Banks are taking longer to complete the foreclosure process for homeowners with high-balance mortgages and those who have more than one home loan — in part because of changes in accounting rules that have allowed them to put off recognizing inevitable losses on those loans.

That’s the conclusion of Sean O’Toole, founder and CEO of ForeclosureRadar, after his company analyzed 153,956 foreclosure sales in California from January 2008 through early July 2011.

The analysis found that homes with loan balances larger than $417,000 (the conforming loan limit) were taking 396 days to complete the foreclosure process, compared with 286 days for homes with loan balances below that threshold.

While it’s taking longer and longer for lenders to complete the foreclosure process on all homes, regardless of loan balance, the foreclosure process has grown even more dramatically for high-balance loans and homes with

more than one loan. The “spread,” or difference in time to complete the foreclosure process for high- and low-balance loans, has grown from 16 days in July 2009 to 110 days two years later.

ForeclosureRadar estimates that the average loan balance on foreclosed homes with high-balance loans is currently about $616,000, and the average current market value was $404,000. After sales costs, ForeclosureRadar estimates lenders stood to lose an average of $250,000 when they foreclosed on those homes.

That compares to an average loss of $115,000 on low-balance loans with an average loan balance of $274,000 and a current market value of $176,000.

The speed at which borrowers are pushed through the foreclosure process “is directly tied to the size of the potential loss that the bank might face,” O’Toole concluded in a blog post summarizing the analysis.

“Perversely, this means those who took the biggest loans, on the nicest houses, with the largest lines of credit to buy lots of shiny new toys will also get the most free rent when they strategically default.”

O’Toole says there are many differences between California and other states, but told Inman News he believes that “the core issue here is more universal” and that analyses of other states would produce similar findings.

The discrepancy in foreclosure completion times seems to appear in early 2009 — around the time that the Federal Accounting Standards Board (FASB) loosened requirements that banks “mark to market” assets, including mortgage-backed securities, to current market values, O’Toole said.

When Treasury Secretary Henry Paulson announced the Troubled Asset Relief Program (TARP) in September 2008, “he made it clear that he didn’t think banks should have to write down these assets to — or be forced to sell them at — what he believed were distressed prices,” O’Toole said.

Pressure was then put on FASB to ease the mark-to-market rules, he said. Some have theorized that relaxing the rules created an incentive for lenders to “extend and pretend” with high-balance loans — essentially put off recognizing losses that could require some banks to raise more capital.

Regardless of the wisdom of such changes, “I think there is little doubt that the changes to these rules were necessary in order for the banks to pass the stress tests that were undertaken shortly after this accounting change was pushed through,” O’Toole said.

It has been a quiet week in the markets, shortened by Good Friday. Oh, Standard & Poor’s created a tempest with its threat to the AAA rating of Treasurys, but as the week wore on, more and more people asked, “How would they know?”

Stocks regained all losses, but Treasury bond yields stayed low, the 10-year at 3.39 percent and mortgages under 5 percent.

Bill Gross, famously dumping all of PIMCO’s Treasurys last month, has lost money on the trade. A federal budget deal is now likely; Europe is in trouble (again, Greek 2-year bonds paying 22 percent), and domestic data is weakening.

Sales of new and existing homes are flat, but distressed inventory is rising. The Federal Housing Finance Agency found that home prices fell 1 percent in January and another 1.6 percent in February.

The fascinating thing about housing, now: it’s no longer news. It’s so yesterday, boring. For seven months, media attention has focused on “Foreclosure Gate,” the so-called robo-signing scandal in which some loan servicers allegedly foreclosed on some innocent homeowners.

The reality is clear now, as then: Some servicers have mistreated borrowers by inattention, finding a work-around for the antiquated local-level foreclosure procedures. Servicers will be fined and newly regulated.

Media have found a handful of wrongly foreclosed families, but that preoccupation has missed this wisdom, attributed to Joseph Stalin: “A single death is a tragedy; a million deaths is a statistic” (if Stalin didn’t say it, he should have — the origins of this saying are cloudy).

The search for human interest has abandoned the real victims: Another 2 million households end up in foreclosure this year, 11 million underwater — and government help is going … gone.

