401(no)(k): Why Retirements Should Not Be Used to Pay Mortgages


The Century Reader: Foreclosure Home for $1.00?

For those of you who are not avid readers of the Detroit News, there was a really well done opinion piece on a new proposal put forward by U.S. Sen. Johnny Isakson, R-Ga., and U.S. Rep. Tom Graves, R-Ga.  The writer for the Detroit News, Brian O’Connor succinctly lays out the proposal as follows:

Right now, if you’re strapped you can take a loan against your 401(k) through your workplace. You have to pay it back within five years with interest, but you’re paying it to yourself. About 85 percent of plans offer loans.

If you’re desperate, 89 percent of plans offer hardship withdrawals. Even though you don’t have to pay the money back, it’s a pretty bad deal: You have to pay income tax on the amount withdrawn and a 10 percent penalty if you’re younger than 59-1/2. For most people, it means at least 25 percent of the money withdrawn goes to penalties and taxes, not to saving a home from the bank.

But here’s where the plan backed by Isakson and Graves fails to the point of uselessness: It allows for outright withdrawals, not loans, but it only waives the 10 percent penalty — you’re still on the hook for taxes, ranging from 15 percent on up to the top bracket of 35 percent.

The plan also limits your withdrawal to a maximum of $50,000 or half of your account balance. So, if you withdrew $50,000 and were in the 25 percent tax bracket, you’d skip a $5,000 penalty but still pay $12,500 in federal tax, plus your state income tax. And unlike taking out a loan, all that money would be due April 15, and it would all go to the tax collector.

O’Connor goes on to point out that 401(k) funds are protected in bankruptcy, which is a point I want to highlight.  Why?  Because if you decide to declare a personal bankruptcy as a way to restart your economic life (which probably means you will lose your home), at least you can hold on to that nest egg in your retirement fund.  That can’t be tapped in bankruptcy to satisfy your creditors.

I’ve already written in a prior blog about my experiences of foreclosure prevention in NYC:  most homeowners are all too willing to run up their credit cards, poach the kid’s college savings fund, dip into their 401(k) and borrow from Aunt Tilly before they give up the home.  This frequently leaves homeowners in a very precarious financial position, and (even worse) frequently does very little to address the underlying economic difficulties in their lives (usually loss of income).  I think it’s just plain bad policy to provide further encouragement to distressed homeowners to act so clearly against their own self interests – especially when lenders and servicers have failed to similarly extend themselves and meet distressed homeowners halfway with timely, accurate and equitable workout solutions.

Personal as Political 

And here’s what really kills me about this proposal:  this solution essentially advocates that homeowners (AKA taxpayers, AKA workers, AKA consumers, AKA citizens) again make a substantial and unprecedented personal sacrifice in an effort to pay back a lender (AKA bank, AKA institution, AKA federal bailout recipient) for a home that is distressed, when that same lender (and the bank that controls it) have frequently failed to provide adequate servicing and support to the homeowner.  This presumed “systemic” response (which as O’Connor notes would really provide very little value over a traditional early 401(k) withdrawal for most people) again puts the burden of attempting to resolve the foreclosure crisis on distressed individuals, and apparently does nothing to address either the problematic history of the mortgage bubble (and all the very messy ways that home mortgages were improperly extended, packaged and securitized), nor the myriad current problems within the mortgage servicing industry (such as problematic denials, improper foreclosure proceedings, and the lack of an effective appeals process).

It just really gets my Irish up.  And I can’t help but point out that the maximum 401(k) withdrawal amount of $50,000 is the exact same amount that many distressed homeowners should have qualified for under the recent Emergency Homeowners’ Loan Program.  In other words, the federal program which suffered from such enormous administrative ponderousness that it only disbursed $432 million of the $1 billion allocated for distressed homeowners should now be replaced by a meager incentive to allow those same distressed homeowners to sack their own retirement savings funds.

That is not really what I would call an effective systemic solution.

For now, let’s hope that the proposal by Isakson and Graves gets all the attention it rightfully deserves. We can do better.

Why Foreclosure Buybacks Are (not) Wrong


Why Foreclosure Buybacks Are (not) Wrong

I happened upon this posting yesterday and I while I try to maintain a position of anti-snarky-ness, I found it very difficult to find any common ground with the perspective that foreclosure buybacks are wrong.

Allow me to explain.

Things are so really ugly out there right now in foreclosure land that some homeowners in Detroit are resorting to an usual strategy:  they appear to be going into default and allowing the bank to foreclose, then purchasing the property back at the foreclosure auction on the courthouse steps (frequently through a family member or similar sympathetic confederate).

The author cites the following:

The Detroit News reports that in the past year “about 200 of nearly 3,700 Detroit properties sold at auction last year that appeared to be bought back by owners, some under the names of relatives or different companies and many for $500. The total in taxes and other debts wiped away was about $1.8 million.”

