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Some homeowners, who can afford the mortgage, still default

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She has a sales job with a six-figure salary. He owns a successful tech company. And they are in foreclosure.

But unlike countless other Americans faced with losing their homes, this couple could make the $5,200 monthly mortgage on the waterfront property in Pompano Beach that they bought for $585,000 in 2004. Foreclosure was their decision – not the bank’s.

They crunched the numbers: $525,000 outstanding on their first mortgage and a $245,000 second mortgage on a home now worth about $319,000. His business was way down, her company was laying off workers and other investments had tanked. It made no sense to hang on to their underwater home. So they stopped paying their mortgage and waited for the foreclosure notice. It came in October.

It is called strategic default – borrowers who have enough money to make their mortgage payments but do not. They owe so much on a home that is now worth so little, that they decide to walk away.

It is not an easy decision. But it is not the inevitable blow to their credit score that troubles some strategic defaulters. It is the ethical dilemma of refusing to repay a loan when they are able to and worrying about what the neighbors will think.

“It felt like such an awful thing to do,” the woman said, who spoke on the condition of anonymity. “I got a car loan at 14 and paid $35 a week until I paid it off when I was 16. “

How prevalent are strategic defaults?

Although the exact number is unknown, half the homeowners in a study conducted by the Federal Reserve Board walked away when they owed twice what their home was worth. A Palm Beach Post analysis of foreclosed homes purchased since 2006 found 72 percent – about 4,124 homes – are worth less than half of the original loan.

In the business world, strategic default is a common tactic – considered a savvy move for financially troubled companies. However, “consumers have been browbeaten and trained to believe that it’s not honorable to not pay your debts,” said Margery Golant, a Boca Raton attorney who represents the Pompano Beach couple in default. “Why should it be any different for consumers?”

Last year, Morgan Stanley walked away from a $1.5 billion mortgage on five buildings in San Francisco despite record-breaking profits in 2009. Real estate giant Tishman Speyer Properties strategically defaulted on $4.4 billion in loans on two housing developments in New York after the properties lost $2.2 billion in value. The company had billions of dollars in assets, including Rockefeller Center and the Chrysler Building, which it could have leveraged to meet its loan obligations.

Even the Mortgage Bankers Association, whose president chastised homeowners who strategically default for the “message” it would send to their “family, kids and friends,” dumped its Washington headquarters in a short sale. After working out a deal with its lender, the MBA sold the building for $41.3 million last year. In 2007, the group purchased it for $79 million.

Ethicist OK with decision

“No, it’s not wrong,” said Randy Cohen, author of the weekly Ethicist column in The New York Times. Although homeowners are emotionally attached to their property, a house is still an investment.

“I don’t understand why you would be asked to make a decision on this investment any differently than you would on any other,” Cohen said. “Why should homeowners be held to a higher ethical standard?”

In many strategic default cases, the moral imperative is self-imposed. Among the arguments: Walking away from a mortgage will depreciate your neighbors’ property values. If all underwater homeowners walked away, the housing market would crash.

“Most people considering strategic default come to me and want my permission,” said Ronald Kaniuk, a Boca Raton foreclosure defense lawyer. “People who cannot pay their mortgage are apologetic. For people who can afford their mortgage or can just barely afford their mortgage and see it as a losing investment, they want absolution.”

They should not get it, according to Luigi Zingales, an economist and professor at the University of Chicago’s Booth School of Business, who became embroiled last year in a debate over the morality of strategic default.

“When you borrow money you make a commitment to pay it back,” Zingales said. “If you walk away because it’s in your interest to do so, you are violating the letter and the spirit of the law.”

Zingales wanted to know why it had become so easy for upside down homeowners to walk away. The answer was simple.

“The stigma is very much a function of how many people do it,” Zingales said. “Once you think it’s socially acceptable, it becomes easier to do.”

Expect more defaults

But there are consequences, including the long-term health of the housing market, Zingales said. Zingales predicts we will reach a tipping point where getting rid of a bad investment outweighs the damage to neighbors’ property values and the borrower’s reputation. In other words, expect more defaults.

“We’re not there yet,” Zingales said. “Clearly this creates a tension in society.”

On one side are homeowners who did not lose their jobs or live beyond their means and are now struggling to make their mortgage payment. Next door are neighbors who have stopped paying their mortgages and are living largely free until they are booted from their homes. “It’s a legitimate resentment,” Zingales said.

“We never bought cars or jewelry,” the Pompano Beach woman said. The second mortgage they took out on their home went toward purchasing and renovating a condominium as an investment rental property. When her husband’s business lost its best client and her company began layoffs, they decided to get out from under all their debt.

