Monday, February 18, 2008

Is Playing Musical Houses Illegal?

LetItSink is lucky to have a reader who has done some nice sleuthing. He wrote the following email to the BankRate.com blogger, and received a good response. We will be analyzing these in coming posts.

Dr. Russ writes:

Could I ask a mortgage question about the opportunities to buy at
distressed prices? Ideas rehashed from the CBS news special house of
cards about borowers thinking about walking away from severely
underwater mortgages...

I was fascinated by seeing recent talk by "calculated risk" (is it a
"bubble blog"?) of the game contemplated by people walking away from
mortgages. After walking away from a mortgage your credit is trash, and I
guess most of these unfortunate people move into apts. But I'd like to
ask- what if you move into a less expensive house that you bought
shortly before you stopped paying the mortgage on your expensive
underwater house? Could a national game of Musical houses may be next?

That's where you walk away from one overpriced house after you buy and move into a foreclosed (or REO) property nearby for a lot less $$. Then your neighbor can move into your foreclosed house doing the same thing, and so on.

When the music stops playing everyone who actually wants to live there has moved a short distance into a probably comparable house at a fraction of their former house price / payment.

In the past apparently opportunities arose to do this in 'mill towns' or 'company towns' when a major negative employment event occurred causing housing prices & demand to drop. and occur they did! Within the span of
a few years everyone shuffled into similar houses at a fraction of the
previous price.

If you have a job, plan on staying, and are not generally dependent on credit scores to finance cars, etc. then it may be worth the potentially enormous savings if you have a large non-recourse underwater mortgage. I guess you have to purchase the second home (at like 50% off) with a good down payment (cash) prior to walking from the first. I don't know how this can be pulled off (the details) but it has happened so i'm told. Like a game of musical chairs.

Anybody know if there will be opportunity for home-debtors to do this again in steeply-depressed priced markets? (040% declines) I have excellent credit and a good down payment! But my house has declined in value tremendously due to foreclosures in the neighborhood.

Thanks, Dr. Russ the rocket scientist

Excellent question Dr. Russ. Here is the response that he received from the gentleman at BankRate.com :

The problem with playing musical houses is that it's against federal
law. I'm not saying that someone playing the game will be prosecuted.
They probably won't. Hardly anyone is prosecuted for mortgage fraud
unless it's to extract cash. People playing musical houses aren't trying
to extract cash; they're just trying to get a better deal on a house.
It's still illegal.

Here's why it's illegal: If you're applying for a mortgage, and you plan
to default on your current mortgage, that is a material fact that you
are legally obligated to disclose when you apply. Withholding a material
fact is deception, and it's just as illegal as lying on the loan
application.

If an applicant *did* disclose the fact that he or she planned to
default on the current mortgage, the application would be denied. So no
one would be able to successfully argue that the deception made no
difference.

Holden Lewis
Reporter
Bankrate.com
(561) 630-2400 x11338
11760 U.S. Highway 1
North Palm Beach, FL 33408
Read Mortgage Matters, the blog about mortgages and real estate:
http://www.bankrate.com/mortgagematters/

We will be looking into the details of this in coming posts. But even if all of this is true and is not up for legal interpretation (and in my opinion, everything is up for legal interpretaion) then that still leaves the huge opportunity to walk away and rent for a couple years at a fraction of what you are paying now. And then there are the rent to own possibilities which are everywhere now.

Stay tuned and we will cover all of these bases.

And thanks to Dr. Russ for his excellent contribution. I look forward to hearing more from him.

Posted by Let It Sink at 9:54 AM

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7 comments:

Anonymous said...

“Here's why it's illegal: If you're applying for a mortgage, and you plan to default on your current mortgage, that is a material fact that you are legally obligated to disclose when you apply. Withholding a material fact is deception, and it's just as illegal as lying on the loan application.”

The basis for Mr. Holden’s argument that “musical houses” is illegal under federal law is that there has to be intent to defraud the lender (“plan to default”). How many distressed or upside-down homeowners originally entered into their loan agreement thinking, “Hey, if this whole homeownership thing doesn’t work out, I figure I can always buy a cheaper home and bail on my current loan”? My guess is that most borrowers never expected to find themselves in a position where they might be faced with returning their homes to the lender, let alone plan for such an event, at the time they took out their loans. It is for this very reason that borrowers are not likely to be prosecuted for buying a cheaper home and defaulting on their current loan…lenders will have a difficult time trying to prove that the borrower knowingly intended to default and commit fraud.

Although I’m no legal expert, it seems to me that as long as a borrower honestly and fully discloses all information required by the lender (keeping in mind that the borrower in my example has no intention of defaulting) and the lender then decides to grant the loan, then any subsequent negative action on the part of the borrower is subject to the terms of the loan agreement that both borrower and lender entered into. Thus, if a borrower who originally intended to keep his house one day finds himself with negative equity, then that borrower’s decision to default on his loan and any remedy available to the lender should be governed by the terms of the loan agreement, regardless of whether that borrower has previously purchased or will subsequently purchase a less expensive home to replace the current residence.

February 19, 2008 at 3:15 PM
Anonymous said...

Oops…looks like I misunderstood Mr. Holden’s comment. What I thought he was saying is that a borrower needs to disclose his intent to default on the original loan at the time he applies for that loan. What Mr. Holden is actually saying is that the borrower needs to disclose that he is about to default on the original loan when applying for a new loan on the less expensive replacement residence. When viewed from this perspective, the borrower may be at risk of committing fraud against the second lender, not the first lender (assuming that the borrower originally never intended to default on the first loan).