Imagine if in 1937 Franklin Delano Roosevelt had said, “I see one-third of a nation ill-clothed, ill-housed, and ill-fed … but if we wait long enough, they’ll get over it.”

Everybody understands the basics: more houses for sale than buyers. However, even those in pain often don’t believe me when I say that credit is too tight and too scarce.

Today, two examples:

Fannie Mae, Freddie Mac and the Federal Housing Administration are the only remaining significant sources of mortgages, and they are frantically trying never to make another bad loan. One cause of default is fraudulent borrower documents.

Early in the 1990s, minutes after the invention of desktop publishing, the first borrower fabricated tax returns showing more income than the ones filed at the Internal Revenue Service. Minutes after that, Fannie, Freddie and the FHA required Form 4506-T in order to pull transcripts from the IRS.

For a while we actually checked, but so few fraudulent returns were found that the signed 4506-T became a threat but not an immediate act.

Since 2009 — as never before — every borrower must bring tax returns (not just the self-employed), and we must run a 4506-T every time. May a merciful Almighty save us this time of year, when the IRS could not find its back end with the help of a medical professional. Transcript delays have run six, even eight weeks.

How many fraudulent returns and defaulted loans are we really preventing? In a billion dollars of loans through here, I know of one case of fraud (a certified public accountant applicant), hundreds of innocent but odd 1040s questioned with red-hot tongs, and thousands of delays. Think Fannie, Freddie and the FHA are tracking cost/benefit? Uh-uh. Just tighten, baby, tighten.

A second example: the Dodd-Frank bill’s Qualified Residential Mortgage, qualifying for capital exemption in securitization. QRMs will require 20 percent down to buy, 25 percent equity to refi, forbid second mortgages … a belt tightened right through the backbone.

An FHFA study (released April 14, at www.fhfa.gov) found annual rates of 90-day delinquency pre-bubble (1997-2003) clustered between 2.5 percent and 3 percent for all loans — which is why Fannie, Freddie and the FHA charge to securitize loans, or require mortgage insurance. QRM-equivalent defaults ranged 0.31 percent to 0.55 percent, but were barely 20 percent of all loans.

By 2009, standards had so greatly tightened that all new purchase loans had a 0.3 percent default rate, and the QRM fraction 0.07 percent. No one need fear the wind-down of government-supported lending: it’s already done — although the 80 percent of supply, non-QRM loans are going to be expensive and scarce.

This self-defeating political backlash against Fannie, Freddie and the FHA has turned them into insurance companies offering hurricane coverage, but only for homes 200 miles from any ocean.

The recent exit of Wells Fargo from the reverse mortgage industry will become a critical point in time for lenders and mortgage companies with plans to service the financial needs of seniors.

Wells Fargo, the nation’s largest reverse mortgage lender, was the kingpin in the industry in more ways than one. It had 26.2 percent market share, according to the latest data from Reverse Market Insight, the largest network of reverse mortgage professionals and a money-making operation.

With Wells gone, now all of the reverse mortgage industry’s big-name players have left the business this year. Financial Freedom, Bank of America and Seattle Mortgage preceded Wells Fargo’s exit. Like the others, Wells Fargo indicated it was closing the reverse component to focus on its core mortgage business, or “forward” mortgages.

The bottom line is that anyone over the age of 62 who wishes to tap the equity in their home without making a payment to repay the debt will now have to show the ability to pay the property taxes and homeowners insurance needed to stay in the home. While seniors have never had to qualify to obtain the “conforming” Home Equity Conversion Mortgage (HECM) insured by FHA, the writing is now on the wall if the industry has any hope of succeeding.

The concept is not new for jumbo reverse mortgages. Atlanta-based Generation Mortgage targets owners with homes appraising between $500,000 and $6 million. Borrowers are required to show that they have the means to pay the taxes and insurance on their home. Unlike the popular HECM (Home Equity Conversion Mortgages), the jumbo reverse mortgage requires no mortgage insurance, but the interest rate on the program is higher.

Reverse mortgage funds can be distributed either in a lump sum, regular monthly payments, line of credit or in a combination of those options. When the house is sold, or the last remaining borrower dies or moves out of the home, the loan amount plus the accrued interest is repaid. The borrower can’t owe more than the value of the home.

