Should I be afraid of Zombie Real Estate?

JohnMenszer-0690It happens so often. I ask clients if they own a home and they say, “No, but I am buying one from the bank.” There is a popular misconception that when you are paying a mortgage, you don’t own the property until it is fully paid for. In fact, when you buy a piece of real estate on credit you are owner from the time the ink dries on the paper.

The three essential documents involved in a credit purchase of real estate are: the Act of Transfer, the Note and the Mortgage. The Transfer, also known as the Deed, transfers ownership from the seller to the purchaser. The Note is a statement of the amount the purchaser owes and the terms of repayment. The Mortgage is a security agreement that ties the note to the real estate, giving the lender certain rights over the property. Among those rights is the option to foreclose if the Note becomes delinquent.

Notice, I said “option to foreclose” because here is where the Zombie Real Estate comes in. There are unknown numbers of these foreclosure horrors where it is the bank’s refusal to foreclose which sets the owner down the path to perdition. Zombie Real Estate is property that nobody wants which keeps racking up costs for the owner.

I read of a property owner in Ohio who fell behind to JP Morgan Chase due to ill health. He received a foreclosure suit and proactively moved out before the date of the sheriff sale to live with his daughter. Then the bank quietly dropped the suit. Two years later he started getting bills for taxes, waste removal, weed control, and was threatened with demolition costs.

In depressed markets banks are walking away from properties. If they foreclose they have the legal costs and the expense of keeping up the real estate owned (known in the trade as “REO’s). In not foreclosing the bank can reap accounting and tax benefits from the government and sell the debt at a deep discount to debt collectors, who then hound the owners.

In my practice I once had a case of Zombie Real Estate in a bankruptcy. A client had a piece of investment real estate that he wanted to give back to the lender, as well as a lot of hospital bills and other debts that justified filing a Chapter 7. We filed his case and listed his intention to surrender this property to the bank. Unfortunately, before the lender could foreclose the property was damaged and the lender decided not to foreclose after all. The wrecked property sat for years with the City racking up liens and charges. The Note on the property was discharged in the bankruptcy, but since the City’s liens and charges dated from after the bankruptcy they were fresh obligations to the debtor.

You can’t force a bank to foreclose if it doesn’t want to and you can’t make them accept a donation, a dation or a quitclaim, unless they sign the document. What you own may not be so easy to get rid of.

 

What you don’t know about homeowners insurance can hurt you.

If you are like me you pay your insurance and forget about it. This article is about how to avoid that sinking feeling when your insurance agent says your loss is not covered under JohnMenszer-1090932your homeowners policy. What you may not realize is that insurance companies exclude, or partially exclude, entire classes of losses. These fall into two main categories : correlated risk and moral hazard.

What insurance companies are afraid of paying for is really big catastrophes. If my house burns down that is catastrophic for me, but it is unlikely to affect the whole city. Since it hard to actuarially adjust the premiums for really big losses that happen infrequently, the companies tend to exclude them.

War is one example. Hurricanes are another. My homeowners policy states that flood damage is an exclusion “regardless of how caused” and goes on to state that flood includes “but is not limited to storm surge, waves, tidal water, overflow of a body of water, whether driven by wind or not.” Whew! If you want protection from flood loss get a flood insurance policy which is a government program.

Another factor to consider is that most policies in costal areas of the country now include enhanced deductibles for “Named Storm Damage” (Hats off to the storm-naming National Weather Service). Unlike a standard deductible which is a fixed dollar amount, the hurricane deductible is based on a percentage of the total insured dwelling value

So far we have been discussing correlated risk – multiple losses that can happen together. Another type of loss that insurance companies try to steer away from is moral hazard. Moral hazard is when the insured’s behavior changes in such ways as to raise the costs for the insurer.

But you might say, “all insurance affects behavior.” That is almost the point of insurance. If my camera is insured, you bet I’ll be more likely to take it on a canoe trip over the rapids. What the companies are concerned about are the hidden moral hazards, where having the insurance will be encouraging indifference. “Yes,” the company says we insure against loss, “but we don’t want to be ridiculous about it.”

Infestations of vermin are not covered. You really should wash the dishes in the sink and keep your house tidy. Mold is not covered. Fix that roof leak. If a bowling ball falls off your shelf and breaks your TV, shame on you.

To learn more about these questions check this National Public Radio Planet Money report.