Real Estate Wars: It's Getting Ugly Between Banks and Borrowers

(MoneyWatch)  Gerald Wolfe is seething. The attorney, who represents homeowners facing foreclosure, is outraged over the pressure he sees banks putting on his clients to continue making payments -- even when it's in their financial interest to abandon their devalued properties.

"What lenders say is, 'We're going to take your house,' " says Wolfe, who's based in Aliso Viejo, Calif. He also noted that such tactics are standard operating procedure by banks in cases when a customer's mortgage exceeds the value of his or her home. "We're going to foreclose, and you're going to be out of the house. And how responsible is that for your family? Neighbors will look down on you."

"They're trying to shame people into keeping their house," he added.

Such anecdotes highlight a grim reality of the ailing American housing market -- banks and their mortgage customers are at war. Other than the fear of bad press, financial institutions have no incentive to modify borrowers' "underwater" mortgages. That's because they typically lose less money by foreclosing on properties. The prevalence of securitization, along with favorable accounting rules, also helps banks dodge the full impact of distressed loans.

Meanwhile, other than emotional attachment to their houses, condos and co-ops, legions of homeowners have little incentive to remain in homes whose values look unlikely to recover anytime soon.

So growing numbers of people are walking away. Some 588,000 borrowers "strategically defaulted" on their mortgages in 2008, according to a recent report by consulting firm Oliver Wyman and credit reporting agency Experian. (Such homeowners are defined as those who went directly from being current on their loans to at least 180 days past-due, while keeping up with all their non-real estate debts.)

That total represents a 128 percent jump over the number of strategic defaults in 2007. Wyman expects such rates to show similar growth for 2009. The number of "distressed defaults," where borrowers are at least 60 days delinquent, and of other categories of people behind on their loans is also rising.

It's going to get worse. Roughly 1 in 4 mortgage holders, or nearly 11 million Americans, owe more on their homes than they're worth. Although the total number of strategic defaults remains relatively low, that could change if the housing market continues to stagnate. Unless home prices recover, defaults could soar.

Homeowners who are way under water stay in their homes for various reasons. Fear of social stigma. A cultural inclination to pay their debts. Concern about their credit records. Honor. But above all, according to recent research, many people just can't grasp when walking away from a mortgage makes financial sense. Industry data shows that homeowners begin thinking about defaulting on the mortgage when a property falls below 75 percent of what they owe on the loan.

And these days, it can make a lot of sense to return the keys to the bank. Sagging real estate prices means it's often cheaper to rent. Walking away also can help conserve retirement funds. And those savings can be reinvested more fruitfully, such as moving to a part of the country with more jobs or even starting a business.

Another reason people are dumping their mortgages is that federal initiatives such as the Home Affordable Modification Program aimed at stemming foreclosures are a bust. They may even make things worse. Wolfe said lenders often string homeowners along in order to keep them in their homes a few more months.

"Lenders send out these letters that say we may have an alternative to foreclosure, we may have a loan modification, we may be able to do a short-sale," he said. "The problem is that that this language is like something you get from Publisher's Clearinghouse -- you MAY have won $10 million."

There are, of course, consequences to kissing off your mortgage. But they're not as severe as commonly thought, University of Arizona law professor Brent White concluded in a paper last year. After a foreclosure, people who formerly had strong credit can regain their good rating (above 660) within two years. In as few as three years, they also may qualify for a federally-insured FHA loan to buy another home.

The conflict between lenders and homeowners exposes the social and moral double-standard to which each group is held. Borrowers have an obligation to pay their debts -- and that's a good thing.

By the same token, it's in banks' interests to ensure that borrowers can repay those debts. On that score, lenders have failed miserably. That's largely because financial "innovations" have allowed them to pass those debts onto other parties, including taxpayers.

It will be no surprise, in other words, if borrowers begin to view repaying their mortgages with the same indifference that banks showed in issuing those loans during the housing boom and exhibit today in leaning on borrowers.

"If this epidemic would've happened 20 years ago, lenders would've been more helpful" with borrowers, Wolfe said, noting that banks historically were more financially accountable for what happened to their loans. "The whole environment has become dehumanized."