Will the banks bail out overextended homeowners?

[sdrealtor]

I just spoke with someone back east who told me some banks are getting ahead of the curve. Here’s what they are doing. Rather than going through a costly foreclosure process for someone that can’t afford their house, they are refinancing them into their home at a lower principle amount.

ex). Buyer purchases home for $500K in 2005 which is now worth $400K. The $100K is a loss anyway the bank looks at it. The bank also stands to lose alot more getting the person out, repairing the damage they do when they lose the house and they have about $20K in selling costs. Rather than going through all this, they forgive $125K of debt and let buyer remain in house with a new mortgage of $375K. It’s faster, easier and much cleaner on their books.

[North County Jim]

Very interesting. If this strategy is followed by a significant share of lenders, this would strike at the heart of the extreme bearish case for housing.

It also illustrates why prognostication is so difficult.

Is there anyone out there who has been anticipating such a move?

[CAwireman]

If this became common practice, it would definitely take the sting off of the current housing downturn.

[PerryChase]

I don’t think they can do that. They would be violating underwriting standards and banking regulations. As far as I know, the only thing they can do is foreclose.

I would be very interested to hear about any such example.

[waiting hawk]

I guess someone forgot to tell Countrywide. Their foreclosures jump each time I look at em.

http://www.countrywide.com/purchase/f_reo.asp

My website tracking Inland Empire

[Dougie944]

I don’t think this would stop the crash. The dagger in the heart of this bubble will be when lending standards tighten back up. Lenders taking $100,000 hits from all directions will certainly make them rethink lending practices. This will tighten up standards and greatly reduce the buying pool….sending prices plummeting.

[davelj]

Perry, the banks absolutely can do this if they so choose. It’s no violation of underwriting standards or banking regulations. BUT, they have to charge off that $125K immediately and that’s a direct hit to the bank’s equity (depending on the size of the bank’s reserve). Essentially the bank is saying, “We made a mistake on the first loan and are charging off the size of our ‘mistake’ and now the homeowner’s debt/income, etc. makes sense so we have a new, properly underwritten loan.” Enough of these ‘mistakes,’ however, and the bank has no equity left. Recall that the average bank balance sheet is leveraged 12.5-to-1, so if the assets are worth 1% less than initially believed, equity takes an 8% hit. The problem in the larger context is that most home loans aren’t on bank or thrift balance sheets – they’re securitized into pools owned by investors (in the form of MBS) and serviced by Wall Street-affiliated firms. The question is whether the owners of these MBS will allow the servicers of these MBS to engage in the same kind of loss mitigating behavior. Possible, but I doubt it. When a bank (or thrift) owns a loan there’s just two parties involved, the bank and the borrower. So, it’s pretty easy to work out a deal if there’s one to be made. Once a loan is part of a securitized pool, however, it gets very complicated to efficiently fix a problem because there are more parties involved. What’s best for the servicer might be in conflict with what’s best for the MBS holder which might be in conflict with what’s best for the owner, etc.

[sdnativeson]

From experience in the past with short sales aren’t there tax consequences for the homeowner also? I imagine this would be reported as a 125k gift to the owner, meaning taxes will be owed on it.

[zeropointzero]

Sounds crazy to me. If they just do it for homeowners who are delinquint, wouldn’t that encourage other folks to stop payments as well to get this deal?

And – if they cut a portion off the principal, and the indivdidual then sells and gets out even – well, that’s a no-win proposition for them as well.

But – if the good people at Chase Mortgage are willing to cut $50k or so off my $260k loan balance if I hold my payments hostage for a little while – hey, I’m all for it and sign me up.

I can imagine banks lowering payments for a short while for some folks, extending amortization schedules – steps that meet people halfway but still largely preserve lender income – but I can’t see them cutting off large (or even small) parts of the obligations that they have already paid to the happy previous sellers. Kwazy!

[(former)FormerSanDiegan]

I can possibly see see banks doing this in very isolated cases. Maybe for loans they originated at the peak and held. As for expecting this type of activity to be widespread ??? I seriously doubt it.

[sdrealtor]

I would be surprised if it became widespread also but it is an out of the box example of banks doing something to limit their losses while decreasing foreclosure activity. I’m sure there will be other methods to bail out homeowners. Sorry but I dont subscribe to the armagedon theories postulated by many on this board. This is America and some way someone will figure a way out of this mess without a complete meltdown. And as it is America…they will probably exploit the hell out of it and get very rich in the process.

[davelj]

zeropoint, people who aren’t forced to resort to this sort of thing probably won’t – remember, this still ruins your credit score. Most people value their credit score and their reputation more than $100K or whatever number it is. For those that don’t, this is one way to work things out if it’s available to them, which it will probably be on a very limited basis for the reasons I presented.

sdrealtor, I basically agree. People are amazingly resilient when backed up against the wall. Sure, lots still implode, but most figure a way out of their mess without blowing everything up around them. I still think things are going to get very ugly, but I discount the views of the armageddoners here pretty heavily. There are too many moving parts of which we are unaware and they tend to make the doom mongerers look silly in hindsight.

I’ll share but one example to make a point: I know of a friend of a friend who’s in trouble financially (he has a bad mortgage that’s resetting). Well, guess what, his parents are helping to bail him out. They’re not super rich but have the resources to stage a small rescue. There are a lot of people in houses they can’t afford who can tap parental/family resources if they MUST. I’m sure they don’t want to go down that road, but it’s available in a pinch to a lot more people than we probably are aware. But it’s something people here rarely put into their calculations…

[sdcellar]

davelj– That’s sheer madness and crazy talk. You are clearly too rational and level headed.

Sorry for the namecalling, but I see no other way to get you to become a full blown mongerer of doom yourself.

[Mexico Resident]

I can’t see banks doing this as a matter of policy. And it would have to be policy to make a difference industry-wide. That might represent something like $10-$100 billion dollars of loss for a large bank? No way.

[IONEGARM]

Any specifics, which bank (s), etc?

A) Most banks dont own the loans they underwrite.
B) The shareholders would crucify the bank, and this would lead to tightening underwriting standards (and/or less loans purchased in the secondary markets, which means higher interest rates).
C) Either way you get higher interest rates and tighter underwriting standards for purchases moving forward. Which means you will sales will drop even more.

This may save some homeowners and prop up prices somewhat, but the cost will be transactional with realtors bearing the brunt.

[Author]

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