Louis Proyect cites the dangers of deficiency judgments if the value of the residence is less than the secured debt:
At least as far as California, which is the location of the overwhelming number of subprime loans, the article is incorrect. California has an "anti-deficiency" statute, which means that if a secured lender forecloses a residence through a non-judicial private sale, the lender is barred from seeking a deficiency. Almost all California foreclosures are private sales (as opposed to judicial foreclosures, which are significantly more expensive for the lender). On a semi-related noted, here is a little Bankruptcy Code trivia that explains in part the recent popularity of submprime mortgages. Until about a decade ago, if a homeowner filed bankruptcy, and the value of the home was less than the debt, the homeowner could use Chapter 13 of the Bankruptcy Code to "stripdown" the mortgage. In other words, if the home was originally purchased for $550k with a $500k mortgage, but the home had a value as of the bankruptcy (as determined by the bankruptcy judge based upon appraisal evidence) of $400k, the Bankruptcy Code permitted the homeowner to essentially rewrite the debt into a $400k secured loan and a $100k unsecured loan, and the unsecured portion could then be effectively discharged. For obvious reasons, lenders did not like this, especially when they disagreed with the appraisal and/or the market later appreciated and the homeowner benefited from the appreciation. So about ten years ago, the lenders got the Bankruptcy Code changed and now there is a statute in Chapter 13 that prohibits the modification of residential mortgages. This change in the law created an incentive for subprime mortgages. Prior to the change, very few submprime loans were made because submprime borrowers are probable candidates for bankruptcy and lenders would not only have the risk of a default, but the stripdown in a Chapter 13. Because of the change of the law, the bankruptcy risk of marginal loans was eliminated, so the only remaining risk was default, which is much more manageable. The subsequent boom in subprime mortgages was not unrelated. David Shemano >> As subprime mortgages crater, here's one of the likely -- and >> as-yet-undiscussed -- consequences: Deficiency judgments, and perhaps a >> massive wave of them. >> >> Here's how it works: Buying a $500,000 house, you put $50,000 down and >> take out an interest-only housing loan for $450,000. Then you can't make >> your house payments, two or three years later, and the bank forecloses. >> But the foreclosure is part of an enormous set of regional and national >> foreclosures, dumping houses on the market while mortgage lenders are >> cutting back sharply on new home loans. Far fewer buyers are chasing far >> more homes, so housing prices fall sharply; the bank sells your $500,000 >> house for $375,000. >> >> You're out of a home -- and you're still carrying $75,000 in >> interest-bearing debt. >> >> Where have we seen this dynamic before? Here's one noteworthy example: >> >> In his 1965 book The Cornbelt Rebellion: The Farmer's Holiday >> Association, the historian John Shover discussed the metastasizing farm >> foreclosures in Depression-era Iowa, which (among other things) followed >> the burst of a farm-buying bubble caused by the decline of European >> grain production during the First World War. American farmers rushed to >> buy up land on borrowed money so they could expand their production for >> hungry European markets; fifteen years later, still carrying debt, they >> found themselves caught in a cycle of sharply declining crop prices. And >> then the trap closed. >> >> From pages 16-17: >> >> Between 1921 and 1933, 13 percent of Iowa farmland was sold at >> foreclosure. Yet at the end of 1932, one billion dollars of debt was >> still outstanding on 45 percent of the land in the state...Land values >> had declined so greatly (from $140 per acre in the late twenties to $92 >> per acre in 1932) that proceeds from a forced sale usually did not cover >> the full amount of the debt. As a result, the debtor was left with a >> deficiency judgment to cover the balance. In 1921, 26.5 percent of >> foreclosures in eighteen sampled Iowa counties ended with a bid for less >> than the amount of the debt; in 1932, 74 percent carried a deficiency >> judgment. >> >> This number will be worth watching in the years to come, but here's my >> guess: A significant number of families who took out subprime housing >> loans will not only lose their homes, but will be left with a crushing >> load of debt that will inhibit their recovery and hamper their ability >> to find new housing. >> >> Posted on Sunday, August 12, 2007 at 6:33 PM | Comments >> >> >>
