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Foreclosures: lenders padding the amount of the judgement?


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2015 Dec 17, 12:51pm   12,023 views  28 comments

by justme   ➕follow (1)   💰tip   ignore  

Note: This is my own case analysis. I have not read it anywhere.

Consider the following: a lender has an unpaid balance of X (the default amount), but then somehow (penalties and interest?) ends up with a much higher amount Y as a judgement against the property.

In a real example I looked at, the judgement is over 2x the defaulted amount. From 2008 (time of default) to 2015, the amount has more than doubled.

Default Amount: X = 220k
Final Judgment Amount: Y = 473k

Now, has the lender really accumulated an additional loss of 473k-220k=253k? I'm not so sure, the increase in the balance would correspond to a penalty interest rate where 1+r is calculated as (473/220)**(1/7) = 1.11622679111861.

That is, r=11.6%. That is a really high rate, and there is no way the lender could have earned such a rate in the open market.

So why are they pretending to have lost 11.6% per year? My guess is the following: Lenders know that the house very well may be worth more than X, so they see an opportunity to make a profit on the foreclosure. By getting a much higher judgement of Y>>X, they get two advantages:

1. By having Y>X, and Y being near or indeed above(!) the real market value of the house, it reduces the probability that someone else will bid Z>Y for the house. Furthermore:

2. The lender can bid Y at the foreclosure auction without really losing any more money than if the bid was X. The lenders own bid is just an accounting fiction. If they bid Z > Y and win, they have to pay Z-Y (the profit) to the next creditor in line. That is real cash out of their pocket, a loss (unless they can sell the house again soon for W>Z).

3. Hence the lender is likely to get the house for the price P=Y, while in reality only having expended X1=X*(1+r1)^N on it, where r1 is the real interest rate they could have earned on on the defaulted amount in the meanwhile.

4. If the lender resells the house for Z>X1 (maybe even Z>Y>X1), the lender will make a pure profit of Z-X1 on the foreclosure. But they only have to pay income or gains taxes on the amount Z-Y, because Y supposedly is what they were owed. Nah, that can't be true? The IRS is not that stupid, they rarely are.

But if X1 < Z ≤ Y, they will still make a profit relative to the r1 rate, and they can also book a loss of (Y-Z), which is not a real loss (X1<Z still), but which can be booked as a loss for tax purposes, against some other loan income.

True or false: by the way, the profit Z-X1 is tax free already, because by using the fake interest rate r, they make it look like they lost money. Wow. Could this be true?

5. In another recent thread (*), it has been noted lenders often pay property taxes and insurance on defaulted properties. In the above case, that might amount to maybe 7*500k*1%=35k in taxes, and some unknown but smaller amount for insurance, say 7k. So maybe the lender is out 262k instead of 220k. The implied penalty interest rate then becomes something on the order of r=8.8%, from (473/262)**(1/7) = 1.08805639804964

6. Back to the original question: Is it a known practice that the mortgage lender intentionally pads their losses in order to increase the probability that they can make an eventual profit on the foreclosure (and by the way shortchanging the lower-priority lien-holders in the process).

(*) Reference: http://patrick.net/?p=1287734

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1   Tenpoundbass   2015 Dec 17, 1:11pm  

Lenders do that on every judgement. Pre and Post CFPB.

In fact, there's more on the table for them to claim post CFPB.

It should have been called.
Bitch Better have my money protection Bureau.

2   justme   2015 Dec 17, 1:16pm  

Tenpoundbass says

In fact, there's more on the table for them to claim post CFPB.

CFPB = Consumer Financial Protection Bureau, I assume. How did CFPB make it worse?

3   FNWGMOBDVZXDNW   2015 Dec 17, 1:22pm  

I don't work in the field, but this is my understanding.