There will be consequences. They will lose the $65,000 in loan payments. The lender could get a “deficiency judgment” to go after the couple for repayment of the defaulted loan.

Their credit score will take a hit, but at least with a strategic default they won’t be homeless.

After liquidating some assets and scraping together what they could, the couple bought a new house – down the street and nearly identical to the old house – for $353,000. They walked away from $770,000 in debt.

“It felt like such an awful thing to do,” she said. “When this is all over I’ll feel like I made a good choice.”

As more homeowners walk away, experts fear for nation’s morals

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Americans have taken a sharp slap in the face from the housing crisis, financial crisis and jobs crisis. Now, some wonder if the residue of those harsh realities is an ethical crisis.

For the first time in the nation’s history, bankers say, people are walking away from mortgages they can otherwise afford to pay. The phenomenon known as strategic default was once unthinkable. It represents a calculated decision to hand over the keys to a home without making good on a loan, reasoning that it makes no sense to keep paying the monthly mortgage when the home is worth thousands of dollars less than the obligation.

Jeff Horton, a 33-year-old Orlando, Fla., technology manager, is among those who recently decided to take the step. He told his lender that he’s done making payments on the condo he bought in 2005 and the home he bought in 2007, because he wants to move from Florida and can’t sell or rent the properties at a price nearly high enough to cover his payments.

“Life is too short,” said Horton, who has mortgages totaling about $400,000 with Bank of America – about twice as much as he thinks he would get if he could sell the property. He says he has little choice because the bank has refused to refinance the mortgages or adjust original terms.

Strategic default is a symptom of a housing market that suddenly turned from “American Dream” to financial trap. With the Norman Rockwell-like images of homeownership decimated by a 30 percent plunge in prices, some fear America is also losing its grip on another idyllic notion: that people will live by the slogan, “My word is my bond.”

Morgan Stanley recently estimated that about 18 percent of defaults will be strategic. In a recent Pew Research Center survey, 36 percent of Americans said that walking away without paying a mortgage is acceptable, at least under certain circumstances. Fifty-nine percent said the practice is unacceptable.

The saying “My word is my bond” was first posted in the London Stock Exchange in the late 1920s to convey living up to promises. Now, after the worst financial disaster since that period, people such as Horton say they have no such image of Wall Street or large banks as trustworthy institutions, and that has allayed guilt about walking away from mortgages.

“I felt guilty at first,” said Horton. “It all stopped when I saw them take $90 million in executive bonuses. They take bailout money and do nothing for the little guy. They wouldn’t do anything for me.”

Most people walking away from homes see little choice, says John Maddux, chief executive of UWalkAway, a Web site that provides advice on the strategic-default process. “They bought the house thinking of it as an investment in their future,” he said. “For some, it was to be their retirement; for others, it was seen as forced savings, and now it’s bleeding them dry.”

Overburdened with mortgages, people conclude they won’t be able to send their children to college, save anything for retirement or move to a place where they can find a job. But as they go through the soul-searching and guilt connected with walking away, Maddux noted they often point to a sense of betrayal.

He said he frequently hears: “I don’t feel bad for the banks. They let this happen. Banks made the mistake of giving a loan to anyone if they had a pulse. Their loose lending standard led to a bubble, and the regulators should have controlled this.”

Banking expert E. Philip Davis sympathizes with that point of view, but he also points out the implication of homeowners walking away from a commitment.

“It makes them as bad as the bankers,” said Davis, a Baptist minister in the United Kingdom who teaches courses on fostering stability in the financial system.

The erosion of the ethic of keeping promises “will be a cancer for society,” said Davis, who was with the Bank of England and is now a fellow at the U.K.’s National Institute of Economic and Social Research.

On the surface, one consequence is evident: If bankers don’t trust that people will pay off their loans, banks will demand higher interest and other assurances before lending in the future.

In fact, there’s research behind the concern, says Tom Donaldson, a University of Pennsylvania Wharton business ethics professor. And it shows that both bankers and borrowers are at risk if trust erodes.

“We’ve known for decades that trust is critical to successful business,” said Donaldson. “Studies have shown that if one party cheats on one end, the other party feels more entitled to cheat. It’s not the most noble way, but it is human nature, and it becomes a race to the bottom.”

Research into strategic default by University of Chicago Booth School of Business professor Luigi Zingales shows what he calls “the contagion effect.” “The stigma goes down once you see someone else do it,” he said.

Foreclosure vs. short sale: pros and cons

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PALM BEACH, Fla. – July 28, 2010 – With today’s reduced property values and increased unemployment, it’s tempting for some homeowners to just throw their hands up in defeat, allow the bank to take their home in foreclosure and rid themselves of the monthly mortgage burden.

