There is a tsunami of wrecked credit that has only begun to hit the credit reporting bureaus.
Many of the victims are those whose FICO and credit scores have been demolished by short sales and foreclosures. With the short sales, or short pays as they are sometimes called, the mortgage lender has agreed to accept less than what is owed on the home–and where more is owed on the home than what it is worth. In the case of foreclosure, the home is auctioned off for non-payment. In both scenarios, credit scores of the former homeowners are generally ruined, which will likely prohibit them from purchasing another home anytime in the near future–or perhaps for years to come.
Many will argue against the idea, but perhaps it is time to consider credit amnesty for those who have lost their homes to foreclosure and short sales. Sure, there were those homeowners who were greedy, who used their homes as ATM machines, who foolishly thought the crazed real estate market would continue forever–or at least until they managed to sell at the top of the market.
We have even met a few of those people. They are among the legions who followed real estate flipping shows and late night television gurus. They followed the promises of big and easy money.
But most of the defaulted clients we counsel have a history of home ownership, pay their bills on time, and were lured into mortgage financing that was so easy to obtain and which offered irresistible terms. Most relied on the counsel of a loan broker or real estate agent (often one person who wore both hats), who assured them of the wisdom of such loans.
It was a diabolical match: Gullible and sometimes greedy homeowners paired with greedy and sometimes crooked mortgage and real estate professionals.
The finger pointing can go on for years, but very soon there will be tens of thousands of people who will no longer be able to purchase homes. Add these numbers to the huge pool of buyers who are already afraid to enter the burgeoning real estate market and we have an economic problem of near-Biblical proportions.
I’m not sure how the details of a credit amnesty plan might work (and the devil always lurks in the details), but something need to be done quickly to help bolster buyer capability in this market. To disenfranchise such a large group of home buyers will only magnify the expanding real estate market glut and lengthen its recovery.
And as with any amnesty plan, there will be a percentage of borderline criminals who are more deserving of jail than being forgiven.
But with tougher mortgage loan underwriting, better oversight and raising the bar on real estate and mortgage lending professional standards, the rotten borrowers would be weeded out. This would also encourage the discouraged to stay current with their other debt obligations instead of giving up entirely on their FICO scores and future home buying opportunities.
It might be a solution that could help our markets recover–and credit amnesty just might offer hope to the hopeless. Might not the rewards outweigh the costs?
I seriously doubt that this could be done. You forget about all the investors that have been left high and dry, CALPERS (the California Teachers’ Pension Fund) for one. They invested teacher’s retirement money in good faith to get principal and interest back over time. Do you really think that the trustees are going to invest someone else’s pension funds in mortgages where the borrower has received FICO amnesty?
In the oil bust in the 80’s in my town, Houston,TX, thousands of hardworking folks lost their jobs and their houses. No one got amnesty or IRS relief around here and our foreclosure rate dwarfed the bubble markets. It took almost 15 years before some of the foreclosure decimated neighborhoods reached the same values they had in the early 80’s. Valuations, when over or undervalued have a way of regressing to the mean. On the downside it can get ugly.
The solution to this problem is not bogusing up a bunch of FICO scores for folks who made dumb decisions. Lenders will then shy away from all but the most pristine borrowers exacerbating the problem.
Tom Johnson
http://www.ERAHouston.com
Thomas:
Thanks for your thoughtful response. I started my real estate career in Houston and was donating properties to the church in the mid-80’s because of dismal market conditions. In those days, IRS tax benefits outweighed what could be gleaned from a sale.
On topic: Investors in the riskier segment of the secondary mortgage market today are going to lose money regardless of FICO penalties assessed against those who have defaulted on their mortgages.
Of concern are the huge block of otherwise credit-worthy home buyers who because of foreclosures and short sales will be removed from the pool of future home buyers. That will further damage the real estate market and its eventual recovery.
Additionally, if only the foreclosure were granted amnesty, the former homeowner would have a keen incentive to maintain other credit and pay bills on time. By so doing, they might be able to purchase a home again–but with tighter underwriting and sensible loan programs.
Roberta.. I doubt we will see any amnesty but we may see lenders take a slightly more liberal view of someone with a credit/foreclosure problem on their record if they can prove it was due to a subprime loan..
