How to Default on Your Mortgage and Stay in Your House

by: Felix Salmon May 16, 2008 | about stocks: MER    
Felix Salmon

Felix Salmon

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Floyd Norris today finds one of the worst bonds ever underwritten: a securitization, by Merrill Lynch (MER), of second-lien mortgages mostly originated by Ownit. The kicker? When the bond was sold, Ownit had already gone bust, a victim of the fact that far too many of its loans were delinquent out of the gate.

But what's bad for bondholders might be good for homeowners.

Let's say you're a Californian who bought your $200,000 house with a $160,000 first mortgage at 6.5% and a $40,000 second mortgage at 11.2%. Your annual interest payments are $10,400 on the first, and $4,480 on the second, for a total of $14,880, or $1,240 a month.

When the housing market implodes, you can simply stop making payments on the second mortgage. As Norris explains:

"In light of the pressure on home prices and limited or negative borrower equity in their homes, many second liens were simply written off" after several months of payments were missed, Moody's said.

With these loans, it turns out, foreclosure is seldom worth the effort, since all the money would go to the first mortgage holder.

With no fear of foreclosure and being kicked out of your house, your monthly mortgage payments have dropped from $1,240 to $867 - a fall of 30%. And that's before you try to renegotiate your first-lien repayments.

It's walking away without walking away: you can default on your second lien, stay in your home, and see a large reduction in your monthly nut. And since you're in California, where mortgages are de facto non-recourse, you don't need to worry about the owner of the second lien trying to get a court judgment against you.

Of course, as Floyd Norris points out, you do give up any upside if and when you decide to sell the house. The second lien is still there, and unpaid interest payments are accumulating: should the house ever get sold, the second lien owner will take anything the first lien owner doesn't. And for the same reason, you'll never be able to use your house as security for a new loan.

Even so, the idea of walking away from a second mortgage seems much more compelling, especially in California, than the idea of jingle-mail, or walking away from a first mortgage. Which is one reason, I'm sure, that this bond of Merrill's is performing so badly.

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This article has 51 comments:

  •  
    May 16 11:25 AM
    Can you imagine how many more 2nds are not performing....could this be the next shoe?
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  •  
    May 16 11:50 AM
    DISGUSTING
    Reply | Link to Comment
  •  
    May 16 12:48 PM
    What has happened to personal responsibility, it shouldn’t be strategized or legislated away. If don’t pay your debts then pay the piper.
    Reply | Link to Comment
  •  
    May 16 12:54 PM
    Personal Responsibility? It's called the decline of American Civilization. Sadly, the country as we know it will deteriorate into nothing but a land of chaos and anarchism.
    Reply | Link to Comment
  •  
    May 16 01:01 PM
    Another way that people are staying in their homes without paying their mortgage (any mortgage) is by way of the lost IOU. Many of the lenders have been bought out. Somehow, during the takover, the IOUs were lost. When the new mortgage company tries to foreclose, the homeowner goes to court and asks the judge and plantiff, 'where's the IOU'. The mortgage company can't find it and can't foreclose.

    I have read an article where a dot-com millionaire is doing this exact same thing. He is squatting in a multi-million dollar home that he no longer makes payments on, and the bank can't foreclose. It's been a couple of years now...

    Shame on him, but I guess if I found such a way to game the system, who knows what I MIGHT do.
    Reply | Link to Comment
  •  
    May 16 01:04 PM
    There have been other items similar to this in the news, implying that millions of people who can afford payments will walk away on a whim. The gotcha in these cases is that in our society, everything is determined by credit scores, including apartment rentals, employment (and even car insurance, in some areas). Anyone planning this stunt should probably run up their credit cards, too, since they will probably get yanked as well.
    Reply | Link to Comment
  •  
    May 16 01:24 PM
    This is an idiotic article, as is the December article (link above). California mortgages are not non-recourse and to suggest that they are is simply wrong. Its time to "man up" and either pay your debts or declare BK, not act like some low-life squatter. Appying the same logic would result in everyone walking away from car loans during the first 2 or 3 years of their term, as depreciation will greatly outstrip "value". Authors of articles and web sites explaining why it is OK to default and not vacate are as slimy as those that choose to game the system.
    Reply | Link to Comment
  •  
    May 16 02:41 PM
    TLM is right, but many banks have stopped even trying to collect on second liens and HELOCs.
    Reply | Link to Comment
  •  
    May 16 02:55 PM
    Mr. Salmon is this article’s title unfortunate or are you advocating this despicable behavior?
    Reply | Link to Comment
  •  
    May 16 03:42 PM
    Personal responsibility has been replaced with "get what you can and screw anyone you have to in order to get it".

