Upper bracket underwater homes are facing unique issues - issues that you ignore at your peril
August 24, 2011
Nash Law Firm, PLLC
By: Stephen J. Nash
As the housing and economic woes continue, it is becoming more common to deal with upper bracket homes that are underwater. When property values decrease and mortgage requirements become stricter, the impact is not limited to "subprime" mortgage properties or to middle class neighborhoods. In many ways, the impact is greater upon upper bracket homes. This article will look at some of the unique challenges faced by upper bracket homeowners.
But My Home Is Special
When you live in a beautiful home in an exclusive neighborhood it is easy to believe that you are immune to the problems facing other real estate owners. The reality is that unless you are in an area where buyers do not need to obtain mortgage financing you are going to impacted no matter how special the home and neighborhood. It is often difficult for the upper bracket home owner to accept how much their homes value has fallen.
Why Are They Doing This to Me?
Upper bracket home owners are not used to not paying their bills. They have never dealt with bill collectors. They are used to lenders fawning over them and know the lenders are attacking them. They are shocked and confused. The lender should understand their situation - its not their fault!
The reality is that the lender doesn't care why the homeowner is not paying their mortgage, the lender just wants to get paid. They don't want to wait. They don't want to reduce the amount owed. They want to get paid everything they are owed. There is little incentive for the local lender to wait for the sale of the property since it takes so long to sell these properties and the local lender normally only receives a minimal payment in a short sale. If they are going to have to sue to attempt to collect the debt after the short sale, why wait?
The upper bracket underwater homeowner has to be realistic about what to expect or the process is going to be difficult to impossible to get through for everyone involved. They owe the money and the lenders do not want to take a loss. They will call to get them to pay. They will send them letters to get them to pay. They will sue them to get paid.
In good times and bad, the more expensive the home the smaller the pool of potential buyers. When lender requirements become stricter, it further shrinks the pool of buyers.
How Do You Prove That Sasquatch Exists?
If you saw Sasquatch in the woods, how do you prove to someone else that it exists without a body? When you sell an upper bracket home you have the same problem when it comes to obtaining an appraisal that supports the purchase price. You may find that there are few sales in the upper bracket neighborhood that you are dealing with in a reasonably close time frame. You look further away at other exclusive neighborhoods but are they really comparable? Is a home on Lake Minnetonka and a home on Lake Calhoun comparable?
Appraisal problems can make obtaining the financing that much more difficult.
Financing Troubles for Upper Bracket Homes
Buyers of upper bracket homes generally need to obtain jumbo mortgage financing to purchase the property. This type of loan requires that the buyer pay twenty percent (20%) down. In economy where cash is scarce, this can prove to be a great hurdle for buyers. They either don't have it or don't want to part with the cash.
It was common for buyers of upper bracket homes to use "stated income" loans to purchase their homes. This type of loan is no longer available. If they have their own business, they may have difficulty qualifying for a loan.
The River of Money Has Dried Up
The economic woes facing the country are broad enough and have gone on long enough that even the owners of upper bracket homes are feeling the effects. Many own their own businesses and those businesses are struggling. Many are executives with companies who are being let go because of the company they are working for are downsizing.
Once their income is down or they lose their job, it is extremely difficult to restore their income to their prior levels. If you lose a 6 figure job, you can't replace that income by working at Costco. While many are highly skilled, their are few jobs available for them. Employers are either not hiring or, when they do hire, they are often looking for younger, cheaper employees. If they look at taking a step (or two) backwards, employers look at their resumes and see that they are over-qualified and believe that they will never be happy at that job. The bottom line is a fifty year old former CEO simply is not highly sought after in a struggling economy.
Multiple Mortgages, Multiple Problems
Upper bracket homeowners often have 3 or more mortgages on their home. Two were used to purchase the home and the third may be to secure an equity line or a business loan. If there is not enough equity, all of the mortgages subsequent to the first will sue the borrower to collect.
In many cases, the lenders holding the mortgages subsequent to the first mortgage are regional or local lenders. As compared to the national lenders, the regional and local lenders move quickly and are much more aggressive. In addition, they also know a great deal about the borrower because the borrower has an ongoing business relationship and had to provide the lenders with annual financial statements and tax returns.
