Local Governments Taking Delinquent Homes?

Eminent Domain to seize private citizen's homes?If you’ve been following the news over the past few months you have probably heard about eminent domain. The definition of eminent domain is “an action of the state to seize a citizen’s private property, expropriate property, or seize a citizen’s rights in property with due monetary compensation, but without the owner’s consent.” But what does that mean?

It really means that the government can force you to sell them your home if it’s for the greater good. There are several reasons a government can use to obtain a property through eminent domain. Most typically it’s because they are expanding a freeway or need to build a government facility. However, they are trying to use delinquency as a reason. No matter what the reason, they must still pay the owner fair market value, they cannot just take it.

The plan would be to raise investor money and purchase thousands of delinquent homes. Then these homes could be sold to apartment operators or individual investors. The government sees this as a viable option to help get through the rest of the housing bust. To be honest, I could see this working.

However, if the governments started to use this power, it raises several other issues. They’ve never done this before, so it’s likely that this will start a new wave of law suits by the owners, if they do not want to sell. What do they have to argue? They aren’t paying the mortgage anyways. I am not an attorney, so I cannot speak to the legal precedence of a program like this; but in the distressed real estate business, stalling is the name of the game.

I think it’s unlikely anyone who brings a suit will prevail, they were going to lose the home eventually, but it’s clearly a good stall tactic. Homeowners and attorneys are using any means necessary to stay in the home longer; from claiming fraudulent foreclosures to bankruptcies. The implications here are serious, a bankruptcy really destroys your credit for the near term and makes it more difficult to use credit cards, get car loans, get home loans, rent a home or even get a job. Yes, a homeowner filing bankruptcy may get an extra 60-90 days to stay in the home for free; but what’s the true cost?

They rack up legal fees, which in the snap of a finger can add up to thousands of dollars, they destroy their credit (making it VERY difficult to rent a new place) and they forgo the free money the bank probably offered them via Cash for Keys.

Example

Let’s take a home worth $500,000 today. It’s easy to think there may be as much as $750,000 owed on that home. In my experience, a bank would offer up to $7,500 in Cash for Keys to the previous homeowner and allow 30 days to leave. If the homeowner rejects, the bank will evict, which can take 90-120 days, perhaps 150 days if a bankruptcy is filed. That’s a total of 4-5 months of “free” rent for the previous homeowner. To do the bankruptcy and extend the eviction as long as possible they will typically incur $3-5k in legal fees. Now let’s value their future monthly rent at $2,500 per month.

In the cash for keys scenario, they get $7,500 from the bank but must leave 3-4 months sooner. At $2,500/month, the bank is basically covering that difference with the $7,500 in cash for keys. The biggest difference is that in the eviction process they spend $3-5k in legal fees, plus they get an eviction and bankruptcy on their record. If you were a landlord, would you rent to someone with an eviction and a bankruptcy on their record in the last 30-90 days? To me, it’s an easy decision.

I digress. Back to the issue at stake, eminent domain. According to housingwire.com, the areas where this eminent domain program is being explored “San Bernardino County, Calif.; Suffolk County, New York; Chicago; and Berkeley, Calif” the mere threat of this programs seems to be working. “A higher percentage of underwater borrowers are still making payments, specifically in areas considering eminent domain to seize the loans and write down principal.”

I think this will give more credence to this program. Whether the higher percentage of borrowers making payments is caused by the threat of eminent domain or an improvement in the greater economy and real estate market has yet to be determined. However, I think it at least gives them what they need to raise capital and start trying this program out.

If done in moderation, slowly so as not to flood the market, I could see it really working. First of all, if the program does cause people to make their payments, it’s a no brainer, you have to proceed. Without a doubt it’s another reason for homeowners to pay. Secondly, the courts are very backed up dealing with these; it’s causing the process to take longer than it should.

As the article states, if borrowers stay current, there is no need for this highly controversial program anyways. Let’s hope that’s what happens. The best thing for everyone is that borrowers make their payments. The borrowers get to stay in their homes, the investors get their money and most importantly the housing markets and economy get much needed relief.

Sources:
http://en.wikipedia.org/wiki/Eminent_domain
http://www.housingwire.com/news/rbs-underwater-loans-hold-steady-without-eminent-domain
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