The bank charges fees (penalties and interest) from 2008 through 2015. This is booked as income (in accrual accounting) in the years that the fees are assessed. Thus, the bank has been paying taxes through the years. If the house sells for Y (what the bank is owed), then they don't pay any further taxes, as they are just realizing a gain that was already booked. If it sells for something less than Y, the bank books a loss in year 2015, and sends a 1099 (for Y-X) to the owner. At that point, the bank books a loss (lessens their tax burden) and the owner books a gain (to offset the bank's loss). The owner had payments in years 2008-2015, but those are not deductible, and can not be used to offset their gain in 2015. If the owner had purchased the house as a business and rented it out to themselves, they could have booked a loss in years 2008-2015 for all of the penalties and fees that they were running up. They might have been able to use some of that to offset their gain in 2015, but there are limits on how many years you can carry forward. That I know of, there is no provision for a person to count bank penalties and fees as a loss on their taxes. They do, however, have to pay taxes when the bank gives them certain rewards and interest.

4   justme   2015 Dec 17, 1:24pm  

Okay, so I think this is what is happening:

1. lender postpones foreclosure (a) in order to increase the judgement, and (b) to wait for the market value of the house to rise, while still keeping the house off their own books, and (c) to crowd out the lower priority lien holders, and (d) making it near impossible for the homeowner to pay off the judgement and get the house back,.

2. Fed QE buying crappy mortgages makes it easier for lenders to postpone foreclosures, AND causes the market value of houses to rise.

3. PROFIT!

5   Tenpoundbass   2015 Dec 17, 1:26pm  

By allowing financial practices that were just a known NO-NO! regardless stipulated or otherwise. To now a company can pretty much do anything they want, while claiming you agreed to it. Just by merley patronizing them. And all they have to do, is put small unread text on their about us page or anywhere on their site. It doesn't matter if you read it or not, and they don't have to go out of their way to direct you to the information until you dispute it.

And in mail correspondence, all they have to do is inform you of where you can find the information in the super fine text on the bottom of the bill, advert or Invoice.
Even if the actual legal disclaimers weren't in the actual mail anywhere!

You're getting easier loans now, and the insurance companies and the finance companies are collusion together. The insurance company will quote a dirt cheap premium for your policy. Just so the car dealer or realtor can close the deal on tight numbers. At which point the insurance company doubles your premium when it is up again the next years. This practice is most common in House purchases about 90% of the homes sold. Then when you try to shop around for cheaper insurance. There's not an insurance company in the world that would touch those teaser rates.

It's dishonest and if those insurance companies were made to honor those premium quotes, with out incident, for five years or some set amount of time. I guarantee you those dealers and realtors wouldn't be able to close those deals. The Auto industry and the Housing market would have come way down to be able to get people in those deals. And/Or the insurance companies would have to come down as well.

It puts the consumer in a a bad spot and epitomizes "Predatory Lending".

Just get your head out of your ass and do your own comparison between what was before and what is now.

You tell me a positive immutable fact about the CFPB.

6   Tenpoundbass   2015 Dec 17, 1:33pm  

Also unheard of until the CFPB Car Dealers selling you a car. Letting you drive away then informing you the next day the bank declined.
These dealers always ALWAYS has a finance company more than willing to write the loan for tripple or more than the interest rate he was originally quoted. They already took ownership of the car, they paid insurance. 99.999% of the time without fail. The person will go ahead and sign for that 15% car loan note.

I've seen that happen about three times in the last 5 years, to friends of mine. It even happened to my SIL and my black bandmate. Both are Minorities of course!

7   justme   2015 Dec 17, 1:41pm  

Obligatory: It's Obama's fault! With that out of the way, can we now return to discussing foreclosure as practiced by lenders?

8   Tenpoundbass   2015 Dec 17, 1:45pm  

No it's not Obama's fault it's our fault for assuming that the very same Congress that was getting flithy stinking rich while picking the winners and losers of 2008 which today are the only players, in those verticles. To craft such a legislation.

I mean think about, we had system wide corruption of insider trader that was going on, on the floor of Congress with impunity. The only person NOT getting richer taking advantage of that was Ron Paul. Or at least so he says.

How can you possibly think that the CFPB that would come out of that woul be worth a hill of beans?

