In the movie Broken Arrow (1996), starring John Travolta and Christian Slater, a government aide is told that they have a "broken arrow" situation - nuclear weapons have been stolen. The aide, played by Frank Whaley, says "I don't know what's scarier, losing nuclear weapons, or that it happens so often there's actually a term for it." We have a similar term in the mortgage industry, now - "jingle mail" - when a homeowner walks away from their mortgage and mails the keys back to their lender.
One some level, walking away just makes sense, especially in jurisdiction where mortgage financing is non-recourse - meaning the lender cannot go after the homeowner for the deficiency. Even in jurisdictions where lenders can pursue collections against the homeowner for the balance due after foreclosure, I don't believe it is routinely done. Perhaps that is because the deficiency judgment is too cumbersome or expensive to obtain, or maybe it just isn't worth it if the homeowner has few other assets to make collections practical. So what is the consequence of giving up on repaying a mortgage and allowing the home to go in to foreclosure?
At this point, the consequences remain serious. For someone with pristine credit, a foreclosure could mean a drop of 200 points overnight, said Craig Watts, a spokesman for Fair Isaac Corp., which developed the nation's most widely used scoring formula, FICO.
. . .
"A foreclosure is a serious delinquency, and it is in the same category — as far as a credit scores go — as a bankruptcy or a tax lien," Watts said.
Many of those walking away are already delinquent and the additional hit they may take on their credit score isn't considered a major deterrent. Even some who could afford to make their payments are dropping keys in the mail because they have very little invested in their home. And, the value has fallen so much that they no longer see their home as a good investment.
This is the biggest problem with the creative financing options we have had for the past decade. No money down or very high loan-to-value mortgages have allowed many people to become homeowners. But the reality is that these people don't fee as much like they own their home as they feel they are renting from the bank. Frankly, if you have no equity, what exactly do you own?
With the record number of foreclosure, we will see many people with plummeting credit scores. That may mean that they will have trouble obtaining credit cards and car loans, which will have an impact on our economy generally. In addition, potential landlords and some employers routinely run credit checks to determine the level of applicants' responsibility. So, these people may also find it harder to rent a home or obtain meaningful employment.
It has been suggested that a foreclosure may not be such a serious problem in the future because it will be somewhat common. Sure it will impact the credit score, but in a few years when the person reviewing the credit report sees a foreclosure in 2008 or 2009, they may just say "oh, that was in the midst of the mortgage and credit crisis... everyone was having problems."
"The more the house is underwater, the more people are likely to walk away from a house and go rent rather than keep money tied up in it," said Todd Zywicki, a professor who specializes in bankruptcy, contracts and commercial law at the George Mason University School of Law.
"The traditional restraint on this has been that people have been concerned about the impact on their credit reports ... but with the large number of foreclosures that we have been going through, my guess is that in a couple of years, a foreclosure is not going to look quite as menacing as it does now."
A generation ago, this would not have been such a phenomenon. When lenders required a meaningful down-payment to purchase a home, people worked hard and saved to obtain the American Dream.... they earned it. They had a vested interest and they actually owned something.
Here is something to think about - the banking industry and Republicans in Congress vehemently oppose changing the bankruptcy laws to allow for mortgage relief in bankruptcy court. The most common reason they cite is that everyone will pay higher interest rates and down-payments because of the losses that lenders will suffer.
Most congressional Democrats say the quickest way to save homeowners like Troy Butler of Saginaw, Mich., is to let them declare bankruptcy and allow judges to dictate new mortgage terms.
[T]he lenders that would absorb the pain — and lose control of any deals to ease the terms — do not want to get dragged into bankruptcy court by millions of overextended borrowers.
. . .
The chief lobbyist for the Mortgage Bankers Association, Steve O'Connor, said new homebuyers would end up paying higher interest and bigger down payments if lenders are saddled with the risk that a judge could change mortgage terms.
But, what does it do to mortgage rates when homeowners are willing to simply walk away from their mortgages because they don't have anything personally invested?
Losses in foreclosure are around 40% - if the bankruptcy changes were to pass we are only talking about modifying the interest rate by a couple of points to make the payments more affordable. It would seem that we are seeing larger losses from jingle mail that we would face if the bankruptcy laws were modified. And, the homeowner is taking about the same drop in their credit score whether they choose to mail their keys back to the bank, or file for bankruptcy.
It seems that most Democrats in Congress and President Obama support bankruptcy reform as a part of the solution to our current crisis.
A bill to give judges authority to alter loan terms for primary residences may be the quickest way to arrest the housing market's collapse. Most Democrats in the House and Senate support that plan. President Barack Obama told Democratic leaders Friday he also backs it, according to a Senate aide who was not authorized to be quoted by name.
However, President Obama has asked that it be removed from the economic recovery package to ensure that it doesn't delay its passage.
Sen. Dick Durbin, D-Ill., the chief Senate sponsor of the bill, said Obama persuaded him in a White House meeting Friday to remove the bankruptcy proposal from an economic recovery package — to ensure it doesn't jeopardize the stimulus bill. But Obama pledged his support for the bankruptcy solution, Durbin said.
Obama said he would work with Durbin to attach the proposal to other "must pass" legislation — with the hope that supporters of the overall bill would not vote against it because of the bankruptcy provisions.
We might see bankruptcy changes in the future, but how many borrowers will lose their homes in the mean time? I hope this isn't one of those things that finally passes when its no longer needed. Perhaps instead of mailing keys back to the lenders, those facing imminent foreclosure should send a little jingle mail to their congressmen. Let them know that they could have kept their family in their homes if they were able to get a little relief in bankruptcy. If only Congress would force lenders to take a loss of a couple of points on the interest rate rather than let them choose to lose 40% in foreclosure.
Robert A. Franco
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