"Buy and Bail" or Buying One Home Before Foreclosure on Another

This has been a noticeable phenomenon for at least the last year in San Diego, but I've been loath to talk about it because I didn't want to be giving fraudsters ideas. Most lenders have now put into place safeguards against this measure. As always, they do not distinguish between guilty and innocent, but the lender is the one risking their money. You have to show that you are a good risk.

The basic event is this: People have decided to relinquish their current property to the lender. It's not worth as much as the loan is for, so they see only a gain to be had there with current law declaring the income from forgiven debts non-taxable for the remainder of the year at least. Perhaps they couldn't afford their new payments after the teaser expired. Perhaps they could; they just don't understand what they are doing to their credit and the fact that the market is going to come back - sooner than they probably think. Perhaps it's a non-recourse loan and they see only the fact that they owe more than the property is currently worth.

But these people don't want to be homeless, and they do understand that after they have gone through foreclosure, not only are lenders going to be highly resistant to lending to them, but landlords are going to be reluctant to rent to them. So they hit upon what they think is a brilliant plan: Buy a new house before allowing the old one to go into foreclosure. After all, the degradation to credit hasn't happened yet! However, it is still fraud. These people have an actual plan to allow a property to be foreclosed upon, and a reasonable person would know that lenders would consider that in deciding whether to grant credit.

Unfortunately, there has been enough of this going on that lenders are no longer willing to let it go unchecked and unchallenged, so they are looking for evidence that new buyers of primary residences and second homes do not plan to "buy and bail". These are by no means the only measures they are taking, but they want one of about 3 things to be present.

• the ability to make both payments without any rental income
• a verifiable job change to a new commuting area, and the need to relocate (i.e. nothing in the same commuting area)
• significant equity in the current property, even by the standards of the down market

It should be noted that meeting any one condition is not a "get out of underwriting free" card. There are other checks being made upon the process, checks I am not going to discuss beyond saying that the transaction has to pass a "smell test." Being someone who doesn't like seeing bad real estate loans made, for a plethora of reasons, I welcome the return of the smell test. I've seen the aftermath of too many transactions that smelled worse that week old fish in dumpster on a hot day. You may think you're a "a special case," but every single one of those folks out there facing foreclosure or having gone through it already also thought that they were "a special case" then, and the ones trying this fraud think so again now.

These new restrictions have hurt, and will continue to hurt, legitimate investors by making it more difficult to qualify for the loans. It is nonetheless a fact of life brought upon us by the market. Furthermore, 20% down is pretty much an absolute minimum for buying investment property currently currently. Furthermore, even the lenders that were accepting loans for both a primary residence and a second home in the same commuting area have now stopped that practice. It was silly to start with, and it has only gotten worse of late, but people who want to avoid the constraints and requirements of investment property loans were eager for it. I just don't understand why lenders were willing to accommodate them. Either the charges and higher equity and qualification standards were necessary, or they were not. If they were necessary, why were the lenders bypassing them? If not, why did they exist in the first place?

I can understand people who don't want to be homeless. However, while "Buy and Bail" may not always be obvious before the fact, but it is afterwards, and the lenders are starting to take notice of foreclosures against other companies, and they are even writing in clauses that make their loan callable, by which I mean they can demand you pay that loan off in full, giving you 7 or 30 days to make the actual payment. Once again, this sort of clause is going to disadvantage people who have had the property a while and be intending no harm who do hit hard times: Job loss, disability, etcetera. Nevertheless, "Buy and Bail" is fraud, and the lenders are entitled to take whatever measures they think reasonable to insure that they don't lose their money to a suddenly unacceptable credit risk, as well as to return a reasonable return on that money. It may seem like cruelty to you, but I'd like to see some of the folks pulling it sentenced to an enforced residency in a government institution wearing funny pajamas, because games like this destabilize the mortgage market for everyone, and every time somebody pulls a game like this, someone who should be able to qualify for a loan is now unable to do so, further screwing up the home loan market for 300 million Americans.

Caveat Emptor

UPDATE: I got a question from Realtor Ricki Widlak of flhotproperties.comwho doesn't understand how people pull this, in that they're going to have another home loan on their credit report. The answer is that they claim they are going to be receiving $X in rent per month. They fake up a lease contract, usually between themselves and a family member or close friend. The added number of dollars per month from this entirely fictional contract makes it appear as if they qualify. However, because the lease is not real, they don't. Ergo, the qualify without rental income restriction.

He ends with this question: "How do people "walk away"? Who walks away from anything in this information age anyway? I just don't get it. These people are "leaving behind" their soc numbers, right?".

The answer to all of these questions is that lenders have no difficulty in identifying this phenomenon in retrospect - these people aren't getting away with anything, and some of the lenders are starting to follow the criminal prosecution route. But identifying the perpetrators in retrospect does not assist the lenders in not making bad loans in the first place, which is the situation the lenders want. So they raise the bar for qualification for everybody in order to weed out these bad apples. Yes, people who would otherwise qualify are getting turned down for loans. However, the lenders are not a court of law, where we'd rather a dozen guilty people go free than one innocent one be punished. In fact, the lenders have precisely the opposite view, especially in the current environment: They'd rather turn down a dozen good loans than accept one bad loan, and they are now writing their lending criteria accordingly.