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The Principal Solution to Strategic Walk-Aways

By
Real Estate Broker/Owner with Mike Bell, REO Broker - Realty World MBA

There’s been a lot of discussion on the subject of Strategic Default over the last year or so, with no shortage of passionate viewpoints.  It’s a favorite topic in all forms of media.  The last time we posted an article on this subject (Feb ’10) it created a virtual firestorm of response.

Ethical and legal arguments aside, it’s always been our opinion that the most practical solution to this issue is for lenders to reduce principal loan amounts.  If you can make payments on a $350K loan but the home is only worth $200K, then does it make sense for your lender to reduce your principal to match the fair market value of your home?  Yes, and here’s why:

  1. If you don’t have a “hardship,” you only have two options: take your lumps or walk away.  You don’t qualify for a loan modification or a short sale.
  2. You likely chose your home for the lifestyle it offered, rather than as an investmentYou would be content to stay if you didn’t feel like the value was a total loss.
  3. Lenders (and their investors) prefer performing loans to non-performing loans, and it’s well-documented how costly walk-away defaults are for lenders.
  4. Governments like performing loans, too, but their solutions aren’t working.

A principal reduction modification could even be an equity-share agreement.  The borrower agrees to share any equity growth with the lender at the time of sale.   It’s a no-lose proposition.  Sound improbable?  Well, it’s already happening.

 

Photographer: Frank C. Müller

Image via Wikipedia

A close friend very recently received such an offer.  It came in an overnight express package directly from the lender, a major bank, with a no-strings offer to reduce the principal loan balance by a substantial amount.  After a lot of “must be a scam” follow-up, it turned out to be legit. Now the loan balance is lower than, or near market value.  The borrower can consider new options: stay and make improvements, or even sell without a loss.

The property in question had lost over 35% value since purchase, and was worth considerably less than the loan balance.  The payments were much higher than comparable rent.  Numerous attempts at loan modification failed because there was no hardship.  The borrower could still easily afford the payments, and loved the house, but was seriously considering walking away.  Seemed like a sound business decision.  Nonetheless, they continued to stick it out.  After about a year, a new lender acquired the loan, and almost immediately they offered the principal reduction.

Some suggest that there is no such thing as “doing the right thing.” Compared to what?  Nevertheless, my friend was rewarded for being faithful and credible.  Everybody wins.  No legal consequences, no ethical dilemma, lifestyle intact, the loan doesn’t default and the bank doesn’t have to dig the occupants out.

There are some prerequisites to qualify for this offer.   I can’t verify this, but from what I understand you have to be current with your payments and it applies only for purchase money, not cash-out refi’s.

This is definitely more the exception than the rule, at least so far, but I expect we’ll see more of this.  There is hope for those you who are hanging in there, and there is still some good old-fashioned common sense afoot in the land of “I, me-me, mine.”

Show All Comments Sort:
Charles Buell
Charles Buell Inspections Inc. - Seattle, WA
Seattle Home Inspector

Mike, I have been saying this same thing and everyone tells me it isn't possible----still makes sense to me.

Jul 02, 2010 01:30 PM
John Pusa
Glendale, CA

Mike - Great information. Some lenders cooperating more with homeowners.

Jul 02, 2010 05:16 PM
Marcy Moyer
eXp Realty of California Silicon Valley Probate, Trust, and Investment Sales - Mountain View, CA
Probate, Trust, and Investment Specialist

Mike,

This is the first logical solution that I have heard since the mess began. It particularily makes sense for the bank to do an equity share in the appreciation. Being a very strong believer in the buy, pay off the loan, and hold theory of real estate, this would be an excellent way for the buyer to buy a home and stay there to reap the future benefit of owning a home free and clear.  That is where the money is in today's real estate.

Jul 03, 2010 03:35 AM
Carol Zingone
Berkshire Hathaway Home Services Florida Network Realty - Jacksonville Beach, FL
Global Realtor in Jax Beach, FL - ABR, CRS, CIPS

I just hope people are reasonable about these types of decisions - it is my belief that everyone wanted a piece of the rising real estate market, and no one wants a piece of the falling real estate market.

At the end of the day, I do not know anyone who sat at the closing table and thought, "Man, what a deal: I'm overpaying by $150,000 for this house!".

Jul 18, 2010 01:48 AM
Elite Home Sales Team
Elite Home Sales Team OC - Corona del Mar, CA
A Tenacious and Skilled Real Estate Team

It is simple and some make it so difficult and complicated.  Thanks for the post.

Jul 28, 2010 06:46 PM
Pamela Seley
West Coast Realty Division - Murrieta, CA
Residential Real Estate Agent serving SW RivCo CA

Mike, I have heard of one incidence like this. GMAC offered a homeowner principal reduction, but there were very strict guidelines for them to qualify and it was a purchase money loan, not a re-fi, as you say.  Good info, thanks

Jul 28, 2010 06:47 PM
Jon Zolsky, Daytona Beach, FL
Daytona Condo Realty, 386-405-4408 - Daytona Beach, FL
Buy Daytona condos for heavenly good prices

Mike,

I realy do not think it is as easy as shown. Loans are very different. On one of the short sales we finally ran into the investors, and they were 3 guys, and they absolutely were not thrilled that they have to agree to get less money that they loaned.

I have a situation where the developer financed units. He is not going to get TARP money, and why would he agree to lose the money?

When we are talking about the logical side, it simply does not sum up. Someone has to bring the money for this Christmas thing to work.

They are not going to fall from the blue. So the money borrowed from children and grandchildren would be covering this solution? Is it fair to them? Banks do not make money, they have to earn it. Where do you expect them to get the money to cover the losses?

On a side note. Hardship is NOT a prerequisite for short sale. YES you can short sale even investment properties. We have done Short sales where borrowers could keep up with payments with no problem.

Jul 28, 2010 06:58 PM
Sharon Klein
Hudson Valley Homes and Land - New Paltz, NY

This is a very interesting post.   Makes business sense to me.  I would consider walking away from my house if I didn't love it so much and could afford the payments?  Why would I stay if the house is worth $100,000 less than what I owe?  Why would anyone?   Why should a person consider a bank's well being?  Would the bank do the same for us?  Heck no!  Business is business as far as I'm concerned.   Equity sharing makes good business sense. 

Aug 01, 2010 04:46 PM
Paul Durry
Collateral Specialist Inc - Lawton, OK
Former Broker Associate, CDPE, CIAS, CHMS

That type of deal sounds like having your cake and eating it also, but with an equity share!!

Aug 13, 2010 03:01 AM
Sergio Horcos
Wickenburg, AZ

In a normal market this is not how it would work, but we aren't in a normal market.  Everytime the government interferes by bailing out the banks, it changes the dynamics of the normal market.  So one might argue that if it is OK for banks to get bailed out why not bail out the individuals as well? I think it is about time people start taking responsibility for their own mistakes.  It is not easy, but may be necessary.

Aug 31, 2010 04:57 AM
Liz Lockhart
Riverbend Realty, Cape Girardeau, MO - Cape Girardeau, MO
GRI, Cape Girardeau Real Estate

I wonder if an "equity share" clause might be a good idea in the original loan paperwork. It might help get buyers back in the market and off of the fence because they fear the market is still falling. If buyers  and lenders share the risk from the start and throughout the ownership, buyers might be more likely to purchase and then stay in the house.

Sep 08, 2010 01:41 PM
Phil Leng
Retired - Kirkland, WA
Phil Leng - Retired

Hi Mike,

Good post.

There are more options than people think.

This is certainly a good one

PHil

Sep 14, 2010 06:32 PM