But what if the homeowner is simply looking to invest in a second home now that prices have fallen? It may not have occurred to this individual to walk away from his first home at the time he applies for the loan on the second home. How, then, can this person disclose on the loan application that he plans to default on his other loan if it hasn’t occurred to him to do so? It would seem to me that the borrower is not withholding material information and that there is no intent to commit fraud. If the borrower in this example eventually decides to default on his first loan and abandon the more expensive house in favor of the less expensive house, he is merely exercising his contractual right to do so under the first loan agreement and this action should be of little relevance to the second loan agreement.

February 20, 2008 at 6:32 PM
Russ DoGG said...

"k"

my attitude exactly- I think it would be awfully tough to claim my intent was to default; at least as long as you at least try to sell the original house at it's lofty loan balance. Here's the hypothetical:

It's like I intended to sell my original (first house). After listing it for sale, it just didn't fetch on the market the price I had in mind (like what was owed).

The stress of making 2 mortgage payments...

So eventually I stopped making the payment on the original house after it wouldn't sell. Aw shucks. I didn't "intend" to default- I intended to "sell" the original property. Darn. That's too bad for my original lender. But it's not witholding material fact or intending to default on my current mortgage.

But Mr. Holden is an expert..

February 21, 2008 at 2:50 AM
Russ DoGG said...

Mish's Global Economic Trend Analysis:
Postpone But Don't Forget
http://globaleconomicanalysis.blogspot.com/2008/02/postpone-but-dont-forget.html

He Points out the possibility of walking away in relation to the latest rescue plan for thrifts. The rest is copy/paste:

""The latest plan in a seemingly never ending series of plans to bail out housing....

http://money.cnn.com/2008/02/20/real_estate/OTC_refinance_plan/index.htm?cnn=yes

In fact, the plan does not even have a name at all. The central idea behind the plan is "Don't forgive debt, just postpone repayment". With that idea in mind, let's call this the Postpone But Don't Forget Plan. Following are the sketchy details.

A new plan from the Office of Thrift Supervision would have lenders reduce mortgage balances, but let them collect the difference later. The Office of Thrift Supervision (OTS) is urging the federal savings and loans lenders under its authority to refinance loans by reducing mortgage balances to the current market values of the homes. Thanks to falling home prices, many homeowners are now stuck with mortgages that are actually worth more than the houses themselves.

But instead of having lenders forgive the difference between the old mortgage and a house's current resale value, called a short sale, the OTS advises that lenders issue a warrant or "negative amortization certificate" for the difference. If a home regains its market value and is then sold, lenders have first claims to the profits.

Few details about the plan have been settled, but it would not involve any legislation, nor would it be mandated in any way. Adoption would be on a voluntary basis by the hundreds of thrift institutions in the United States, like Washington Mutual (WASH) and IndyMac Bancorp (IMB).

Indeed, banks may not want to take this approach in markets where prices have fallen so steeply that it is unlikely they'll recover any money.

...rather than spending $50,000 to foreclose on a home or to write-off the negative amortization in a short-sale, they get a certificate that permits them to share in the up-side, if and when housing markets recover.

Once again, assume you are a homeowner $100,000 in the hole on a house now worth $250,000. Perhaps you are attached to the house and want to stay. You agree to participate in this scheme. Then out of the blue (or negotiated in advance) you find someone willing to pay $250,000 for it. Like magic, you suddenly become unattached to the house. You accept the terms and sell the house for $250,000. Voilà! You escaped the debt trap. You owe the bank nothing, there was no short sale, and your credit is not even impaired.

House Swapping Anyone?

Unless there are sale restrictions, time restrictions, or unless the appraisals are ridiculously high, banks might get killed on this idea as presented. This scenario is a perfect solution for some set of homeowners but not the bank. Those with potential buyers at lower prices can take advantage of the offer and escape the debt trap scot-free, perhaps by swapping similar houses. Those without potential buyers or who simply want out now, can still walk. This sounds like a free option to me. I am all in favor of free options for the homeowners.

On the other hand, if too many restrictions are placed on the plan or the appraisals are too high, homeowners will see through it and just do what they were going to do and that is walk. Depending on the details, this plan is going to either backfire badly on the banks, or will simply be dead on arrival.""
================
So he (Mish) arrives at house swapping or musical houses as the logical conclusion of this latest rescue plan too. Note the phrase ""(or negotiated in advance)"" to indicate some forethought on the part of the lender / consumer. He's done a few "walk away" posts along the line of letitsink.

enjoy. Russ

February 21, 2008 at 3:07 AM
Let It Sink said...

Excellent posts K and Russ. Let me chew on these for a bit.

February 21, 2008 at 11:17 AM
Russ DoGG said...

realtors getting in on swapping houses:

Wednesday, January 30, 2008
Tips for buying another home before your goes into Foreclosure


If you are considering purchasing another home then letting your present home go into foreclosure here are some tips that will save you trouble later down the line as well as help the transaction run smoothly.

http://kathyneilsen.blogspot.com/2008/01/tips-for-buying-another-home-before.html

February 25, 2008 at 5:36 AM
Let It Sink said...

Once again Russ Dogg, excellent work! I believe that I will contact her to see if she will post here for us.

Thanks
Keith

February 25, 2008 at 8:01 AM

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