Friday, October 22, 2010

Five Myths About Foreclosure

Foreclosure is not the end of the world as we know it.

With the record number of foreclosures going on right now, you'd think people would know all about the process. You'd think wrong.  The idiot media reports only on sensationalism and likes to imply that banks are "greedy" and "making money" from foreclosures - and that Joe Consumer is liable to be booted out of his home on a moment's notice.  But most of this, like the scare stories about "identity theft" is just nonsense - usually emotionally hooked stories designed to get you to watch, or to get you to vote for certain politicians.

And in many cases, the stories are sad - people losing jobs, or having horrible medical bills - that sort of thing.  But when planning your finances, you need to take such possibilities into consideration - as they are quite likely to occur!  Many people plan their finances using the "pie theory" - dividing up the paycheck into little payment slices, with nothing set aside for savings and nothing used to pay down debt.  When even a tiny setback upsets this system, your personal rowboat is swamped quickly.

And most of these stories in the media gloss over the fact that the people in foreclosure paid too much for their homes, and often owe more on them than they will every be reasonably worth in a decade or more.  And they gloss over the toxic loan documents the borrower stupidly signed.  And yet many people willingly signed such documents - nothing down, payment optional toxic ARMs, convinced they would later 'flip' the property and make a million bucks.  And we are supposed to feel sorry their dreams of avarice didn't work out as planned?

If you take out a loan, you have to pay it back.  That seems pretty simple.  It isn't anyone Else's fault that you signed the papers or that the house isn't worth what it used to be, or that you lost your job.  Rather than sit around and whine, buck up and move on.  Taking control of your life is always more profitable and enjoyable than being helpless!

Anyway, here are some common myths I hear from the media and from friends and acquaintances about foreclosure.

1.  Banks Make Money from Foreclosure.  Banks lose money on foreclosures, period.  The best they can hope to do is break-even, but they rarely do even that.  The only reason banks seem "eager" to foreclose is that the sooner the process takes place, once a borrower defaults, the less money they lose.  For every day, month, or year, a foreclosure is delayed, the more money the bank loses.  So the sooner the process is completed, the sooner the property can be sold and at least some of the loan money returned to the bank.

Banks don't "profit" from a foreclosure.  If the property sells for more than the balance on the loan, that difference has to be returned to the homeowner.  But rarely, if ever, is a house sold for more than the balance on the loan - for the simple reason that, if the house was worth more than the balance on the loan, the homeowner would sell his home and take a profit, rather than let it be foreclosed upon.  Only an idiot would let a house go to foreclosure if they could sell it at a profit!

Banks generally lose quite a bit of money on foreclosures.  They rarely get back the loan balance owed, plus they are out all those interest payments from the time the owner stopped paying his mortgage ($19,000 a year from me).  In addition, they have to pay legal fees, court costs, Real Estate Agent fees, closing costs (on the resale), re-hab costs, and even maintenance (someone has to mow the lawns on all those foreclosed properties!).

It is a nightmare for banks, and the only way to ameliorate the losses is to move as quickly as possible to get these things off the books.  They are not "eager" to foreclose, believe me!  But they don't want to drag out the process anymore than you'd want to drag out a root canal.  The longer you wait, the worse it is - for everyone involved!

2.  You can "Walk Away" From a Home by Letting It Go to Foreclosure:  If the bank takes possession of the home and sells it, in 99% of cases, they will get back less in the sales price than the balance due on the loan.  In some cases, they may write this off as bad debt, as chances are, you are insolvent at that point anyway (or have declared bankruptcy).  But under the law, they can still come after you for the difference between the loan amount and the amount received from the sale of the property.  This is why it is a good idea to talk to an Attorney before doing anything rash like mailing the bank the keys and just leaving.  You may be shocked to discover you are still on the hook for tens of thousands of dollars of that loan debt.

2.  Stalling or Delaying Foreclosure Will Help Homeowners "Keep Their Home" There is a lot of talk in the popular press and by politicians trying to whore for votes, about how we should "freeze" foreclosures or provide "workouts" for people who are underwater on their mortgages.  While both sound like humanitarian gestures, both are bad ideas for everyone in general.