    Personally, I love seeing these banks take it in the shorts. The greedy SOB's deserve to fail.
    Reply | Link to Comment
  •  
    May 16 06:04 PM
    The originators of these loans did not factor "personal" responsibility. For them it was a calculated and amoral decision to lend. It was a decision they lost. Too bad.... soooo sad. If you are a blue collar worker in America, why the hell should you care about faceless institutions? We all know they are rapacious entities without any national allegiance.
    Reply | Link to Comment
  •  
    May 16 08:46 PM
    Personal responsibility is a moral choice, just like honesty, keeping your word, etc. People have a choice, and someone that uses a technicality to steal is the same as a common thief to me, whether it is a corporation or an individual that gets victimized. It's simple amoral greed; no one twisted the borrowers arm to sign the loan contract.
    Reply | Link to Comment
  •  
    May 16 11:14 PM
    Most employers will fire an employee if they can save a dollar by doing it. Nothing personal, just business. Sorry 'bout that. All you rightious critics are the same ones always harping about loyalty to your employer. Then your blindsided by HR and wonder why you did'nt earn THEIR loyalty. These mortgages are governed by the contract agreed to by both parties. Either party can breach the contract and accept whatever penalty allowed by the contract.
    There is no morality involved. Always protect yourself first.
    Reply | Link to Comment
  •  
    May 17 05:56 AM
    I agree with you Allan. Well said. Also, banks made BILLIONS off of slimy, high-risk loans which are now causing people to lose their homes, so I do not feel sorry for the banks, or the companies that bought these risky, near-worthless investments.
    Reply | Link to Comment
  •  
    May 17 09:00 AM
    For better or worse, Salmon's idea exemplifies the zeitgeist of our times. Each party, the usurious second mortgage lender and the irresponsible borrower, can rationalize his "morality", but neither is a true victim.
    Reply | Link to Comment
  •  
    May 17 09:44 AM
    its interesting that the word 'morality' popped up here...since when are banks and millionaires moral? since when are laws moral? since when has the constitution survived over the last 100 years or so without a bunch of moral lawyer-politicians trying to bleed the carcass dry?

    somehow, i still remember the sammy davis estate deal...it owed about $100 000 000 and paid ten cents on the dollar.

    try that as a little guy and see what happens. and then...mr and mrs hillary made $109 000 000 last year...and how much did they pay? hmmmm? what was their tax rate?

    bottom line....t. jefferson...you should remember him...they cut part of his face off the nickle...stated..when a country loses control of its currency, it is no longer a country

    so.......as of 1913 give or take, wilson suddenly turned the united states of america into the united states of anarchy.

    so much for morality.

    the rich cut our throats. the government bleeds us dry...and the constitution is more or less dead. and then, of course, the dems will raise taxes....oh and btw, what ever happened to getting out of those sand-filled and/or mountainous countries? do we seem to be building a huge prison in afghanistan? with our tax dollars? is this the 51st state or something?

    food never gets to the starving in how many countries?

    what happened to all those dollar bills shoveled off trucks?

    why do economists even bother with core cpi?

    why do some stores ration rice here of all places?

    why does milk cost the same as gasoline? should we use deathanol in our cereal or ride a cow to work? (for those of us who still have jobs?)

    does it really matter who wins the election?

    as the GMG says quite often...we are freaking doomed.
    Reply | Link to Comment
  •  
    May 17 09:46 AM
    wow.finally it begins to dawn that this country might be "falling like the roman empire". of course the romans may not have seen it coming like most in this u.s.a. that dumb & dumber.can you give me yesterdays score of a game-of course.can you name a supreme court judge-i dont think so.how sad.
    Reply | Link to Comment
  •  
    May 17 11:42 AM
    It seems like the banks and lenders are the villians for everything. However, I have yet to hear of an example where a bank made anyone sign up for a mortgage. The biggest, and lamest excuse you read about is that someone didnt understand the loan docs. That usually means they didn't read them. I have no idea why you would sign up to a contract to repay up to 5x your annual salary, and NOT read the docs, or take the time to ask someone. And what about the lawyers who usually sit in on the closing - did they forget to tell their clients about interest rate risk?