9   justme   2015 Dec 17, 1:46pm  

I could really need that "minimize" button right now.

10   justme   2015 Dec 17, 3:52pm  

Ironman says

The balance on the judgement will have no bearing on the final sale price.

Certainly that is true(*), but the judgement (balance) affects how much of the sales proceeds the lender gets to keep before having to give any surplus to the next creditor in line. That was the point I was making.

ADDENDUM: (*) I was being nice here. What Ironman said was a complete strawman. I never claimed that the balance on the judgement *will* always have a bearing on the final (meaning to a new owner, by the bank) sale price. It can have a bearing, but then again it might not.

11   justme   2015 Dec 17, 5:38pm  

Ironman says

I guess that's possible. I have never seen a foreclosed house sell for more than the balance due.

Again, that was exactly my point, that lenders artificially inflate the judgement (which you call "balance due") so that no-one in their right mind would bid MORE than that. But at the same time, the lender can make a profit because their true cost can be much less than the inflated judgement.

Ironman says

justme says

1. lender postpones foreclosure (a) in order to increase the judgement,

There's no benefit for them to do that.

See above. There is a benefit.

12   justme   2015 Dec 17, 5:52pm  

I feel like I am in the twilight zone when discussing with Ironman/CIC.

In all of the above, either he is just wrong, makes strawmen, or he parrots back to me something I already said, but with an air that he is CORRECTING something I said. iI must say, there are very few things in this world more annoying than a dishonest person that lectures back to you what you already have said, all the while pretending that you are wrong and HE is the person that is coming up with the correct analysis.

Does this happen to other people a lot? I have seen it before, mostly in work situations, where person A is trying to take credit for person B's work, and at the same time trying to make it look like it was B that was wrong before A came up with the right solution. Does this phenomenon have a name? I guess it could viewed as a form of "gaslighting", but it is not quite the same.

13   justme   2015 Dec 17, 10:38pm  

Ironman says

The majority of houses went to foreclosure because the mortgage balance was BIGGER than the current home value. This was BEFORE the bank tacked on all their fees and penalties...

There is NO surplus to go to any other creditor.. Should I type slower so you can understand that point?

Did you READ my example? It is in the thread intro. The default was in 2008, and the foreclosure was delayed until 2015. By now, with current market values, there IS a surplus (i.e. market value is above X=220k), and the 1st mortgage lender is trying to make a big profit , and it appears that the lender has been intentionally maneuvering and manipulating the judgement amount to shortchange both the other creditors and the original owner.

I don't know if I can explain it any more plainly. If you do not understand the salient points of the case by now, I suppose you never will.

14   bob2356   2015 Dec 17, 10:50pm  

justme says

In a real example I looked at, the judgement is over 2x the defaulted amount. From 2008 (time of default) to 2015, the amount has more than doubled.

Default Amount: X = 220k

Final Judgment Amount: Y = 473k

Now, has the lender really accumulated an additional loss of 473k-220k=253k? I'm not so sure, the increase in the balance would correspond to a penalty interest rate where 1+r is calculated as (473/220)**(1/7) = 1.11622679111861.

That is, r=11.6%. That is a really high rate, and there is no way the lender could have earned such a rate in the open market.

So why are they pretending to have lost 11.6% per year?

Where is this real example at? I looked at a bunch of houses for investment in 6 different markets in 2013 including a lot of foreclosures and didn't see anything even close to those numbers for interest and penalties.

Your argument has a couple of holes in it. If the default amount was 220k then someone owed more than it was worth at the time and walked away. So the market value was obviously less than 220k or they would have just sold it. Probably the market value was considerably less than 220k. So your 11.6% per year is low, possibly very low. Even at that there are very, very few markets if any in the country that have had 11.6% gain a year for the last 7 years. So there is almost no way the actual market value today could be 473k. No one is going to pay judgement value, the house will sell at market value. The bank is going to book a loss. The larger the non monetary (interest and penalties) loss the bank can stuff onto the books the better since the entire loss will be written down against taxes even though there was no money actually spent on the interest and penalties. It's a paper loss that reduces taxes.

