Do non-recourse loans become recourse in the new mortgage plan?

I was reading Dean Baker’s commentary on why the Obama mortgage plan brings no relief in the Guardian when it dawned on me that the ‘new’ plan is an enhancement of the old plan. And this is significant because the old plan turned non-recourse loans into recourse ones (or so I believe from available evidence). Recourse loans give banks the ability to seize assets of the debtor other than the home against which the mortgage is secured. This is further evidence that the new mortgage plan is designed to help recapitalize banks and not to help underwater debtors.

Back in July I wrote Is the new affordable FHFA loan program predatory lending? specifically because of this feature. Then I said:

  1. In the state of California, you can just walk away because first mortgages on primary residences are non-recourse.  That means that the mortgage is only secured against the house you have bought.
  2. However, in the state of California, refinance mortgages are recourse loans.  What does that mean?  It means you are on the hook for that loan.  You cannot just walk away.  The bank can come after you and take your car and the stocks in your E-Trade account. They can garnish your wages. They can even take your clothes and the shirt off your back, literally.  The only thing they can’t touch is your 401-K.  But it’s down 40% anyway.

Why would you trade a non-recourse loan from which you can walk away for a recourse loan that guarantees you’ll end up as bad as some poor slob at Tappahannock?  It doesn’t seem like an incredibly appealing choice, does it?

But, of course, this is a classic case of asymmetric information because you don’t know that you are getting a poor trade, but your bank and the government do.  In fact, the bank makes more money this way because of incentives it receives for refinancing these loans – incentives, I  might add that come straight from the taxpayer to the bank via the Federal Government (see my post “How refinancing helps the likes of Bank of America and Wells Fargo”).

So, to recap, you get shackled to a house with a recourse loan because you don’t know what the bank and government do.  Meanwhile, your bank gets to forgo a writedown (remember, your loan was for the same amount as before).  And the bank gets a refinance fee which is goosed by government incentives.

Is this predatory lending? Sure sounds like it to me.

This time around the banks do write down the loans (for a fee from the government, of course). Moreover, upon doing a bit of investigation, I have concluded that these ‘new’ features also turn non-recourse loans into recourse loans.  If anyone has evidence to the contrary, please provide it.

The March 26 Treasury memo touting these features is titled "Housing Program Enhancements Offer Additional Options for Struggling Homeowners."  So these are program ‘enhancements’ indeed. They are not new programs. So the same rules do apply.

To recap, my July 2009 post says that banks receive an incentive fee to do modifications and that these modifications can be ill advised as they give recourse to your other assets to a lender who had none. In a March 26 post, It’s unanimous: Propping up underwater mortgages is a bad idea, I also said:

it is clear that the principal reduction is more about the banks than the homeowners. In reality this is a another backdoor bailout for the banks camouflaged as support for homeowners. It is a way of recapitalizing banks by having the government pony up for the dodgy assets still on their balance sheets which they have not yet written down.

Finally, Dean Baker makes a very compelling argument that modifications are not designed to help homeowners, but to help banks.

If the point is to help homeowners then there are two incredibly simple questions that must be asked:

  1. Are homeowners paying less under the plan than they would to rent the same place?
  2. Are homeowners going to end up with equity in their home?

These are the key questions, because if we can’t answer yes to at least one of them, then we are not helping homeowners. If we can’t answer yes to at least one of these questions, then taxpayer dollars being put into the programme are helping banks, not homeowners.

Update 1500ET: the question I ask is a serious one because I am far from certain whether HAMP modifications are indeed recourse.  I should note that under HAMP, a homeowner may be incented to apply for a HAMP modification and default strategically in order to save money. It’s not yet clear to me how those incentives would change depending on whether the HAMP loan is recourse.

Update 1600ET: The treasury has a fact sheet in pdf form called "FHA Program Adjustments to Support Refinancings for Underwater Homeowners." It says that the program:

Enables refinancing into more sustainable loans that are no higher compared to the value of the home than the standard FHA refinance loan (97.75 percent).

Notice the word refinancing.  This is key.  It still appears to me that modifications are refinancings i.e. not the original loan, but a new loan. In all cases that I know of, refinancings are recourse loans.

13 Comments
  1. Anonymous says

    Hey Ed,

    Since mortgages are governed by state law, I don’t think that it is possible to make a blanket statement as to whether they may or may not be subject to deficiency judgments in the event of modification. I’ve had several conversations with attorneys over the statutes in
    Arizona on various occassions and the bottom line has always been to forget about trying to recover anything over and above the value of the property if you’re foreclosing on residential real estate.

    Here’s a link (http://www.sackstierney.com/articles/antideficiency.htm) to a decent article on the Arizona statutes. Notice how a simple concept gets really complicated really fast. You may note that the article implies that a refinance may not enjoy antideficiency protection. It fails to reference an Arizona court decision that many feel extends protection to refinance transactions. I don’t have that link readily available but if I can find it again I will send it to you.

    I think that the bottom line on this one is that the banks probably don’t want any part of jumping through the hoops that would be required to obtain deficiency judgments. Putting aside the bad publicity, the expense and complexity of trying to wring blood out of very dry stones probably isn’t worth it.

  2. Mike says

    In Florida they can come after all loans even 1st mortgages and they have started doing so on some shocked people and some were even short sells where a professional didnt verify there was no recourse for the banks for the difference.

  3. Edward Harrison says

    Tom and Mike, What I hear you saying is that recourse varies from state to state (40 have recourse on 1st mortgages I understand). In the past, banks didn’t try to recover assets. But now banks are pursuing their recourse options. Thanks on both counts for the color.

    Could this be due to strategic default by prime borrowers who have a lot more assets to chase after

    1. Mike says

      Probably, Rumor in Florida is that the banks are starting to look at the person’s credit report besides the foreclosure and their job listed to see if they are a good target to collect something on. Wouldnt be surprised if they start selling the ones that dont look as good to collection firms.

    2. Mike says

      http://www.housingwire.com/2010/01/28/lenders-pursue-mortgage-payoffs-long-after-homeowners-default/

      “When John King stopped making payments on his home in Coral Gables, Florida, two years ago, he assumed the foreclosure ended his mortgage contract, he said. Last month, a Miami-Dade County court gave collectors permission to pursue him for $44,000 stemming from the default.

      King is among a rising number of borrowers who are learning that they can be on the hook for years after losing their homes. Amid a crisis that stripped $6.4 trillion, or 28 percent, from the value of U.S. residential real estate since the 2006 peak, lenders are exercising their rights to pursue unpaid mortgage balances. To get their money, they can seize wages, tap bank accounts and put liens on other assets held by debtors.”

      1. Edward Harrison says

        Banks will start pursuing recourse on more people if strategic defaults increase. They want to preserve capital.

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