    As for the comment "why should Mr Blue Collar care about a faceless institution" is uneducated, at best. If the consumers continue to break contractual obligations, then banks and credit unions will restrict credit, or not provide it all all. So the next time someone making $45,000/year want to buy a house, he will have to cough up that purchase price in cash. Chances are that he will not have an extra $275,000 laying around. Next option, ask friends and family, but probably will have the same outcome. Last chance is hard money lenders at credit rates....
    Reply | Link to Comment
  •  
    May 17 12:05 PM
    This article and some of the comments neatly frame the decline of American civility. Perhaps we should repeal the antideficiency laws and let lenders go after defaulted borrowers.
    Reply | Link to Comment
  •  
    May 17 12:18 PM
    Corporate America broke the contract with the Middle Class starting about 1975. If these poor lenders don't like the terms of these mortgages, they shoundn't agree to them. Capitalism is an ugly beast. Get used to it.
    Reply | Link to Comment
  •  
    May 17 12:25 PM
    When I was a young lawyer I represented house builders. to make a sale the builder would often provide second mortgage financing. If the second became delinquent, I would foreclose the second without joining the first mortgagee. The first mortgagee was cooperative because of the business the builder sent its way, and because it was understood the builder would not let the first become seriously delinquent. The debtor would generally cure all defaults , but, if not, the foreclosure would proceed to deed, and the property would be refinanced and resold. There, of course, may be some circumstance that now excludes this procedure.
    Reply | Link to Comment
  •  
    May 17 01:01 PM
    Ah, the "morality" of Capitalism. It seems to me, the burden of morality should rest with the "professional&quo... lender when dealing with the "amateur" borrower. The lender has the "moral" obligation to ensure it's product and terms will meet the needs of the borrower. I guess commisions, bonuses, and options are now the lenders primary obligations.
    Reply | Link to Comment
  •  
    May 17 03:09 PM
    This may turn into a valuable lesson for the future. I live in Sacramento. I know over a dozen people who bought homes in the last few years. None put any of their money down. If that was a requirement, none would have been able to buy. Without buyers with ample "cash" the prices could not have gone up so high. In my area, they more than doubled in 4 years. Think about that. Now the reset is starting. Most of the homes have gone down far more then the piggyback loan. It is just a matter of time before these people have to sell. Now, if they couldn't come up with any down payment money when they wanted a house how will they bring money to the table if they sell at a loss? Do you think these buyers will never divorce, lose a job, get sick, etc.? Even if they don't want to sell it will be forced upon them when they can't come up with the payment. The banks need to lose big so they don't ever recreate the cycle. Think of the people who stay and pay regularly at the expense of funding their 401k. We will be taking care of their health costs in 30 years since they spent all their money on housing.
    I am renter and have plenty saved for retirement. However, I don't see how the math will work out for all the people who put too much into housing. Later, years later, they will cry poor and expect a subsidy from somewhere else. We need to end this cycle and return to rational house prices.
    Reply | Link to Comment
  •  
    May 17 06:13 PM
    Yes the banks were stupid. But they were not entirely at fault. If the borrowers had been honest, they would have known that A) they couldn't really afford the payments and B) every budget has a limit. This isn't the first housing crunch, and it won't be the last. If the banks are smart, they'll tighten up on credit rules and the slackers won't be able to do this again. But to encourage (or even just suggest) that people should/could walk away from a second mortgage... that is sick. They won't care about the credit rating either. That's the kind of people they are.
    Reply | Link to Comment
  •  
    May 17 09:34 PM
    Don't care for the title either but I don't get the impression the author is in favor of it and he does misstate a few "facts".

    Heard this before ????

    "If it sounds too good too be true - it probably ain't."
    Yeah - capitalists are a bunch of bastards and the country is going to hell. The worst place to live in the whole damn world - except for all the others.
    If I assume that most of the bank bashing posters here are investors, then I would like to know where the hell you make your money ?
    If any of the companies you invest in have ANY dealings with banks or other financial institutions then I would expect you to immediately either make them terminate those relationships or sell your stock. If not - you are a hypocrite.
    When I look in the mirror every day the guy that looks back at me has never really screwed anyone that didn't truly deserve it.
    If I enter into a legitimate agreement I will honor it no matter who it's with.
    Reply | Link to Comment
  •  
    May 17 10:14 PM
    There's nothing Patriotic about spending your last dollar on a mortgage payment while your family suffers. Righteous indignation usually masks some dark weakness. What's your temptation?
    Reply | Link to Comment
  •  
    May 17 10:57 PM
    If my back was against the wall, and it isn't, I would certainly be influenced in my decision by what morality and integrity I have seen in the banking and legal system in America. Investment bankers, bankers, and lawyers would exploit every conceivable loophole, profit from it, and be glorified and rewarded for it. So why would I, as Joe Citizen, somehow step forward and 'man up', if it meant putting my family on the street. Would my bank cards, my mortgage holder, the IRS, the corporate raider about the downsize me, or anyone else 'do the right thing' if there was a way around it? Hardly. Sorry America. You reap what you sow.
    Reply | Link to Comment
  •  
    May 17 11:04 PM
    There is no fault........everyone was greedy........the homeowners were not innocent.......they were all equally greedy........and the homeowners should simply walk...........
    Reply | Link to Comment
  •  
    May 17 11:06 PM
    Right on. Who are these brainwashed corporate zombies posting. The rules of the game have changed and Corporate America changed them. It's every financial entity for himself.
    Reply | Link to Comment
  •  
    May 18 12:36 AM
    I was fearful of taking the second on my primary from WAMU in order to close the deal for a smaller home as yet unbuilt but with an elevator - a cable winch parisian lift- offering a way for my 89 yr.old crippled m-in-l to have escape from the basement apartment.

