"Occupancy in default": a solution to future mortgage crises?

As we all know, there has been a wave of primary residence foreclosures in our country. Foreclosures always do two things: someone who is living in a house can't live there anymore, and the bank or mortgage company now has another house in their inventory. However, when there are many foreclosures happening within a fairly short period, as is the case in America now, a third thing happens: significant numbers of houses remain vacant, creating crime and safety hazards in the community.

There are various government initiatives that may or may not solve this problem, but it seems to me that it is partially due to the absolutist way in which mortgages are structured. That is, either you make your payments, or you lose your home.

There is another possibility, one that I think would be a net win for all concerned, especially in times of mortgage/home ownership crisis: occupancy in default (a word I just made up meaning something that continued occupancy of a property after defaulting on a mortgage).

The way this would work is very simple. When a homeowner fell behind on payments to a sufficient degree that foreclosure proceedings would commence, the mortgage lender would make all of the standard notifications, put the home on the market, and try to sell it, exactly as under current law. The difference is that the homeowner would not be evicted. That is, the dwelling would continue to be occupied by the homeowner until someone else bought it and was ready to move in. Furthermore, all of the usual negotiations would continue regarding interest rate, payment schedules, and so on, and if an agreement could be reached, and the homeowner could raise the cash and meet the requirements before someone else bought the house, then the (possibly modified) mortgage could be resumed with no disruption of the homeowner's family. On the other hand, if someone else bought the house and wanted to move in before the previous owner could meet the requirements, then a conventional foreclosure and possible eviction would take place.

I believe that it would also be advantageous for previous mortgage holders who are still occupying the premises to have a one-shot opportunity to accept (and to qualify for) the terms agreed to for the would-be owners. I say "one-shot" because the last thing we would want would be a bidding war between the current occupant and the prospective owners. Basically, the law would establish that in the case where a previous occupant in default still occupied the premises (under the occupancy in default law), the previous owners would have an opportunity (three business days?) to qualify for the same terms as the new occupant before the sale could close. If they did qualify, they would be able to stay under those terms; if they did not, the sale could close with the new buyer, but only on those terms.

I also believe that a court should decide whether and how much money the in-default occupants should pay the mortgage holder. This will depend on their circumstances, not on the size of the debt or even the value of the property. One possible rule of thumb is that it be no more than 1/4 of their net or "take-home" income. As long as they remained in occupancy in default, the payment would be split between principal and interest in proportions reflecting the term implied by the payment amount and the size of the debt, with an interest rate determined by the average rate for the time and region. This amount would be garnished from their wages if necessary. That is, it is theoretically possible eventually to pay off the mortgage and become the full owners of the property while still in occupancy in default. (Of course, not if someone came along willing and able to pay the full market value of the property.)

Now reliance on occupancy in default would not solve all of the problems of bad mortgage debt, but it would certainly do one thing: it would not allow situations such as the current mortgage crisis to cause largescale evictions at a time when new buyers are not available. Owners would not be so quickly evicted and would at least have a chance to retain the property; lenders would receive a reduced but greater than zero flow of cash from defaulted properties. In "good" times, where there is a healthy stream of home purchases, this new law would have little effect, because new owners willing and able to pay the market value of the property would come along fairly quickly. Basically, the new law would only serve to add a three-or-so-day delay into the purchase timeline. But in "bad" times, this law would have a profoundly positive effect on both lenders and borrowers.

I believe that both lenders and borrowers would be in favor of this possibility, but I do believe that for it to work fully, it should be supported by state and/or federal law, because part of the motivation for it is to protect our economy against crises of mortgage lending. For example, how would the occupancy in default status of a property affect inheritance or other transfers of the property (it seems to me that the law might want to distinguish between transfers to someone already living in the property versus to someone else).

The main target of occupancy in default is, of course, primary residences of mortgage borrowers. However, I can see little reason why the laws should not be extended to all residential properties, or even to all improved properties. It is less clear how it could help with unoccupied and/or unimproved property, but on the other hand, I don't see how it could actually hurt.

Greg Shenaut

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