Even suffering through the paperwork and stress of a short sale may seem too much for an overwhelmed borrower to handle.

But Florida homeowners should be aware of unique rules in the state that make the benefits of a short sale typically outweigh the ease of walking away in a foreclosure.

“I want to be very clear on this, short sales are a better solution than a foreclosure, even when all the options in a situation where you lose your house are not great,” said Mark Greene, owner and president of Short Sale Operations LLC in North Palm Beach.

The biggest difference between Florida and many other states when it comes to losing a home is the deficiency judgment.

While some states ban lenders from collecting the remainder owed on a loan after a foreclosure or short sale is completed, Florida law allows banks to go after borrowers for up to 20 years. That can lead to a garnishment of wages long after the home is gone.

In a short sale, where the bank agrees to take a lesser amount for the home than what is owed on a loan, lenders sometimes are willing to write off the deficiency on the front end.

Greene said in 90 percent of the cases he handles, the bank has waived its right to seek a deficiency.

That was the case with Jupiter resident Kathryn Lorello, who in 2008 found herself in a home she couldn’t afford.

Following a divorce, and with three children, Lorello bought a $408,000 home that she lived in comfortably for a year. But then she lost her job as a manager of a real estate company.

She remembers the day the bank served the notice of foreclosure.

“I cried my eyes out,” Lorello said. “That’s when I panicked because I really didn’t want it to happen.”

Lorello got advice from Greene on doing a short sale.

Her bank, Wells Fargo, waived its right to seek a deficiency even though it ended up taking $200,000 less than what was owed on the loan.

Also, if a bank refuses to waive the deficiency in a short sale, it still would have to go back to court to seek a judgment.

In a foreclosure, at the end of the proceeding, a deficiency judgment is automatically awarded by the courts and the bank is free to seek a claim.

“In the past, people just wanted to move from the property and get on with their lives and didn’t understand what the lenders’ rights were in terms of pursuing a deficiency claim,” said Paul Baltrun, director of loss mitigation at the LaBovick & La-Bovick law firm.

“I think people are more aware now about what can happen after the fact and that their nightmare can continue.”

Another consideration is the effect of a foreclosure or short sale on credit.

According to the Fair Isaac Corp., which developed the widely used measurement of credit risk called a FICO score, the negative effect of a foreclosure is only marginally worse than a short sale.

But in Florida, a deficiency judgment from a foreclosure is likely to have a much larger impact that will prohibit your ability to buy another home for many years.

Daniel Poulos, a mortgage broker with Elite Lending in North Palm Beach who has studied the effect of foreclosures and short sales on credit, said unless a borrower pays off the deficiency, it may be 20 years before someone is eligible for another mortgage.

“That’s the kind of information that’s not getting out in Florida,” Poulos said.

There are a few situations where some experts believe it is better for someone to go to foreclosure rather than do a short sale.

To do a short sale, a borrower must give all of his or her financial information to the bank before it will decide whether to allow the short sale. The idea is that if a person can afford to pay the mortgage, the short sale may be denied.

“Now the lender knows everything about your finances and they can better decide whether they will go after you or not,” said Jon Maddux, CEO of YouWalkAway.com, a company that advises people on strategic defaults.

If a lender doesn’t know your finances, Maddux argues, it reduces the chances it will go after you following a foreclosure.

“You might fly under the radar,” he said. “With the millions of people going through this, they are probably going to go after the low-hanging fruit.”

Want to Invest in Real Estate? 7 Questions You Must Ask Yourself Before You Buy

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You’ve heard that investing in real estate can be very lucrative. Before you get started, here are seven questions to ask yourself.

1. Is this a hobby or a business?
Ask yourself why you want to invest in real estate.
-Do you want another income stream
-Do you want to build equity in a house
-How many sellers and buyers do you want to speak with each day/week/month
-How much time do you have to invest in real estate
-Are you working a full time job
-Are you retired looking for additional income
-What do you want to do with your time?
If you want to build a real estate investing business, then you need to treat it like a business.
Are you going to be a landlord? Then you need to determine how much time you want to spend collecting rent, maintaining the property, making repairs, answering tenant calls late at night, etc.
Or have a property management company handle the tenants and maintenance? Then you need to determine who you will hire to manage your property and how much you will pay them. Typically a property management company will charge one months rent to locate a tenant and then charge 8%-10% of the monthly rent for collecting the rent and answering all calls from the tenant. You still need to set aside a reserve fund for maintenance.