For years, HECM loan servicers have been asking that a “financial assessment tool” be brought into play so that they could better predict the success rate of reverse mortgages. It would also allow lenders some discretion to reject applicants.

That way, they would limit the chances of having to foreclose on senior citizens with limited incomes — a public relations nightmare and financial hardship for all.

The U.S. Department of Housing and Urban Development (HUD) oversees the Federal Housing Administration, which is the agency that insures HECMs. When a homeowner fails to keep current on property taxes and insurance, HUD directs the loan servicer to foreclose on the home.

While mortgage insurance premiums are required on HECMs in the event the senior outlives the value of the home, the mortgage insurance does not cover the inability to pay taxes and insurance.

“Seniors with reverse mortgages paid the insurance premiums and other fees,” said Jeff Taylor, principal at Wendover Consultants and former head of Wells Fargo’s reverse mortgage division. “And now it’s like losing their car for not renewing their license plate.”

According to Reverse Market Insight, a provider of data and analysis for the reverse mortgage industry, approximately 5 percent of all HECM borrowers are behind on their taxes and insurance payments. Adding to that problem percentage is the number of “trailing spouses” who remain in the home after one spouse dies — but had never been vested in the reverse mortgage.

For example, let’s suppose a 75-year-old man marries a 60-year-old woman. The man has significant equity in his home and prefers to tap the equity in that rather than his other assets. Because much of the reverse mortgage is calculated around the age of the younger spouse, the woman “divests” herself from the house in order for the man to qualify for the reverse.

Years later, while driving his jet boat, the man suffers a heart attack and dies. The distraught widow wants to stay in the home. However, because she was not part of the reverse mortgage transaction, the loan becomes due and payable at the time of the man’s death. Does the lender really need the aggravation of forcing the widow to pay up or move?

Another negative component has been the inability of the estate to purchase the home at a short-sale price after the residents die or move out. For example, when the last parent leaves the home, the lender is due $200,000 on the reverse mortgage.

One of the children wants to buy the home. Because of falling home prices, however, the home is worth only $150,000. If the child wanted to buy the home before it hit the market the price to them would be $200,000 — or $50,000 more than the person on the street who could negotiate a short sale with the lender.

Reverse mortgages were never intended to pay off a first and second mortgage for a homeowner with absolutely no other means to pay their taxes and insurance. Reverses were intended to help seniors tap some of the equity in their homes to make lives more comfortable — not set them up for failure.

However, that is exactly why Bank of America, Financial Freedom, Seattle Mortgage — and now Wells Fargo — got out. The reputation risk created by HUD needs to compromise its reverse mortgage guidelines. And, homeowners need to find a way to pay their taxes (some counties offer deferral programs) and insurance if they expect to stay put.

Fannie Mae quietly made a rule change last week that could be of huge significance for cash buyers of houses — whether they’re investors or owner-occupants — starting immediately. Call it cash-outs for all-cash players.

The company modified its long-standing requirement that all-cash home purchasers must be on the title for at least six months before pulling out money from the house by obtaining a mortgage. Now you can do it — if you qualify — virtually overnight.

Under Fannie’s new “delayed financing” option, buyers paying cash to gain a competitive advantage — lower prices, cleaner and quicker deals than purchasers requiring financing — can now turn around and pull out substantial money from the transaction shortly after settlement.

Given the growing role of all-cash purchases in many markets, Fannie’s change could create new opportunities for players in the bank-owned, foreclosure and short-sale segments, including Realtors, small-scale investors and ordinary buyers who have access to ready cash.

All-cash purchases accounted for about 30 percent of total home sales nationwide between mid-April and mid-May, according to the National Association of Realtors. That’s up from just 12 percent in May 2009. In hard-hit markets such as Las Vegas, they’re even bigger — 53 percent of sales, according to DataQuick.

During the first quarter, all-cash purchases accounted for 63 percent of sales in the Miami-Ft. Lauderdale metropolitan area, according to Zillow.