15   justme   2015 Dec 17, 11:00pm  

bob2356 says

The bank is going to book a loss. The larger the non monetary (interest and penalties) loss the bank can stuff onto the books the better since the entire loss will be written down against taxes even though there was no money actually spent on the interest and penalties. It's a paper loss that reduces taxes.

Indeed. You are saying the same as I already have said in the intro.

bob2356 says

So your 11.6% per year is low, possibly very low. Even at that there are very, very few markets if any in the country that have had 11.6% gain a year for the last 7 years. So there is almost no way the actual market value today could be 473k.

It appears you did not understand what the implied 11.6% interest rate is. Let me try to say it with some other words:

The 11.6% interest rate is the interest that turns a 220k debt into a 473k debt over the course of 7 years.

473 = 220 * 1.116^7 where ^ is the exponent operator (^ is sometimes also written as **).

The 11.6% has nothing to do with the house market value. And it is not some appreciation that the house "needs to have" for the bank to profit.

Indeed, one of the other main points I made is that the bank can make a profit even at a sale price smaller than 473k, precisely because 473k is such a highly padded number. AND as I said (and you repeated), the gap between actual recovered sales price and 473k can be used as a loss for tax purposes, although the bank did not really lose any money.

Location of property: Sorry, not willing to reveal. I am still considering it.

16   bob2356   2015 Dec 18, 12:21am  

justme says

It appears you did not understand what the implied 11.6% interest rate is. Let me try to say it with some other words:

The 11.6% interest rate is the interest that turns a 220k debt into a 473k debt over the course of 7 years.

473 = 220 * 1.116^7 where ^ is the exponent operator (^ is sometimes also written as **).

The 11.6% has nothing to do with the house market value. And it is not some appreciation that the house "needs to have" for the bank to profit.

Indeed, one of the other main points I made is that the bank can make a profit even at a sale price smaller than 473k, precisely because 473k is such a highly padded number. AND as I said (and you repeated), the gap between actual recovered sales price and 473k can be used as a loss for tax purposes, although the bank did not really lose any money.

Location of property: Sorry, not willing to reveal. I am still considering it.

Yea sure right. What county or at least state is this mythical house in that was worth say 175k maybe and is now pushing a theoretical half a million dollars. I understand your interest rate just fine. The value of the house is what someone writes a check for. Is it worth 473k or not. If you are considering it then you must have looked at comps already. If not then why does it matter what the judgement amount is other than to the banks accountant?

If the market value went above the unpaid loan amount the bank would have been stupid not to sell it. Carrying insurance, paying taxes, dealing with maintaining the property, keeping vandals and squatters out is not what banks do or have any desire to do. They may make a profit because of sheer ineptitude in getting rid of it in a rising market. Hoping for future appreciation on an empty house, no way, banks don't do that.

17   justme   2015 Dec 18, 1:55am  

bob2356 says

If not then why does it matter what the judgement amount is other than to the banks accountant?

How many times do I have to say it: The judgment amount matters because it crowds out the other creditors, as well as other potential bidders at the foreclosure auction. The bank can bid 473k without having to pay anyone anything. The market value of the house may be less than 473k, so nobody else will bid. BUT the bank is still angling to make a profit, because they do not really need to recover 473k to break even. What they need to recover is some number 220k < B < 473k.

>bob2356 says

Yea sure right. What county or at least state is this mythical house in that was worth say 175k maybe and is now pushing a theoretical half a million dollars.

I NEVER claimed that the house is worth 473k or pushing 500k. All I am assuming is that it is worth more than 220k, and maybe worth enough to allow the bank to turn an actual profit on their mortgage, more than what they would have made if the owner had not defaulted. The whole point is that 473k is a fiction, it is a padded number, it is fake, it's a scam to benefit the bank, how many different ways can I say this?

