The buy-and-bail is a rapidly growing real estate strategy in which homeowners who are underwater on their home quickly buy a new home at today’s low prices and allow the old home, with the inflated mortgage, to go into foreclosure. For example, say a pair of homeowners bought their home two years ago for $400,000 and now it is worth $200,000. So rather than keep the existing home and its inflated mortgage, before their credit gets damaged they go buy a new home for today’s price of $200,000 and let the old home go to foreclosure. Works great for them, right? Sure, their credit will be bad for a few years, but surely they find that is worth $200,000.
A debate has emerged in the real estate industry about whether this is a legitimate strategy or simply mortgage fraud. Nevertheless the practice is growing and there are even real estate agents out there who are coaching homeowners on how to do it.
I will start off by saying that the buy-and-bail strategy, as it is most widely used, is most definitely mortgage fraud. The main reason I can say this without a doubt is that in practice, homeowners typically lie to the lender when they apply for their new loan. The homeowner will tell the lender that they are planning to rent the home out and give an inflated value for what they expect to get in rent. Since the homeowners' intention is in fact to let the home go into foreclosure (and they may or may not even attempt to actually rent it out), they are deliberately deceiving the lender. Any time a borrower deceives a lender, you can bet they are committing fraud.
Lenders are starting to wake up to this scam, though. Fannie Mae recently upped the waiting period for borrowers with a foreclosure on their credit to get a loan from four years to five. In addition, they also will require a minimum down payment of 10 percent for these borrowers, according to The Wall Street Journal. They are hoping that borrowers will see how a foreclosure can ruin their future prospects and think twice about going through with strategies such as the buy-and-bail.
Lenders also have the ability to sue borrowers if they find that fraud has been committed. And while it is questionable whether or not they will actually start suing borrowers for damage, it is an option they have available to them. The most successful defense lenders have is the one that many lenders are beginning to turn to. Basically, they are changing the loan guidelines to require homeowners who claim they are going to rent out their old home to provide a fully executed lease agreement. In addition, borrowers are also required to have sufficient income to cover both mortgages, unless they have at least 30 percent equity in the home. IndyMac has already changed to these guidelines and Fannie Mae is planning to make the switch as well, according to The Wall Street Journal.
I think this last strategy will go a long way toward solving the buy-and-bail problem. People who have enough income to cover both mortgages are probably unlikely to default, and those who have 30 percent equity in their home would likely sell before losing their home and equity to foreclosure. The disturbing part to all of this is that there are real estate agents out there who think that this buy-and-bail practice is completely okay--and who are even promoting and coaching the practice. This is a scam that is costing lenders a lot of money, and whether or not you feel sorry for the lenders, it is still wrong. It is also my belief that these real estate agents and other promoters need to be punished right alongside the homeowners--and probably even more severely. The agents know, or should know, it is wrong, and the fact they are helping homeowners to do this is inexcusable.
Labels: housing bubble , real estate
