Facing one of the most common questions about the Florida foreclosure process, even the most astute Florida foreclosure attorney can be stumped. Which question? “If my lender is willing to short sell a property for market value, why won’t they modify my loan to reduce principal down to market value?” This is a staple question of our consultations with prospective clients here at KNZ law. There are a variety of reasons that lenders might not reduce principal on a loan.
The most prominent of these reasons is that the banking industry as a whole has been loath to write down loans to market value because of a perceived risk of moral hazard. That is, the myth has been spread that if borrowers were given principal reductions, more underwater homeowners would be induced to default on their loans to attempt to seek such a deal. However, this logic has been disproved in a study by Professor Brent White, who notes that by and large, those homeowners who can pay their mortgages but might stand economic gain if they defaulted and sought a modification, actually remain current.
So instead of pondering the mysteries of the foreclosure process in Florida, consider some possible solutions to bank intransigence: first, bankruptcy has been talked about as a potential solution. A few years back, congress debated a bill that would have allowed bankruptcy judges to write down principal on home loans. Unfortunately, the bill did not pass after a close vote in the senate. Homeowners may be able to benefit, however, in a Chapter 13 bankruptcy. In some instances, a second or third mortgage may be able to be wiped away if it is wholly underwater. Thus, those homeowners who are only under water due to secondary or tertiary loans may stand to gain through a Chapter 13.
Secondly, the private sector has stepped in to alleviate this problem embedded in the Florida foreclosure process. Consider, as an example, Boston Community Capital: this “community development financial institution” identifies homeowners with stable income but who are under water on their homes, buys the home, and then sells the property back to the homeowner at a reduced price, ostensibly market value. BCC takes a share of whatever profits the homeowner might eventually gain through a sale. This innovative profit sharing incentive gives BCC the enticement to complete such deals. We can only hope that banks and lenders eventually get around to the same line of thinking. After all, with all the griping commentators and administrators do about a lengthy Florida foreclosure timeline, just think of the innumerable homeowners who would settle immediately under a BCC type modification.