Roberta, this is one solution to hopefully hedge off a recession. If we continue to bury our heads in the sand and say…too bad for all those folks…I believe it not only will come back to bite them but US.
Perhaps, getting the old history books out and taking a look at the Depression might help…
– Gena Riede
Kaye: Perhaps this underwriting exclusion should come from Fannie Mae and Freddie Mac? Or FICO scores could be generated with and without the foreclosure. That would encourage people to keep up with all other debt payments.
Gena: This is a frightening situation. To disenfranchise such a large group of borrowers could delay real estate market recovery for years.
And I would like to live long enough to see another seller’s market. So would many of our real estate clients!
Roberta – Enjoyed your article – Made it down to “L’s” – lol. I believe you’re right – the long term impact is going to be huge. I can’t believe how many people I personally know touched by short sales and foreclosures. – Cyndee Haydon
Cyndee: I know you’ve been busy helping people in the Clearwater, FLA area–and if I run across anyone needing to sell (or buy) in the Clearwater area, I’ll have them give you a call.
This is a market that requires an enormous amount of expertise and sensitivity to client’s needs.
Roberta,
Maybe we should eliminate FICO scores entirely?
I originated and underwrote loans for years without the use of FICO scores. I was able to evaluate a clients credit worthiness without an arbitrary credit score. And if you ever ask Trans Union, Experian or Equifax how they came up with a particular score on your client they would refuse to answer. They said their credit scoring was a proprietary business secret.
And a very profitable secret to sell I might add…
When we read a credit report before FICO scores were used we would view a foreclosure or bankruptcy on a case by case basis. Usually if they were two years out of foreclosure or bankruptcy they were fine to borrow for a new home. And if they were less than two years out of their foreclosure or bankruptcy we could ask for an exception if they had a good explanation, like a divorce, death to head of household, illness, etc. So we can always go back to industries previous common sense methods to underwriting.
In fact in this loan broker’s opinion FICO scores were abused in the past five years as the secondary loan market lowered FICO score requirements to allow “Stated Income” into every risk category. And “Stated Income” allowed too many borrowers to borrow more than their actual income supported. It was no longer just a streamline method to underwriting, once reserved for your better risk clients or self employed borrower. In fact as home prices soared into 2005-2006 most everyone had to use stated income in order to qualify for the lofty prices…and that’s another long dicussion for another day.
Although I don’t believe we will ever see the elimination of FICO scores or the adoption of a blanket credit amnesty in mortgage lending. We may see more of common sense underwriting that does allow foreclosure forgiveness after a one to two year period with some exceptions.
Keep up the good work
Regards
Billy Taylor
I think that credit amnesty is a great idea. In the bible there was a time period when the debts of borrowers were released and of course they were freed of all owed debt. The credit scoring system is tricky as well as many creditors. My husband had a pretty favorable score(680-720) back in 1999-2003. Due to our lack of understanding mortgage terminology, we had mortgage brokers as well as banks that took advantage of us. To top it off my husband was out of work due to a work related injury that required two operations. He was out on workmans compensation for four years. The entire experience cost us everything we owned including 5 rental properties. When it rained it rained. We paid out thousands of dollars to keep properties within the time frame of trying to sell, only to have the mortgage company take them because we missed a payment down the line again. Again, all of this was a result of a work injury. I did my best to help but my husband’s income far exceeded mine. Nevertheless we are still suffering till this day because with the injury came the inability to work, and with that came mental depression and the roller coaster stayed downhill. After many attempts to get help from the Banking Department, I left my prayers in the Lord’s hear and here we are today with some regulations being put in place. No one cared about us nor our 3 children and how we were thrown out of our homes due workmans compensation laws, lawyers, and the employer trying to starve us out as they put it. We filed bankruptcy to stay a float but that did not help either. So until you go through a MAJOR financial disaster as we have experienced please don’t be too quick to judge. Credit Amnesty is on my prayer list everytime I think about it because going from owning 8 homes to renting and paying 21% for purchases just keeps you in the hole. They do have credit amnesty for auto purchases maybe just maybe this can really come to past. May the Lord keep you and may you never, ever experience financial devistation like we have experienced.