Maybe you don’t want to be a landlord and you want to wholesale property. Then you need to develop a buyer’s list of buyers who have the cash to purchase the house. You will still need to work with sellers to locate properties, get it under contract. You then need to get your wholesale buyer to sign the assignment of contract. And you have to make sure you follow up with the closing agent to make sure the deal is funded by the wholesale buyer and the deal closes. You will get your assignment fee once the deal closes.

Here are the questions you need to ask yourself.
-Do you want to be a landlord
-How much time do you want to put into real estate investing
-Do you want to build a business or just make some extra money once in a while
2. Do you want to work directly with sellers?
There are many investors who want to get into the real estate investing business who don’ t have prior sales experience. Yes, you can call homeowners directly and negotiate the purchase of their home, it is possible. It’s even easier when you are speaking with a motivated seller. I mean a seller that is really motivated to sell, not someone who wants to sell, wants full price for their home and just doesn’t want to wait for the all cash buyer that will pay retail price.

Are you someone that wants to help these motivated sellers? Do you have it in you to hear their stories over and over? Some of these sellers will break your heart and you will want to help them. You have to make sure that you only work with those that you can help and make a profit for yourself. Just because someone is willing to deed you their house does not mean it is a good deal.

Think about a situation where the seller has two mortgages, judgments, and liens on the property. Yes, you can work this as a short sale and get the liens removed and negotiate with the lender to get a smaller settlement for the payoff of the mortgage. You need to decide if you want to put in the time and effort it takes to negotiate the short sale and get the liens removed. I have seen investors in the short sale negotiation process with the lender for anywhere from 2 months to 18 months. Do you want wait months to close the deal?

You need to decide if you want to work directly with homeowners or have someone handle this for you.

3. Do you want to work directly with buyers?
Once you have a house under contract, it is time for you to find your buyer. The best thing you can do is to build a buyers list before you have a property. Find out where the buyers want to live, and then go find a house in that area. It is much easier to find a house for a buyer than it is to find a buyer for a house.

Do you want to take calls from the buyers? They call at all hours, while you are having dinner, before you wake up in the morning, when you are driving to work, etc. Are you willing to drop everything you are doing to take a call from a buyer?

4. Where are you going to get the money?
This is one of the biggest concerns of all real estate investors, where to get the money.
Yes, you can buy a house with little of your own money. Some of the techniques to do this are:
-Buy the house subject-to the existing mortgage
-Have the seller carryback the financing in the form of a note
-Lease/Option the house
You can also build relationships with other people who have money, such as
-Private lenders
-Hard Money Lenders
-Mortgage Brokers
The biggest money concern that you never hear about is where to get the money to market your business. You can buy a house subject-to the existing mortgage. But how do you find that house? You have to continue to MARKET, MARKET, MARKET.

Marketing costs money. That is what most of the gurus forget to tell you. You hear all about how you can buy a house with no money down or little money down. What they don’t tell you is that you have to spend money on marketing to find the house, and money on marketing to find the buyer.

Before you get started, put together a marketing plan so you know how much money you need to get started.

5. Do you want chunks of cash or cash flow?
What is the reason you want to invest in real estate? Are you interested in getting chunks of cash? Cash Flow? Or Both?

What you want out of real estate investing will help you determine what type of real estate investing you want to get into.

If you are looking for chunks of cash, you have a couple of choices. Consider wholesaling or rehabbing (fix and flip).

If you are looking for cash flow, consider landlording, selling a home with seller financing, or be a private lender.

6. Where do you want to invest?

Many investors will start out in their local market because they are familiar with it and they already have some relationships in the area. It’s easiest to start local since you are familiar with house values and have access to local experts to answer your questions.

7. What is your plan to learn more about RE investing?

The most successful real estate investors are those who keep up with the changes in the industry and are constantly learning new techniques.

One of the best things you can do is find a local mentor, someone who is making money investing in your local market. Ideally they should be investing in the area that you are interested in. If you want to wholesale properties, find a local investor who is wholesaling properties. Not only will you ask them to mentor you, but they may buy some of your properties from you.

If you are interested in commercial real estate, then you shouldn’t spend your time with an investor who deals only with single family homes.

Always continue to learn about Real estate investing. There are many gurus that travel the country teaching real estate investing. Ask the people at your REIA whose products they have purchased and whether or not it helped them in their business.

First determine the niche you want to work to get started. Learn everything you can about that specific niche and create income in that niche before you move on to the next niche. Don’t get distracted by the “shiny ball” syndrome.

Real Estate investing can be very lucrative. You need to create a plan, continue to educate yourself, and continue to market for sellers and buyers.

When you have a game plan, call me so we can setup a search and study the market to pick the best deals!