Nationally, many struggling or underwater homeowners have begun to take advantage of a financial strategy which has become well know to first tuesday readers: they default on their mortgage, but continue to stay in their home until the lender forces them to leave. Voilà, the strategic default, otherwise known as exercising your put option in the trust deed.

So far this year around 1.7 million of the nation’s homes have been exposed to the foreclosure process. Nationally, homeowners who lost their homes to foreclosure this year spent an average of 438 days in default, a significant upward trend from the national average of 251 days in early 2008. During this enlarging time period, the owner is allowed by law to remain in his home rent free.

Over 650,000 national homeowners were in default on their mortgage for at least 18 months. Most of these homes were somewhere in the process of foreclosure. However, 19% of these homes had seen no action on the lender’s part to begin the foreclosure process. This non-action on mortgages in default for at least 18 months has doubled since last year — a significant national trend.

first tuesday take: Presently, the average time period in California between a homeowner’s first default and the trustee’s sale is around 12 months: five months in default before the notice of default (NOD), and another 7 months to complete the foreclosure. Prior to 2008, foreclosure periods stretched across three months of delinquency followed promptly by the recording of an NOD, with the trustee’s sale occurring four to five months later.

However, the foreclosure routine has been altered and extended as the result of California legislative changes in the periods for enforcement of lender foreclosure remedies.

Entirely aside from the lender’s inefficiency in handling their files, what lenders are not doing currently is putting all of the real estate owned (REO) properties on the market in order to avoid declaring a loss. Lenders do not declare the loss at the time of the actual foreclosure sale. At the trustee’s sale, they bid on the property for the amount of the outstanding loan balance, declaring their bid as the cost of acquiring the property.

After, when the sale of the REO takes place, it inflicts damage on the lender’s reported solvency since they accept the price for the property the new buyer pays, a price generally well below the original outstanding loan balance paid by the lender at the trustee’s sale. On closing, they must declare for the first time the loss they have long held on that loan. On a resale of the REO they must “book” the loss as the asset (mortgage, turned home, turned cash) has been liquidated.

Lenders have some 400,000 more loans to foreclose in California alone before the real estate market can return to normal. Currently, lenders are eating through foreclosures with renewed vengeance. We will see if they have the appetite to continue, or if the REO inventory will continue to remain in its phantom state. Bookkeeping is a wonderful thing.

Day by day, negative equity homeowners are learning to exercise their “put option.” Whether by word of mouth, through information from their agents or observations of their neighbor’s conduct, the power of the put option is being realized. These negative equity homeowners merely need to default in order to exercise the put option in their trust deed, forcing the lender to buy the property at a foreclosure sale.  Thus, the property is absolutely sold and no longer the wiped-out owner’s problem. [For more information on negative equity, see the March 2010 first tuesday article, The underwater homeowner, his future and his agent: a balance sheet reality check – Part I and the April 2010 first tuesday article, The underwater homeowner, his future and his agent: a balance sheet reality check – Part II.]

Part of the homeowner’s education has included the awareness of the “right to remain” in possession rent free until after foreclosure and service of a notice to vacate.  At that point the negotiations start over the amount of “key money” the lender will pay for a voluntary transfer of possession to the lender.

And homeowners have learned something else of equal importance about liability for their purchase-assist home mortgages in California: the lender can not under any conditions collect any amounts due on that note from the foreclosed homeowner.  A free walk, if you wish to default and exercise that put option. Relief can come from sources other than a bottle of aspirin. [For a more detailed explanation of the put option and lender recourse, see the November 2009 first tuesday article, California homeowners: exercising your right to default.]

Re: “Owners Stop Paying Mortgages, and Stop Fretting” from the New York Times