In most cases where people have been offered workouts, they end up being foreclosed upon anyway.  Even if a bank could "write down" the bad debt and offer to knock $50,000 off the balance of a loan to bring the debt/equity ratio back in line - and offer to refinance on new terms - in most cases, they end up foreclosing on the property a year later, this time having lost even more money on the deal and delayed as a result.

Why is this?  Well, if you have lost your job and your income is cut by 3/4, there is no sweetheart deal in the world that can keep you in more home that you can afford.   If you can't afford to live in a home, trying to delay the process or "work out" a deal isn't going to work, particularly if you have lost your job and have little or no source of income.  We'd all like to have a nice house and not pay for it, but that is usually not in the cards.

Not only that, but such sweetheart deals are unfair to other homeowners who are in similar situations, but are still making their mortgage payments.  If my neighbor gets fifty grand knocked off the balance of their loan, because they are "financially stressed" - but have two brand new cars parked in the driveway - why is that "fair" when I am making my payments by sacrificing and doing with less?

Similarly, putting an arbitrary "freeze" on foreclosure doesn't help the homeowner - they still have to deal with the issue once the "freeze" is over, and once that occurs, the banks have lost even more money - which means we all have lost more money as investors (directly or indirectly, through our retirement plans).

Strong medicine tastes bad, but it is better to swallow it in one gulp than to sip it for months.

3.  It is Easy to Foreclose on a Home:  The foreclosure process is anything but simple.  The documentation needed to proceed is enormous and it can take months, if not years, to complete the process.  The idea that you miss one payment and are out on your ass in 30 days is nonsense.

Given the staggering number of foreclosures going on in this country, it is no wonder than banks and attorneys are overwhelmed with paperwork - and no wonder many discrepancies are showing up in some paperwork.  But the bottom line is, people are not paying their mortgage payments, and they have no "right" to live in a home, even if a foreclosure affidavit was improperly prepared.

The idiot media likes to create innuendo that these improperly prepared affidavits are resulting in people being tossed out of their homes, even though they are making their mortgage payments.  This is not the case, and had not been alleged, or shown, in the cases discussed recently in the press.  But it is a good story, with emotional hooks, because everyone likes to hate banks, right?

But the reality is, it is not "easy" to foreclose on a house.  It takes a lot of paperwork and legal fees and hassle on the part of the bank.  They would rather you just pay your mortgage on time!

Compounding this issue, in many States, if you declare bankruptcy, it can stay foreclosure proceedings for months, if not years.   Again, this is why it pays to talk to a real Attorney (not some "debt repair" agency) before just handing over the keys and walking away.

If you really are behind the 8-ball, be smart about foreclosure - not dumb.  Many folks think bankruptcy is some sort of shameful thing, and will burn through their 401(k) savings trying to "hang on" to an upside down house.  Here's a clue - your 401(k) is not attachable in bankruptcy, so don't tap into it!  TALK TO AN ATTORNEY about your options, first!

4.  You Could be Tossed Out on a Moment's Notice:  Again, the press likes to play up this idea that people are being "forced out of their homes" like the Joads in the Grapes of Wrath.  If you stop making your mortgage payments, you should have a pretty good idea of what is going to happen next - and take steps to move on with your life.  It should be no surprise that you are being foreclosed on, and that within a few months, or even a year, you will have to move.  Start packing now.

Staying in your home, not making the mortgage payments, and making no plans to move, is idiotic.  Would you do that if you were renting?  Of course not, because you'd know that eviction papers are coming eventually - and the Sheriff after that.

Again, the process can take months, if not over a year, to complete.  So if you find you are missing mortgage payments, wake up and smell the coffee, and start thinking of where you are going to live next.

Because it is far easier to find an apartment or other place to live before your credit rating is utterly destroyed.  If you wait until after foreclosure proceedings have started, you might find it hard to rent even the cheapest of apartments.

