New York Times has me seeing red. On one hand, it is a good piece of reportage. It describes the current level of defaults on home equity loans, contrasts them against other types of debt, and discusses how some homeowners are proceeding in an unsure economic climate.

On the other hand, the article's underlying premise is dangerous, at best. It describes a lending regime where banks are unable to collect the debts that are owed to them. It describes people simply defaulting on their loans and walking away, confident or hopeful that the bank won't pursue them for the difference between the value of the loan and the value of the property.

No matter how many billions of dollars that banks write off as uncollectable, and no matter how many anecdotes the article offers, the personal obligations people face on their equity loans can last up to seven years. This means that just because nothing has happened for 18 months, there are 66 months remaining on the clock. Hoping that there is "safety in numbers" won't prevent someone from attempting to collect the debt.

Many home owners are engaging in strategic defaults. Doing so without a plan can expose you to significant personal liability, not to mention seriously impact your credit score and possibly your tax liability. While many people are simply filing bankruptcy, if you do not qualify for a Chapter 7 discharge, you will be forced to repay that deficiency balance in a Chapter 13.

If you are planning to walk away from a mortgage or home equity loan, you should plan your strategy carefully. Consult with a few qualified attorneys. Some will suggest bankruptcy. Some will suggest various loss mitigation tactics. Consult with an accountant. Build a plan for your future before simply walking away. Articles like this make it seem as if there is a free-for-all afoot. Just remember: the exception is generally NOT the rule.