Fannie Mae’s rule change allows some of these all-cash purchasers to tap their equity and put it to work elsewhere — perhaps buying additional real estate. Of course, there are some limitations and restrictions:

The mortgage cannot exceed the documented amount of the borrower’s initial cash investment in the house to be mortgaged. That’s no matter how much you subsequently invest on remodeling improvements.

The all-cash purchase must have been arm’s-length, with no conflicts of interest among the parties.
The purchase must be documented with a HUD-1 confirming that no financing was involved (i.e., there’s no existing mortgage lien on the property).

The sources of funds used for the all-cash purchase must be documented, including bank statements, personal loan documents or a home equity line secured by another property. But to the extent that loans were used for the cash transaction, they “will be required to be repaid on the new HUD-1.”

The loan-to-value (LTV) limit follows Fannie’s rules for cash-out refinancings. Generally, it’s a 70 percent LTV limit, but for owners of two to four investor units the maximum LTV limit is 65 percent. All of Fannie’s regular underwriting, credit and documentation requirements for cash-out refinancings also apply.

In its guide change on June 28, Fannie offered no rationale for liberalizing its rule out of the blue. A Freddie Mac spokesman, Douglas Duvall, said in an email that his company not only is retaining its six-month seasoning rule, but “we are not considering a change to this requirement.”

Fannie Mae spokeswoman Amy Bonitatibus said that her company is making its change to serve the growing number of purchasers making all-cash offers to obtain advantageous pricing.

“Why not have that option and close that deal?” she asked in an interview.

My own interpretation is that Fannie has concluded, “Hey, why leave money on the table? Why not generate new business by providing thousands of credit-qualified buyers with a lot of cash a way to liquefy their investment rather than leave it tied up for half a year? Give them a quick cash-out tool but insist they also have adequate skin in the game.”

Initial reactions from investors and Realtors appear to be mainly positive. Tom Demogenes, an agent at Re/Max Realty Team in Cape Coral, Fla., said he sees “no downside, only an upside” in his local market, where he estimates about one half of sales are all-cash.

Demogenes said cash buyers get an average 5 percent to 7 percent price break compared with purchasers needing financing to close, and they virtually never lose head-to-head competitions for houses.

Paul Skeens, CEO of Colonial Mortgage Group in Waldorf, Md., and an active investor in some of the foreclosure-burdened suburbs south of Washington, D.C., welcomed Fannie’s loosening of its rules on cash-outs. But he’s concerned that the fine-print restrictions might be problematic for investors.

For example, he said, the limitation on maximum loan amounts to a buyer’s initial cash investment will be a serious obstacle for investors who buy homes requiring major repairs and upgrades — some of which may exceed the price they paid in cash for the house itself.

Other aspects of the new option could also prove challenging, such as the documentation of sources of cash and the payoff of any existing liens on the property to be financed.

Skeens, for instance, uses a commercial line of credit — across-collateralized by personal and business assets — to draw down funds for cash purchases of houses. He said he is not sure how the delayed financing program would treat that source of funds.

Despite these limitations, Skeens said Fannie’s new option “is great — I love it. And I think it’s going to work for a whole lot of buyers.”

In today’s down market, many homeowners are reluctant to pour more money into their homes. Before deciding whether to replace a roof or merely patch it, homeowner’s should consider the tax implications.
Home improvements — a new bathroom or kitchen, for example — can increase the value of a home and reduce any taxes due on the profit earned from its sale.

Home repairs provide no immediate tax benefits to a homeowner. They are not tax deductible and they are not added to the home’s basis (cost), for tax purposes. As far as taxes go, they are a nonevent. Thus, a homeowner who patches a leaky roof gets not tax benefits.

Home improvements are very different, though. The cost of an improvement is not deductible, but it is added to the home’s basis for tax purposes. For example, the cost of adding a new roof to a home is added to its tax basis. This reduces any taxable gain when the home is sold.

Of course, a substantial amount of gain is usually tax free, anyway, under the home sale tax exclusion: $250,000 for single homeowners and $500,000 for married owners filing jointly. But homeowners with substantial equity can still benefit from an increased tax basis in their homes.

