What happens if you default on your mortgage?

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dclegg

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#99780 27-Mar-2012 10:30

I've just had my mind blown by a conversation with a US work colleague. He said he was "under water" on his house (referring to Underwater Debt, the term for negative equity over there), and was advised by his lawyer and tax attorney to stop paying his mortgage and property taxes for a year. As an end result he shed $100K of debt, and improved his net worth by the same amount. He did also take a hit to his credit rating, but nearly two years later he as almost recovered back to where he was prior to defaulting.

This got me thinking about the situation here. What happens if you default on your mortgage in New Zealand. Is it just as easy to walk away from the debt?

It was also very interesting hearing the arguments justifying the morality about doing so. Both from him and a UK colleague, who said the similar thing was possible there. In a nutshell the prevailing sentiment is that its OK to let the banks take the hit on the bad debt, as they are responsible for the property becoming undervalued in the first place.

Don't get me wrong, I have no intention of doing the same (in fact, I'm desperately trying to find a place to buy, which will increase our debt :-)). But I find the whole concept very interesting, and wondered whether the same scenarios could easily play out here.

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BDFL - Memuneh
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#600591 27-Mar-2012 10:33

Sorry, but wouldn't the bank just call you up on your home loan after a few months and then get the house back?

How the house value going under would help, unless the home loan was tied to the value, which I don't see happening here?

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dclegg

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#600596 27-Mar-2012 10:40

freitasm: Sorry, but wouldn't the bank just call you up on your home loan after a few months and then get the house back?

In this case, they were forced to sell short (IOW, sold the house for less than they paid for it). Apparently many banks over there won't actually allow you to sell short unless you've defaulted on your loan first. While they lost the house, they also lost the debt and loan repayments on the negatively geared property. And in a couple of years, they will be in a position to buy again, in what is very much a buyers market.

How the house value going under would help, unless the home loan was tied to the value, which I don't see happening here?

Thats where I was blown away too. I am far from a financial wizard, but I'm guessing its to do with it not making fiscal sense to make payments on a property which are based on a higher asset value that no longer applies.

And home loans are tied to the value over here too, aren't they? I know that while I've been approved for a loan of X dollars, the bank still needs to get a valuation on the property to ensure they're happy to lend against it. Or are you talking about something else (I did mention I'm not a financial wiz, right? ;-))?

freitasm

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#600597 27-Mar-2012 10:43

The value is tied when you sign the home loan, but after that it's fixed to what you contracted. Do you mean to say that if the house devalues then people would be better off simply stop paying and let the bank take it away, just so that you don't get less value from money?

Mind blowing. Still...

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bazzer

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#600600 27-Mar-2012 10:47

You hear a lot about people just abandoning their homes over there and leaving the keys behind. Once the house is worth less than the mortgage, there's no point paying it in some states due to their non-recourse laws (I presume your colleague lives in CA or similar?). In these cases, the lender can't come after you for the difference between the selling price of the house and the mortgage. Even in the states where they can sue you for the difference, there's no guarantee they will.

I suspect the difference here is that if there's a shortfall you're still liable so you would probably need to declare yourself bankrupt, which is not great.

grant_k

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#600601 27-Mar-2012 10:48

There is one very significant difference between the home loan regime in the US and what applies here:

- In the US, a majority of home loans are made under a "non-recourse" arrangement, where the lender has no recourse to other assets of the borrower beyond the asset tendered by the borrower as security i.e. the house

- In NZ, our banks get borrowers to sign an "all obligations" mortgage where the lender has the right to pursue the borrower for the debt, regardless of what happens to the asset tendered as security.

Thus, it is not possible for borrowers in NZ simply to walk away from their debt as is often done in the US. If the borrower tries to do that, they will most likely be bankrupted, which will have severe financial repercussions for many years to come.

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#600603 27-Mar-2012 10:49

bazzer:
I suspect the difference here is that if there's a shortfall you're still liable so you would probably need to declare yourself bankrupt, which is not great.

+1

A guy I know' got caught a while back. If you price low enough to sell it would not have covered the mortgage, so you'd be left without a house but still with $30,000 debt, which is then unsecured, so the interest rate would rise to 23% or whatever the credit card rate is etc.

dclegg

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#600604 27-Mar-2012 10:50

freitasm: The value is tied when you sign the home loan, but after that it's fixed to what you contracted. Do you mean to say that if the house devalues then people would be better off simply stop paying and let the bank take it away, just so that you don't get less value from money?

Apparently so. The asset is so undervalued that it no longer makes sense to make the monthly payments. You're better off letting the bank take the hit on the debt, losing the house, and renting for a bit until your credit rating improves.

At the time he did this, he had a credit rating of 825. A stellar rating over there is 850. When he was done with the short sale it was down to 625 (not good, but not the worst possible). 5 months after the short sale, it's back to 725 (good). It'll be back in the 800s by two years. The house remains as a "bad item" on his credit record for 10 years, but it's ignored after 2 years assuming he does nothing else to ruin his credit.

