Experts say America needs to fix 'underwater' home loans

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Barbara Buckley realized early in 2009 that Las Vegas was entering a full-blown housing crisis.

That's when the executive director of the Legal Aid Center of Southern Nevada began to see clients who were struggling to make their house payments, but couldn't reach any accommodation with their lenders.

The people coming through her door had a recurring complaint.

"The refrain was common: 'I'm in trouble, I need help. And if only I could get someone on the phone who had a brain, we could work this out. I have an adjustable rate mortgage, the interest rate is out of whack, my hours were cut -- anybody with a brain would work this out and stop yet another senseless foreclosure, but I can't get anybody on the phone.'"

She was in a unique position to respond to those pleas.

Ms. Buckley was the speaker of the House in the Nevada legislature then, and so she drafted a foreclosure mediation bill that was quickly signed into law.

The law requires a lender to do four things: 1) attend a mediation 2) prove it owns the note -- an important rule when a loan might have been sold by a mortgage broker to a bank, and then resold to investors; 3) have authority to renegotiate the terms of the loan and 4) act in good faith.

She is the first to concede the law hasn't been perfect, but said it has helped thousands of homeowners. From September 2009 through June this year, the most recent figures available, there have been 12,556 mediations, and only 12 percent of the cases ended up in foreclosure.

About 44 percent of the cases resulted in agreements between the homeowners and the banks, she said. But in an equal number of cases, "the bad news is that the homeowner is in limbo. The banks can't prove they own the notes, but they won't work out an agreement, and they're stuck."

The foreclosure crisis in Nevada has been aggravated by the fact that it is a "non-judicial foreclosure state," meaning that lenders can simply tell a homebuyer that he is in default and then sell his home at a public auction, without automatic review by the courts.

Homeowners can now stall that process by seeking mediation within the first 30 days after the default notice, but if the mediation leaves them in limbo, they often end up in court anyway, where their lawyers try to get a judge to order a resolution.

Why won't banks negotiate?

Some may wonder why banks aren't more willing to adjust loans, since a foreclosure means they will be selling a house for far less than the original loan was worth.

Local attorneys and real estate experts said one reason is that many of the outstanding mortgages are insured, meaning the banks will recover most of their loan amount if they foreclose.

"If you look at the banks," said Linda Rheinberger, a leading Las Vegas Realtor, "they're not interested in modifications. Most of these loans have back-end insurance, so they're going to get their remuneration one way or another."

Tom Goyda, a spokesman for Wells Fargo, one of the biggest mortgage lenders in the region, denied that his bank is more likely to seek foreclosure when a loan is insured. Nationally, only 2 percent of Wells Fargo homes have gone to a foreclosure sale in the last year, he said, and the bank is able to avoid foreclosure in three out of every four cases where homeowners are 60 days or more behind on payments.

However, when banks aren't willing to bend on foreclosures, some Las Vegas housing experts say, it makes many homeowners less willing to stick with a losing proposition.

Nasser Daneshvary, an economics professor and housing expert at the University of Nevada at Las Vegas, said many people "are giving up their homes even though they have incomes, because they are saying 'I owe the bank $500,000 but my home is worth $200,000, and so how long is it going to take to pay that extra $300,000? I want to do the right thing, but what am I going to do, throw money away for the next 20 years hoping the economy will recover and make up some of that value?'"

He estimates that up to 30 percent of the foreclosures in the Las Vegas area are "strategic," meaning people who can afford to pay their mortgages are walking away from their homes. They are willing to take a hit on their credit in return for getting out from under seemingly insurmountable debts.

And when banks foreclose on properties, it has a devastating spillover effect on the housing market, Mr. Daneshvary said. Not only does a supply of cheaper foreclosed homes depress prices and delay construction of new housing, but his research shows that people who live next to a foreclosed home experience a one-third drop in their property values.

A need to reduce the principal

To fully address the foreclosure mess in Nevada, Ms. Buckley and Mr. Daneshvary said, there needs to be a national initiative to reduce the principal on loans in places where houses are worth far less than what the residents owe.

Banks have been reluctant to do that on their own, Mr. Daneshvary said. From 2008 to 2010, banks modified more than 2 million loans nationwide, but reduced the principal on only 4 percent of them, he said.

He and Ms. Buckley said that reducing the principal would allow thousands more homeowners to stay in their houses. And if banks were willing to be a little creative, he said, they wouldn't necessarily have to write off the entire difference between the reduced value and the original loan amount.

One technique would be for the homeowner and bank to agree to reduce the principal to the current value of the house, but also agree to share any future profits if the home's value rose above that amount.

"My idea is that if you sell within five years, you and the bank share in the net proceeds," Mr. Daneshvary said. "If you don't sell, you wait for 15 years and then reassess the home's value, and give maybe $50,000 in extra equity to the bank if the value has appreciated."

Mr. Goyda, the Wells Fargo spokesman, said his bank has reduced the principal on a number of mortgages nationally. Since 2009, he said, the bank has reduced $4 billion worth of mortgage principal and will reduce another $600 million over the next several months if the customers stay current on their payments.

Ms. Buckley said she would like to see a more widespread national program of principal reductions.

"I think it would make sense to have a modification program that addressed underwater loans, where the lenders would receive more than they would if they foreclosed and the homeowners would be able to stay in their homes, such that we would hasten the economic recovery -- that seems to be a win-win for everyone."


Mark Roth: mroth@post-gazette.com or 412-263-1130.


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