18   lostand confused   2015 Dec 18, 5:18am  

justme says

All I am assuming is that it is worth more than 220k, and maybe worth enough to allow the bank to turn an actual profit on their mortgage, more than what they would have mad if the owner had not defaulted. The whole point is that 473k is a fiction, it is a padded number, it is fake, it's a scam to benefit the bank, how many different ways can I say this?

So if the bank takes possession at this fictional 473k and then turn around and sell it at say 350k-can they claim a loss and write off taxes too?

19   bob2356   2015 Dec 18, 6:40am  

justme says

All I am assuming is that it is worth more than 220k, and maybe worth enough to allow the bank to turn an actual profit on their mortgage, more than what they would have mad if the owner had not defaulted. The whole point is that 473k is a fiction, it is a padded number, it is fake, it's a scam to benefit the bank, how many different ways can I say this?

Ah, the assume word. How do you know 473k final judgement (which is called the upset price in the industry) is fiction since you haven't researched the property. What does the bank really have in it and what would they have collected if the mortgage had been paid and what is the market value currently. Depending on the state and the house the amount of expenses in 7 years can be pretty damn substantial. The house could have been trashed and rehabbed. There could have been 5 years back taxes or some type of federal or state lien the bank has to clear. The bank is certainly entitled to claim the interest as being owed. . Mortgage rates were 7-8% prior to 2003. If it were a 8% loan with little paydown that's 18k a year or 126k right there. You know none of these things so how can you say it's fiction?

Banks aren't holding onto non performing houses to pad the final judgement amount to try to game a potential gain in the market. How many different ways can I say this? It makes zero sense for them to gamble on it and would be irresponsible to the shareholders. If the final judgement were substantially padded above the market value the banks would have to book the loss which triggers all kinds of regulatory scrutiny if it happens often. Banks really really don't want that at all.

20   Blurtman   2015 Dec 18, 8:25am  

Of course one would argue that an 8% interest rate would be warranted based upon the credit worthiness of the borrower, but how can recently bankrupt banks borrow at next to nothing?

21   justme   2015 Dec 18, 11:15am  

Ironman says

justme says

The bank can bid 473k without having to pay anyone anything.

Why does the bank have to bid anything, they already own it by default? If they are selling at auction, they may put a "bid" in, just to keep the house from selling a really low price and get the maximum amount...

I think it is fair to interpret "they" in your above statement as meaning "the bank/lender".

Here's the problem: You are ignorant of the facts. The bank does not own the property, the defaulting owner still does. AND, it is not the bank/lender that is auctioning off the property at a foreclosure auction, it is the trustee. The bank/lender is one of the parties that can BID on the property, and they almost always do. Generally the bank will bid what it is owed (Y, the judgement). If nobody else bids more, then the bank will then get title and possession of the house. If anyone bids more than Y, the bank will get paid Y by the winning bidder, and the rest of the creditors, if any, will get paid the surplus. If there are no other creditors, the originally defaulting homeowner will get paid the surplus.

I suggest you stop trying to make up faults in what I am saying. Instead try to learn and correct your own misconceptions. On a good day, I don't mind educating you.

Homework: After having read and learned the above, see if you can now follow the original logic of my original post, and see if you can come to the conclusion that the 1st mortgage lender may benefit from padding the default amount (X) with excessive penalty interest rates, excessive other penalties, and real or fake expenses, to get a judgement Y which is much larger than X, indeed a Y that is excessively large by any standard of reasonability.

22   bob2356   2015 Dec 18, 12:44pm  

justme says

Homework: After having read and learned the above, see if you can now follow the original logic of my original post, and see if you can come to the conclusion that the 1st mortgage lender may benefit from padding the default amount (X) with excessive penalty interest rates, excessive other penalties, and real or fake expenses, to get a judgement Y which is much larger than X, indeed a Y that is excessively large by any standard of reasonability.

Homework, tell us how bankers get promotions, raises, and bonuses booking losses? Any amount the house sells for less than the judgement is a loss. Even if it is just a paper loss of potential income it goes on the financial statement as a loss. That padding you keep talking about goes on the books as non current asset while the mortgage itself is a current asset. Together they make up the total asset value. Any time you sell for less than the asset value it's a loss. Padding the judgement beyond what the house will sell for on the open market just pads the losses.