    I signed a contract with the builder - his 9 month schedule turned out to be 2 years not completed until Feb 1 2007. I was downpayment out over $250k - I told WAMU and the builder I wouldn't close because I was afraid the new place couldn't stand the appraisal and I would be better off losing my life's savings than risking closing on a loan that would mean I would own one new home maybe underwater and still have my primary residence.

    I hired a real estate attorney - he explained my situation to all parties.
    WAMU assured my the new home appraised at more than the purchase price or they wouldn't close on the loan. The assured me my primary home inside the DC beltway with a half acre pool and spa and 3ook under their apppraisal would sell in weeks - "close on the new house - get the elevator for your crippled mother in law" they said - "WAMU will give you a second on the new house to get you through" then"sell your primary, pay off the second on the new house and everything will be fine".

    "Other wise, WAMU reminded me if you cancel you will lose your life savings deposit and be subject to a deficiency judgement if the builder can't recover their total cost." That scared me - I wasn't smart enough to see the built in mutual exclusive - if the property was worth it then the builder wouldn't have cause for a judgement. Better to lose my lifes savings and walk - this only came clear six months later.

    Ok I agreed with WAMU - you appraise and prove and I will close. WAMU appraised, and the appraisal proved the new home was woth the purchase price and WAMU even financed a wrap second for 10% as promised.

    Of course it turns out it was all a lie - WAMU and the builder were both screwed if I didn't close. They colluded - the appraisal turns out to be a fraud - the builder turned around and sold another house like mine for $400k less than the one I closed on.

    Today I owe $3million on two houses- best price combined is $2.2 million - after 47 years I am insolvent, I have lost my total life's savings, I could have canceld the second closing but believed the WAMU appraisal, and now have payments exceeding my spouse and my own total take home pay and to top it all off my mother in law fell down the first week in the new home with the elevator, broke her back, neck and shoulder ran up $170,000 in death bills and died six weeks later.

    Do I want bail out relief? Not on your life. Is the barney frank bill a travesty on Jeffersonian liberty? You bet. Shoud Ben Bernanke and friends get out of the way and let this mess find its own equilibrium as fast as possible? Absolutely.

    Should I get any special treatment? Only equal justice under the law -- what does that mean? Wipe me out - I have nothing left. Don't chase me with the IRS (remember the second house has no debt forgivness) - don't force me into bankruptcy - is that the penalty, is that the price the Limbaugh, Paulson, Bush right wingers insist on - that I have to hope my father dead these many years must see his son in bankruptcy. Thanks a lot America - is this all you have after 47 tax paying FICA contributing years that I have to go through bankruptcy to have any chance of even surviving at my age?

    I am not asking nor accepting anything from our "government" - I wouldn't even cash the rebate check. It's just more debt for my daughters and their husbands to pay. But I tell any reader of this message and that includes George Will, Rush Limbaugh, Sean Hannity, and the hundreds of others that if I can't receive equal justice under the law - at least equal to Bear Sterns - If I have to undergo the indignity of bankruptcy after a life that included 3 years as a LT. Foward Observer during Nam, an entrepreneur that created over 6ooo new jobs, a defender of civil liberties, and protector of the unprotected then I say to you right wing idealogists that the Fascist Hatred that you are going to see appear in the land of the free and home of the brave is well deserved.
    FOR ALL OTHER HOMEOWNERS: If your loan is underwater by more than 6% as of March 31, 2008, - you owe more than the property is worth and if your payments are such you cannot make them from your take home pay DO NOT SPEND ONE DIME OF YOUR IRA, 401K , ROTH IRA, SEP OR OTHER RETIREMENT TO MAKE HOUSE OR MORTGAGE PAYMENTS. You will never see a dollar of equity in your home - before your credit fails look for a nice apartment that include s utilities if possible, abandon your property, do not notify the lender as you will not be able to reach anyone except a Collection Agent, give no one your name, account number or anything else they can track you with. Move into your new home and forget the past - document your financial circumstances - pay a CPA and Attorney to sign and date your financials. If you are insolvent you will not have any farther claims against you that cannot be easily defeate at low cost in a non attendant hearing. Even if you are not insolvent you can still preserve what you have and avoid any farther liabilities.
    Best of luck to all who are living a nightmare only your parents warned you about and now you are livng it.
    BSCGOVMAN
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  •  
    May 18 02:00 AM
    User-Dude!
    Reply | Link to Comment
  •  
    May 18 02:34 AM
    Multiply User 194313 by millions. The corporations may control our government currently, but they can't eliminate our vote. These are the moments in history that drive monumental change. Within 10 years we'll see a new party whose platform centers on Protectionism and Regulation. It's time to take America back from Red China.
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