5.  You can Buy Foreclosure Properties on the Courthouse Steps:  Many folks are hoping that the foreclosure crises will mean "bargains" for home investors.  And there may be a few bargains out there, too.

But the deal is this:  Foreclosure sales result in prices dropping everywhere in the same area.  Foreclosures depress prices for the whole market.  So the "bargains" are not necessarily in buying a foreclosure property, but in the overall Real Estate market.

I have bought foreclosure properties in the past - after the LAST Real Estate debacle of 1989 (remember that?  Few did, while buying like mad in 2005!).  And I bought them the usual way, through  a Real Estate agent, who had it listed on the MLS the same as any other other home.

The foreclosure process does include an "auction" of the property on the courthouse steps.  However, in 99.9% of cases, the property is bought by the bank, who holds the note, which is worth more than the property.  The bank is essentially paying itself back for the property by "buying" back for the note price.  Since the house is "upside down" - no one else will bid higher than the bank.  The bank still has the debt to pay off, but now, legally, they own the home.  It is just a form of legal fiction, really.  Rarely are these foreclosure auctions really auctions in the sense that anyone is going to outbid the bank.

And yes, once in a great while, someone finds a bargain at the courthouse steps.  And once in a great while, you hear a story where the rich Uncle buys the property back at the courthouse steps - outbidding the bank by a dollar (the bank is happy about this, believe me!) and keeps the Joads on their farm.  But bargain auctions and rich Uncles are few and far between.

In some smaller communities, back in the day, there would be sweetheart "deals" made by smaller banks, once they had taken possession of a property.   A banker, stuck with a foreclosure property, would call one or more local investors he had on his short list.  These were usually developers or local builders, who could buy such a property, re-hab it, and then flip it for a modest profit.  The banker would sell to them because it got the property off the books quickly (banks lose money the longer they hold property) and they avoided a lot of transaction fees such as Real Estate Agent fees.  A friend of mine in rural Maine did this back in the 1970s and 1980s.  But that was long ago, in a small town.

But today, with banks under intense scrutiny and with banks being multi-State (or multinational) in size, it is not feasible, or perhaps not even legal, to sell off foreclosures this way.  If you sell a foreclosure to "Jimmy" because you play golf with him, questions will be asked.  It might work in a small town with a small town bank, but not for a huge conglomerate bank with shareholders to report to.

So the short answer is, if you want to buy a foreclosure property, talk to a Real Estate Agent.  Chances are, they can show you a dozen or more, in your area, listed for sale, if you live in an area with a lot of foreclosures.

But real bargains can be hard to find.  We went down to Cape Coral a few years back, during the height of the foreclosures there, and found that local investors "on the ground" with cash in hand, had bought up every property we had printed out on the MLS the week before.

And that is the deal with investing in Real Estate - you have to have money (and good credit) and know the area.  I had lived in the DC area for 10 years when I bought my properties, and had some connections with Real Estate Agents representing banks, as well as some bankers.  Who you know and what you know, is important in those sort of deals.

* * *

If you are facing foreclosure, first of all, relax.  It is just a house - a thing - and not something worth killing yourself over.  Life will go on, and it may actually get better, once you get off the consumerism bandwagon and get out from under onerous mortgage payments and the nightmare of negative equity.  "Losing your home" is not the end of the world like the politicians make it out to be.  But it sure does get out the vote, don't it?

Talk to an Attorney and get some advice - talk to several, if necessary.   A real attorney, not some "Stop foreclosure" organization or "credit repair" scam artist.  Declaring bankruptcy may be one option - as a means of getting out from the debt, as well as leveraging your negotiation position.  It may also delay the process in your favor - further increasing your leverage in negotiation.

But the end result is, you are probably going to lose the home if you can't make the payments.  That is axiomatic.   But don't let that get you down.  Millions of people have gone through this process (or are going through it now) and finding that, contrary to popular belief, there is life after foreclosure.  And a very good life, at that!

And not having to live with onerous monthly mortgage payments can be a good thing!  Learning to live on less is not necessarily a bad idea all around.

Good Luck!