He was advised this course of action by one of the best real estate attorneys in the country (actually he said THE best, but I'm allowing for the US exaggeration quotient here ;-)).

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#600605 27-Mar-2012 10:51

bazzer: You hear a lot about people just abandoning their homes over there and leaving the keys behind. Once the house is worth less than the mortgage, there's no point paying it in some states due to their non-recourse laws (I presume your colleague lives in CA or similar?)

Correct, he's in CA. As you stated, he told me all purchase money loans are NON-recourse, meaning that the lender can only foreclose or let you short sell. After that they cannot go after you for the unpaid balance.

dclegg

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#600611 27-Mar-2012 10:54

grant_k: There is one very significant difference between the home loan regime in the US and what applies here:

- In the US, a majority of home loans are made under a "non-recourse" arrangement, where the lender has no recourse to other assets of the borrower beyond the asset tendered by the borrower as security i.e. the house

- In NZ, our banks get borrowers to sign an "all obligations" mortgage where the lender has the right to pursue the borrower for the debt, regardless of what happens to the asset tendered as security.

Thus, it is not possible for borrowers in NZ simply to walk away from their debt as is often done in the US. If the borrower tries to do that, they will most likely be bankrupted, which will have severe financial repercussions for many years to come.

Thanks, that clarifies things nicely.

It also goes a long way to explaining why the US economy is in the state its in. That and the banks over there who were willing to loan insane amounts of money to people, often with 0% deposit.

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#600618 27-Mar-2012 11:06

dclegg:
grant_k: There is one very significant difference between the home loan regime in the US and what applies here:

- In the US, a majority of home loans are made under a "non-recourse" arrangement, where the lender has no recourse to other assets of the borrower beyond the asset tendered by the borrower as security i.e. the house

- In NZ, our banks get borrowers to sign an "all obligations" mortgage where the lender has the right to pursue the borrower for the debt, regardless of what happens to the asset tendered as security.

Thus, it is not possible for borrowers in NZ simply to walk away from their debt as is often done in the US. If the borrower tries to do that, they will most likely be bankrupted, which will have severe financial repercussions for many years to come.

Thanks, that clarifies things nicely.

It also goes a long way to explaining why the US economy is in the state its in. That and the banks over there who were willing to loan insane amounts of money to people, often with 0% deposit.

Yes it does. Whilst non-recourse loans sound pretty good from the customer’s point of view, when you get a downturn in the economy the impact ofdrop in housing values is magnified many times. In NZ people in negative equity will still keep their houses and making payments unless they have absolutely no choice, but in the USA they will default, causing a glut of houses on the market, making prices drop even further, and thus increasing the number of people who will default in a vicious circle of defaults and foreclosures.

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#600619 27-Mar-2012 11:06

dclegg:

It also goes a long way to explaining why the US economy is in the state its in. That and the banks over there who were willing to loan insane amounts of money to people, often with 0% deposit.

Yep, one of the root causes of the GFC.

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Kyanar

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#600648 27-Mar-2012 12:08

Jaxson:
bazzer:
I suspect the difference here is that if there's a shortfall you're still liable so you would probably need to declare yourself bankrupt, which is not great.
+1

A guy I know' got caught a while back. If you price low enough to sell it would not have covered the mortgage, so you'd be left without a house but still with $30,000 debt, which is then unsecured, so the interest rate would rise to 23% or whatever the credit card rate is etc.

In a fit of boredom I had a look at the case notes from the banking ombudsman recently, and it seems a lot of people then go to the ombudsman at that point and claim "the bank didn't obtain the maximum possible amount for the property" (which as you can imagine is very hard to prove). In most cases, it seems the bank opts to settle it by consolidating the complainants debts with them at a secured rate, despite having no security. I guess it's less effort than arguing the point.

bazzer

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#600688 27-Mar-2012 13:20

I would think it's in the bank's interests to get as much as they can, within reason. They'd rather have the extra $10k in their pocket than have you paying it off (maybe!). I would've thought once the bank had foreclosed you don't have much say in the matter. If you thought you could sell it for more, why didn't you? The bank is not a charity.

Kyanar

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#600787 27-Mar-2012 15:43

bazzer: I would think it's in the bank's interests to get as much as they can, within reason. They'd rather have the extra $10k in their pocket than have you paying it off (maybe!). I would've thought once the bank had foreclosed you don't have much say in the matter. If you thought you could sell it for more, why didn't you? The bank is not a charity.

The problem with "if you thought you could sell it for more, why didn't you" is that you need the bank's permission to sell, and on occasion they have refused that permission and then proceeded to sell it at auction for less than the offer they refused to allow you to accept.

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#600807 27-Mar-2012 16:04

bazzer: You hear a lot about people just abandoning their homes over there and leaving the keys behind.

It's called jingle mail, mailing the bank the keys. Luckily NZ is different. People can't just walk away from their debts.

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