I should note that the author appears to be a mortgage broker who is no doubt losing possible commissions the to so-called “buyback artists” he discusses in his article.  No doubt he would prefer they all do short sales (ugh).  We’ll leave aside the author’s obvious self-interest for the time being.  Let’s also leave aside the following:

  • That the banks clearly are dying to unload these properties if they are actually selling them for $500 a pop (they’ve essentially written these properties off as worthless);
  • That if they aren’t sold at auction they go into the bank’s REO portfolio where they would likely rot, causing all kinds of mischief for the bank, the neighbors and the city of Detroit; and
  • That if these properties are going to sell, they are going to be bought by somebody – so why not the former owner who actually has a personal stake in the well-being of the property and the community.

Taxes and “other debt” of $1.8 million are being “wiped away” in the auctions, depriving the good citizens of Detroit of much needed municipal revenues.  That is a concern.  While 200 “buybacks” are significant, that’s just over 5% of the total foreclosed housing stock sold at a given auction in Detroit.  Furthermore, according to the very lovely Detroit Drilldown provided by Social Compact, there were a total of 6,259 foreclosures in 2010 (and a total of just under 59,000 since 2005).  We’re talking about 500 properties “bought back” per year, if the ratios hold.

In doing the math, that $1.8 million loss comes out to about $9,000 a property.  Last time I checked, it costs about $10,000 to knock down an abandoned property and turn the foreclosed home into a vacant lot.  Detroit as a city clearly comes out a winner when property owners “buyback” foreclosed properties based on the cost of removal of blighted and abandoned properties alone.

Never Fear, Buybacks Won’t Go Mainstream

I actually think this is a very clever and viable solution for homeowners in unaffordable mortgage products, but it’s a niche solution.  It’s never going to be the solution for the foreclosure crisis.  Why?  Because in order for such a solution to obtain, you need an extremely weak housing market, and very little competition among purchasers.  Markets like this do exist in cities with long-term population decline (like Detroit), but these are the minority of housing markets (despite weak real estate prices across the board), and appear to be fairly limited to “rust belt” cities in the midwest.  And I can say “rust belt” without irony or derision because I was born in Dayton, Ohio.

Sheriff refuses to conduct evictions in Philly.

Furthermore, most homeowners in my experience don’t actually want to risk the credit damage of foreclosure, the trauma and logistical challenges of vacating the home when the sheriff shows up, or the risk of losing the home at auction to another bidder.  While this may be a solution for some, it’s just not going to become the kind of trend the author wants to portend.

They Are All Cheats and Liars

I believe good policy is based on how people think, and not on how people feel.  What the author here is really saying is:  these homeowners are cheating the system.  They are breaking the covenant of the mortgage agreement and taking advantage of weaknesses in the system for their own personal gain.  They are systematically ripping us off, and we deserve to have our rights protected against the likes of these malefactors.

This should sound familiar.  First off, dear reader, I hope it will remind you of claims made about so-called “strategic defaulters” – where underwater mortgage holders were purportedly defaulting on their mortgages, then buying the marked down house a block over and walking away from their initial home.  This did happen, but at nowhere near the scale the punditry might suggest.  In my experience in NYC, I never met a single one of these strategic defaulters.  On the contrary, I met hundreds if not thousands of homeowners who valiantly fought mortgage default by wrecking their 401k’s, poaching the kid’s college savings fund, maxing out the credit cards, and generally robbing Peter to pay Paul.  People, ultimately, really don’t want to lose their homes.

But this should also remind readers that brokers, mortgage originators, banks, servicers, and foreclosure mill attorneys HAVE been systematically taking advantage of the system.  This is not just about “robo-signing,” but also the lack of ability to show standing, poor document handling during modification, and dubious origination practices.  Again, let’s leave aside a whole host of other issues between those who securitized mortgage backed securities or sold credit default swaps against them in their relations with their counterparties.  Those are deep waters and the subject of a soon-to-be-post.

It might be tempting, therefore, to toss “buyback” homeowners and less than scrupulous financial sector actors into the same bucket, or to paint them both with the same black brush.  But I believe there are important differences for “buyback” homeowners:

  • They are not acting out through multiple, serial transactions a pattern of neglect, manipulation or abuse – they are acting instead in (what I would call rational) self-interest on a single transaction that is saving their home;
  • The net outcome of a buyback looks like it’s ultimately of benefit to all parties: banks get rid of a property they don’t want, homeowners get to keep a property they do want, communities avoid an eyesore and keep a neighbor, and cities avoid costly abandoned properties that they then have to deal with at a net loss;
  • Contracts are built to be broken.  That’s why the terms of every contract include elements that dictate what happens when the contract IS broken.  What these homeowners are doing is actually legal.  And intelligent, given their circumstances.   While it’s possible to raise the question of whether such actions should be governed by other terms that make it more difficult or impossible, that is a policy discussion or a matter between contracting parties.  As I hope I make clear above, for public policy purposes buybacks appear to provide a net win for all parties.

So, I don’t buy it that buybacks are wrong.  On the contrary, they appear to me to be a viable solution, if a limited one, and should probably be encouraged by local authorities and advocates where possible.  I would be surprised if we hear a lot more about this issue itself, but it’s as good an opportunity as any to highlight the differences between systematic abuse and practical, strategic revision.