While the overall housing market is finally starting to recover following the mortgage crisis, homeowners in many areas are still severely underwater on their mortgages. Some cities and counties are exploring ways to help. To that end, a few have considered using the power of eminent domain to seize and restructure underwater loans. In fact, Richmond, California is moving forward with just such a plan. Not surprisingly, mortgage lenders are posing strong opposition to Richmond's plans.
Read on to learn more about how eminent domain works and how it could be used to help homeowners who owe more than their home is worth.
What Is an Underwater Mortgage?
Your home is considered underwater if you owe more to your lender than the home is worth. For example, if your mortgage is $400,000 and your home is worth only $350,000, you are underwater.
Being underwater creates problems for homeowners in several ways.
- If you need to move to a new location (to accept a new job or a higher paying job, for example), it is harder to sell your home.
- You may owe a deficiency if you go through foreclosure or a short sale. (Learn more about deficiency judgments.)
- You cannot refinance.
(To learn more, see Nolo's article What Is an Underwater Mortgage?)
During the recession, many people with underwater mortgages let their homes go through foreclosure. In neighborhoods with severely depressed property values, this meant many empty homes and the problems that accompany vacant homes (blight, further decline in property values, increase in crime, and the like).
What Is Eminent Domain?
Under the power of eminent domain, the government may forcibly take private property so long as it is used in a way that benefits the public. For example, property that is acquired by eminent domain could be used for new roads, schools, parks, and the like. If a property is taken by eminent domain, the owner is entitled to the fair market value in compensation.
Recently, some municipalities have proposed using eminent domain to:
- acquire underwater loans (by paying the fair market value to the lender)
- write down the loan principal to match the current property value, and then
- re-sell the reduced loans to new investors.
Example. Let’s say that the homeowner paid $400,000 for her home and financed the entire amount. As a result of the economic crisis, that home is now only worth $350,000. The municipality could take the property using eminent domain by paying the note holder $350,000. The reduced loan would then be sold to a new investor and the homeowner would end up with a lower mortgage payment and a new loan servicer.
Arguments For and Against Using Eminent Domain to Seize Mortgages
Since eminent domain is usually used to seize land, not mortgages, this is a novel and controversial idea.
Proponents claim that it will help end the financial crisis. They argue that housing prices may take years to recover and underwater mortgages will continue to drag down the economy if something is not done. Furthermore, it is in the public interest because this option will prevent foreclosure and allow people stay in their homes, which in turn helps keep neighborhoods from deteriorating.
Critics state that it will hurt the economy even more. The mortgage and investment industries have said that using eminent domain in this manner is an illegal overreach. They also claim that these types of plans pose a critical threat to the housing market and will actually increase the cost of borrowing because lenders will lose faith in the durability of contracts -- making it harder for people to get loans at decent rates.
Failed Eminent Domain Plans: San Bernardino County, Ontario, and Fontana
In 2012, local officials in California's San Bernardino County and two cities, Ontario and Fontana, proposed using the power of eminent domain to restructure underwater mortgages. However, the plan was abandoned after the public showed little support and Wall Street groups opposed it.
Learn more in our article The Underwater Mortgage Problem: A Solution in California?
Richmond, California, Moves Forward With Eminent Domain Plan
Just because the plan failed in San Bernardino County and the cities of Ontario and Fontana, this does not mean that the concept is dead.
Richmond, California is the first city to actually adopt a plan that will allow it to invoke eminent domain to restructure underwater loans. In July 2013, the city sent notices to the holders of more than 600 underwater mortgages, asking them to voluntarily sell the loans to the city for 80% or less of the home’s value. If the holders of the loans, who are mostly investors, refuse to sell then the city may move forward with using eminent domain to seize the mortgages.
Richmond will be an important test case since local governments and cities around the country, including El Monte, La Puente, Orange Cove, and San Joaquin in California, as well as North Las Vegas, Newark, and Seattle, are entertaining similar plans. How the situation plays out in Richmond will likely be an indicator of what will follow in other cities.
Backlash Against Eminent Domain Mortgage Seizures
The Federal Housing Finance Agency (the regulator of Fannie Mae and Freddie Mac, which own or guarantee 90% of all new mortgages issued in the U.S.) is threatening to limit, restrict, or cease business activities in cities, including Richmond, that use eminent domain to seize underwater loans from lenders.
Banks file suit to stop the plan. Additionally, two major banks (Wells Fargo and Deutsche Bank) filed a lawsuit seeking an injunction against the city of Richmond and its private partner in the eminent domain plan, Mortgage Resolution Partners (a for-profit investment firm), alleging that the plan is unconstitutional and illegal. The suit claimed that Richmond’s program targets performing loans (where the borrower is current on payments despite being underwater) because they are not at serious risk of default and therefore can easily be refinanced with a new loan for an amount significantly greater than the price paid by Richmond to seize the original loan.
The Bank of New York Mellon has filed a separate, similar suit against the city.
Judge dismisses Wells Fargo and Deutsche Bank's suit. In September 2013, a federal district judge dismissed the lawsuit filed by Wells Fargo and Deutsche Bank.
However, the city's eminent domain plan may fail anyway since the Richmond City Council is one vote short of the five-vote supermajority it needs to invoke its municipal authority to seize mortgages. California law requires a two-thirds supermajority in all eminent domain cases so unless there is a fifth vote in favor of using eminent domain, the seizure plan won't go anywhere.
If you are struggling to pay your mortgage or facing imminent foreclosure, visit our Foreclosure section for help.