Extend and Pretend Loss Mitigation Strategies In Shadow Inventory

Lenders who chose “Extend and Pretend” loss mitigation strategies will eventually realize these massive losses when they finally account for homes stuck in the “shadow inventory” for seven years.

A friend of mine here in Portland showed me a copy of the judicial foreclosure paperwork on one of his expired listings, pointing out the massive “Escrow Advances” incurred by the lender ever since the borrowers defaulted on the loan back in the Spring of 2008.

“Are you kidding me?  $40,470.04!!!!!  Holy sh*t!!!!  Seriously?  That’s horrible,” was my response.

Then I added up the rest of the default fees. $47,343.97! Ugh!

“Some public pension fund or insurance company is going to absorb the cost of this awful loss mitigation strategy. This is “Extend and Pretend” accounting at it’s finest.”

I kept looking at the cost breakdown on the paper and ran some numbers in my head about the lost revenue stream on the cash flow over the past 75 months.

The borrowers defaulted in 2008 with approximately $360,000 remaining on the mortgage. Monthly payments were $2,275 (Principal & Interest) at approximately 6.00%. The value of the home was about the same amount as the outstanding balance and falling fast until (we’re guessing) the price bottomed out at approximately $300,000 in 2009-2010. (The home appraised at $450,000 in 2007 when the owners refinanced at 80% LTV).

From Spring 2008 to mid-2010, the homeowners went back and forth with the lender (servicer actually – Fannie Mae owns the loan) about getting a loan modification before eventually filing for bankruptcy, which is less than 12 months from being completed. (They originally filed a Chapter 7 but their income just barely exceeded the threshold for a Chapter 7 and were switched to a Chapter 13 (the kind where you pay back a portion of the money)). The portion of the BK payments going to the lender is about $150/mo. The bank has received $7,200 since 2008 for this loan. Ridiculous, isn’t it?

Since Oregon is now a Judicial Foreclosure state with a six month Redemption Period (similar to Minnesota), this house is going to linger in the “shadow inventory” for about another 18 months until it hits the market priced around $325,000.

Here’s my estimate of the total costs associated with this loan:

  • $360,000    Mortgage Balance as of June 2008
  • +$47,343    Present Default Balance
  • +$20,000    Additional Default Charges – estimated (Taxes, Ins, Utilities, Municipal Fines, etc)
  • +$15,000    Property Repairs – put it back on the market
  • +$26,000    Closing Costs (@ $325,000)
  • -$9,000       Bankruptcy Income – Hooray!
  • $459,343     Total Costs Incurred up to the sale date sometime in the Spring 2016

Come Spring of 2016, this house will probably sell for $325,000 minus $26,000 in Realtor commissions and closing costs, netting Fannie Mae $299,000. Then subtract out the $99,000 in net default related expenses (see expenses above minus the $9,000 income from bankruptcy payments) and they are left with a $200,000 cash recapture. Fannie will lose about $160,000 on this loan.

Even though Fannie Mae is owned by the US taxpayers and doesn’t have any shareholders to answer to (except 317 million citizens who are mostly clueless when it comes to financial matters and definitely clueless about the bailouts of 2008), it’s still a shame that this “Extend and Pretend” strategy led to such a large loss on this one loan. Multiply that loss by several million additional loans still lingering in the shadow inventory and you start realizing that there are still hundreds of billions, if not a trillion dollars, in mortgage losses that need to be fully accounted for on the books of the largest financial institutions.