Rising Strategic Mortgage Defaults Broadly Impacting Debt Collection Industry

Dyck O’Neal, Inc. has seen business volume grow about 300 percent since the housing mortgage crisis began. Given the millions of Americans currently on the path to foreclosure, the Arlington, Texas-based real estate debt buyer and collector and mortgage servicer may still have lots of room to grow.

According to the National Association of Realtors (NAR), a record 3 million homes received foreclosure notices in 2009, and some housing industry experts expect a similar number of foreclosure notices to be issued this year.

With unemployment near 10 percent, many of the foreclosures will occur because borrowers simply cannot afford to pay. But some foreclosures will result from borrowers walking away from a mortgage they no longer want to pay.

During an interview on The Early Show, Jill Schlesinger, Editor-at-Large for CBS MoneyWatch.com, said that “strategic defaults,” are becoming more common as people decide they may be better off renting than owning a home. Schlesinger said some people are being advised to walk away if their mortgage is at least 20 percent more than the value of their home.

“They can afford it, but they are saying I can’t, I don’t want to do it anymore. The hole is too deep,” Schlesinger said.

While creditors are being more discerning when making loans, requiring larger down payments and income verification, Kaulkin Ginsberg Analyst Michael Lamm said it’s not enough. He said education is the key to keeping some people in their homes and helping others avoid taking on debt they can’t afford.

“If someone is about to drop their keys in the mailbox and abandon their property, clearly there was no education,” Lamm said. “There needs to be stricter governance over consumers obtaining mortgages. There needs to be more detailed processes in underwriting and determining who can get a mortgage.”

The downside to homeowners who chose to walk away from their mortgage without negotiating some kind of settlement will be ruined credit for at least seven years. But the decision could leave some consumers with more money to pay down other debt.

Michael Cramer, President and CEO of Dyck O’Neal, said many borrowers will never face collections action against their default because it’s costly – as much as $4,000 to begin legal action. Some lenders can’t pursue collections after a foreclosure because some states, including California and Arizona – where foreclosures are the highest in the country — allow only a single action against a borrower. Other states, including Georgia, limit the amount of time the lender has to pursue mortgage deficiency collections.

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“There are probably 15 states where it’s not practical to pursue a deficiency,” Cramer said.

But the biggest hurdle to collecting mortgage deficiencies is securing proper documentation, such as the original note and the chain of title that proves that the borrower owes the debt, Cramer said. That’s not an easy task these days, given the way mortgages were packaged and sold throughout the world.

Cramer told insideARM that a lot of Dyck O’Neal’s collection work comes from short sales – a process where the homeowner and lender accept an offer for less than the total amount owed to pay off the home, resulting in a deficiency balance.

“Sometimes we release the consumer from the debt and sometimes we don’t,” he said of the deficiency. The firm may also arrange for the borrower to make partial payments on the loan balance over time with no interest.

“What’s best is that the consumer pays something and works with the lender to sell the property,” Cramer said.

Many homeowners and lenders, however, are hoping to avoid any action with help from the federal Home Affordable Modification Program. But borrowers must still show that they can make the lowered mortgage payments.

Though collection calls, letters and credit reporting continue, Cramer estimates that only 1 percent of lenders currently pursue mortgage deficiencies through the legal system.

Some lenders avoid it because they do not want the negative publicity. Some perceive more favorable consumer sentiment in the local courts. And some fear political backlash, he said.

“One client doesn’t want to, because of the politics,” Cramer said.

But mortgage collections could increase if strategic foreclosures increase, especially among real estate investors, noted Cramer.

“I think lenders are getting mad and they want to make a statement,” he said. “People are walking away and they have the ability to pay. So they need to make a statement.”