People keep making up faults in what you are saying because in the real world of accounting and financial statements what you are saying doesn't make any sense.

23   EBGuy   2015 Dec 18, 2:27pm  

Ironman said: Think about it, why would they bid it up and buy it at a artificially inflated value?? It's at auction because they want to dump it.

I think you're talking past each other. It's at a (foreclosure) auction because the bank wants clear title so that they can resell it without any existing encumbrances.
Note that: Banks have to provision for nonperforming assets from their profits. In extreme cases, nonperforming assets can’t be provisioned from profits. In such cases, a bank has to take a hit on its capital.
Any impact on capital affects a bank’s ability to continue operations. This makes nonperforming assets one of the most important indicators to track.

I think this speaks to bob2356's point. Any amount you "pad" means you have to over provision for it as an NPA.

24   bob2356   2015 Dec 19, 5:50am  

EBGuy says

Any amount you "pad" means you have to over provision for it as an NPA.

Exactly. There has to be 2 sides to every accounting entry. The "padding" comes right out of profits after 90 days of non payment. Accrued interest and penalties are booked by a lender as revenue on the income statement and an asset on the balance sheet. You can't only count the actual cash entries like amount loaned and sale amount. Accrued interest is a real liability to the borrower. No one would loan money if it wasn't. It all has to be accounted for.

Bank executives are, for obvious reasons, very unwilling to pursue policies that reduce profits.

25   justme   2015 Dec 19, 11:20am  

Ironman says

The bank/trustee will either have a reserve amount or they might just bid up the house to get the most they can, but that will NOT exceed market value. PERIOD.

They WON'T bid it up to cover all their "extra" fees they've tacked on and exceed market value.

You still have not understood that when the bank/lender bids anything up to the amount that it is owed, it does not actually pay anyone anything.

Ironman says

It's at auction because they want to dump it.

And you still have not understood what foreclosure auction (a.k.a. trustee sale) actually is.

26   justme   2015 Dec 19, 11:57am  

EBGuy,

It seems very common for mortgage lenders to utilize the concept of a "penalty interest rate". Following the logic that a further default on the imposed penalty will be booked as an additional loss, then why do lenders even bother doing this?

I did a search on "mortgage default penalties" and found a publication on the topic:

"Case Law Summary-Default Interest and Late Charges"
http://www.americanbar.org/content/dam/aba/publishing/rpte_ereport/2012/5_october/rp_murray.authcheckdam.pdf

I have not read all of it yet, but the article does seem to support my contention that high penalty interest rates are common, Indeed they speak of rates in the 8 and 11% range.

So: Are all these banks/lenders foolish people that do not understand loss accounting, and do not understand that they will not be getting any bonuses. Or could it be, that the explanation I originally proposed actually is correct? For easy reference, a short and somewhat simplified version of my contention is the following:

justme says

Okay, so I think this is what is happening:

1. lender postpones foreclosure (a) in order to increase the judgement, and (b) to wait for the market value of the house to rise, while still keeping the house off their own books, and (c) to crowd out the lower priority lien holders, and (d) making it near impossible for the homeowner to pay off the judgement and get the house back,.

2. Fed QE buying crappy mortgages makes it easier for lenders to postpone foreclosures, AND causes the market value of houses to rise.

3. PROFIT!

27   EBGuy   2015 Dec 21, 4:05pm  

justme, I'm still having a hard time believing that bank makes any money in most scenarios; however, there is one case where I can see this working. That's when a loanowner remains in the property and makes good faith payments in the hope they can get current (but of course, never does, due to the usurious rates). Otherwise, I think the costs to the bank are prohibitive (I suppose that may also depend on the neighborhood and how many foreclosures the bank has to manage).

28   beershrine   2015 Dec 21, 5:51pm  

Now you know why people trash the house.

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