For example, if Joe and Jane purchased their home in 1990 for $250,000 and it is now worthy $1 million, they will have a $750,000 gain. A full $500,000 of this amount is tax-free because Joe and Jane are a married couple and qualify for the tax exclusion.

But this leaves $250,000 subject to taxation. If Joe and Jan had spent $250,000 adding improvements to their home, they would have no taxable gain. This is because the $250,000 is added to the home’s original $250,000 basis, providing an adjusted tax basis of $500,000.

As a result, their gain on the sale would only be $500,000, not $750,000; and this entire gain would be tax-free because of the $500,000 exclusion.

So how do you tell the difference between an improvement and a repair? Here’s the basic rule provided by the Internal Revenue Service: A repair keeps a homeowner’s property in good operating condition but it does not:

-Materially add to the value of the property
-Substantially prolong its useful life, or
-Make it more useful (see: Treasury Regulations, Subchapter A, Section 1.162-4).

In contrast, an improvement adds to the value of a homeowner’s property, prolongs its life, or adapts it to new uses.

The problem with this definition is that virtually all repairs increase both the value and useful life of the property being repaired. The key difference between a repair and an improvement is that a repair merely returns property to more-or-less the state it was in before it stopped working properly. The property is not substantially more valuable, long-lived, or useful than it was before the need for the repair arose.

In contrast, an improvement makes property substantially more valuable and/or long-lived or useful than it was before the improvement.

You need to compare the situation before and after you made the expenditure involved. Have you just returned your property to the state it was in before the need for the repair arose? Or, have you made it much better?

If the answer to the first question is “yes,” you’ve repaired the home. If the answer to the second question is “yes,” it’s a home improvement.

Good examples of repairs include repainting a home, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows. Examples of improvements include adding a deck to a home, a new bathroom, installing a new heating system, or putting on a new roof.

Next week we’ll discuss how homeowners can make sure that the IRS will view their changes as home improvements rather than repairs.

Wells Fargo announced it would no longer accept reverse mortgages through its broker network, and last week it got out of the industry altogether.

Wells Fargo, the nation’s largest reverse mortgage lender, was the kingpin in the industry in more ways than one. It had 26.2 percent market share, according to the latest data from Reverse Market Insight, the largest network of reverse mortgage professionals and a money-making operation.

It simply did not like the road ahead.

HUD has been considering lowering the maximum borrowing amount for its reverse mortgage. In addition, lenders are concerned that if taxes and insurance payments are not kept current on homes, they could be forced to foreclose on cash-strapped seniors. No lender is eager to do so.

A reverse mortgage historically has enabled senior homeowners to convert part of the equity in their homes into tax-free funds without having to sell the home, give up title, or take on a new monthly mortgage payment. Reverse mortgages are available to individuals 62 and up who own their home.

The maximum amount of funds received is based on age, current interest rates and a current home appraisal. Funds obtained from the reverse mortgage are tax-free.

“Reverse mortgages and HECM loans are readily available to seniors as an important tool to help them stay in their homes and to fund their longevity,” said Peter Bell, president of the National Reverse Mortgage Lenders Association. “The decision by Wells Fargo that it will no longer originate new reverse mortgage loans does nothing to change this. The HECM program remains a relevant tool and the vast need for it continues.”

In April, reports show Wells closed 1,317 reverse mortgages and its annual total for 2010 came to 16,213 FHA Home Equity Conversion Mortgages. While its monthly average was down slightly, overall volume did not appear to have any substantial change leading up to the exit.

All of the reverse mortgage industry’s big-name players have left the business this year. Financial Freedom, Bank of America and Seattle Mortgage preceded Wells Fargo’s exit. Like the others, Wells Fargo indicated it was closing the reverse component to focus on its core mortgage business, or “forward” mortgages.

Earlier this week, Vicki Bott, HUD’s deputy assistant secretary for single-family housing, announced she was leaving to focus more time and energy on personal family matters.

Bott hastily uprooted her family in Austin, Texas, and moved to Washington, D.C., to help supervise FHA’s single-family loan programs during a period of unprecedented growth as the nation slowly dug itself out of a housing foreclosure crisis. Although she supervised a staff of hundreds focused primarily on FHA’s “forward” mortgage programs, she had a profound impact on the HECM program.