The homeowner who has a business loan secured on their home also have the additional consideration that if they default on the business loan, their business will be adversely impacted. If the credit line is still open, it will be shut down. The bank may have liens on business equipment that can be foreclosed if the owner defaults on the business loan.
Hard to Sell the Yacht at a Garage Sale
Owners of upper bracket homes tend to own many fine things. Cars, boats, summer homes, winter homes, etc. Unfortunately, many of these assets have also lost value and are upside down so that selling them results in very little money to apply to the home debt.
A Mountain of Debt/An Avalanche of Monthly Expenses
Successful individuals often buy many fine assets. Instead of paying cash, they preferred to borrow the money. Why use cash when they will lend you the money? As a result, they have a tremendous amount of debt. When they purchased the asset the debt was not seen as a problem because the assets were worth much more then the debt and the borrower had the income to make the monthly payment.
Unfortunately, when the value of those assets plummet, the amount of debt stays the same. In other words, if a person has $10 million in debt but owns $15 million is assets, they are worth $5 million. If the assets drop 40% ($6 million), they are upside down.
Not only are they upside down, but they have a tremendous cost of maintaining those assets. A 14,000 square foot home costs a great deal of money just to keep the doors open. Repairs and maintanance of the Mercedes is not cheap. The boat has to be maintained and stored over the winter.
Can't Get No Satisfaction
While your upper bracket homeowner may not have enough money to continue to make the home mortgage payments, they still make money (or at least appear to be making money). Lenders will have no sympathy for them and will not believe that they don't have the means to pay off the loan. As a result, you may find lenders to be more difficult to negotiate with when dealing with the upper bracket home owner. This generally means that the lender will refuse to satisfy the underlying debt without full payment and will sue the borrower soon rather than later to collect.
When the lender is dealing with a subprime borrower, they see a person who has never had great credit or significant income or assets. What is the likelihood of successfully collecting money from them? It is probably more cost effective to simply write off the unpaid debt.
The upper bracket homeowner perpetuates the image that they can pay the debt by driving their nice car (of course, they owe more than it is worth), by continuing to go boating on the weekends (of course, they owe more than it is worth and they sit at the dock because they can't afford to actually run the boat) and their business website still shows a thriving, successful business (what business owner is going to project an image to potential customers that they are struggling?). But from the outside looking in, the upper bracket home owner is projecting an image of success, not trouble. An image that is going to fuel the aggressive collection actions of their lender.
Keeping It Local - The Friendly Smile Turns Upside Down
The upper bracket homeowner tends to have loans with local banks - a line of credit and/or a business loan. The upper bracket home owner was the perfect client for the local bank. High income, well-known in the community, high credit rating and "good people". The local bank treated them well. when they went into the bank everyone greeted them and knew their names. When they needed money, they could just pick up the phone and the bank would make it happen. The bank never worried about them, they always made their payments. They have great jobs and great businesses.
When the payments stop, the local banker is shocked. This doesn't happen to them, they only lend to good people who live in great neighborhoods.
When the payments stop, the impact on the local bank is much greater than on the national bank. First, the person who made the loan at the bank is the person who has to deal with the default. This is personal to them. Second, our local banks are all facing significant problems which get more difficult when another loan goes bad. Third, the local banks loans tend to be subsequent to the first loan which means that when the property values decline, the local banks loan becomes partially or totally unsecured.
Because the default has a greater impact on the local bank coupled with the fact that they know more about their customers, you can expect the local bank to move quickly and aggressively (at least until they decide that they aren't recovering enough to justify the cost).
If you plan on working with upper bracket homeowners who are upside down you have to understand the unique problems that they face. They have numerous and complex problems that have no simple solutions.
The foregoing is not intended to constitute legal advice for any specific circumstance, but is intended to reflect broadly applicable principles, under Minnesota law, relevant to a typical situation. Each set of facts and each contract is, or can be unique; the unique facts and specific language of the contract may require a different legal analysis and may result in a different outcome. Before proceeding in reliance upon this or any other general description of law, consult with an attorney competent in the field of practice relevant to your situation.
Copyright 2011 Nash Law Firm