Good Deeds.calhFA Report

8/3/2019 Good Deeds.calhFA Report

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Good Deeds Punished:

State-Run MortgageLender Forecloses onCalifornians Currenton Their Loans

Caliornia Senate Oce o

Oversight and Outcomes

A report prepared for the California Senate RulesCommittee

October 24, 2011

Prepared by John Hill

John AdkissonJohn HillDorothy KorberNancy Vogel


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october 24, 2011

Caliornia Senate Oce oOversight and Outcomes

Prepared by John Hill

Good Deeds Punished:State-Run MortgageLender Forecloses onCalifornians Current

on Their Loans


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Table o Contents

Executive Summary 1

Good Deeds Punished: Californias State-Run Mortgage LenderForecloses on Californians Current on Their Loans 5

Sidebar 1: CalHFA Gambled in Hot Housing Market,Now Pays the Price 9

Sidebar 2: How Other States Deal with Renting 15


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Oversight and OutcomesOctober 24, 2011

Executive Summary

Despite the housing slump, the California Housing Finance Agency istaking an unusually strict line with borrowers who are trying to avoid severelosses by renting out their residences, in some cases foreclosing even thoughthe borrowers are willing and able to continue paying. The practice notonly puts borrowers in a bind it costs the agency money.

Battered by the real estate downturn, the Caliornia Housing FinanceAgency, known as the states aordable housing bank, recently shited itsocus rom making low-interest home loans to reducing oreclosures inthe overall market.

Preventing oreclosures will not only benet the amilies directly impacted,it will help stabilize neighborhoods, communities and the entireCaliornia economy, according to the state agencys latest annual report.

Yet CalHFA is orcing some o its own borrowers into oreclosure - eventhough they stay current on their mortgage payments. The agency istrapping others in homes that they have outgrown.

These borrowers want to rent out their CalHFA-nanced homes becauseo a change in lie circumstances, such as getting married or havingchildren. In a normal real estate market, they would have sold theirhouses or condos and paid o their mortgages. Selling now means severelosses. Instead, they hope to lease out their residences until the housingmarket begins to recover.

But unlike state housing nance agencies in most other states, CalHFA ishewing to a strict policy o allowing rentals only i the borrower is acingan unoreseen economic hardship such as the loss o a job.

It has oreclosed on at least 21 borrowers who were violating itsrequirement that a borrower occupy the home or the lie o the mortgage.That number may just be the start. Another 49 borrowers who rented outtheir residences are delinquent, likely headed or oreclosure. Still more,186, are renting out their CalHFA-nanced homes without permission.CalHFA is telling these borrowers they must return to their homes, payo their loans in ull, seek a waiver or ace oreclosure.


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Much o this activity has occurred within the past year. So ar in 2011,the agency has sent out 218 acceleration letters, notiying borrowersthat they are in technical deault and must take action or ace oreclosure.

As the housing crisis continues, these numbers will keep growing.

The agency says it doesnt know how many borrowers were deniedpermission to rent and as a result remained in homes they no longerconsider suitable or moved back in to avoid oreclosure.

Nor does it seem to have a rm grasp on the size o the problem. BetweenMay and October 2011, the agency provided the Senate Oce o Oversightand Outcomes three widely varying sets o statistics o borrowers whowere denied permission to rent or renting without its approval.

The state o aairs at CalHFA should not be conused with the largeroreclosure crisis among private lenders, in terms o the number o peopleaected or the causes. But the relatively small number o borrowers squeezedby CalHFAs policy nd themselves in a unusual situation not seen in theprivate sector: They are willing and able to live up to their commitments,only to be told that their mortgage payments will no longer be accepted.

Among those who have run aoul o CalHFAs policy is Marcia Wold.The Mountain View school teacher bought a condo in Sunnyvale witha CalHFA loan. She loved living in a quiet place with a pool a ew stepsrom her door, so happy to have her own washer and dryer that sheactually looked orward to doing laundry. But ater marrying a man witha young son rom a previous marriage, she concluded they could not livein her 724-square-eet place. She moved into the house that her husbandco-owns with his parents.

Even ater she rented out her condo, she was losing $1,000 each month.Still, she was determined to meet her obligation to keep paying her noteuntil she could sell or renance. Somehow, CalHFA ound out she wasrenting and oreclosed.

Wold cried the weekend beore the oreclosure sale.

They took away a part o me, because I worked so hard or it, she said.This represented that I had made it. And they took that away rom me.

CalHFA also denied Wolds request to orego reporting the technicaldeault to credit reporting agencies. Her credit rating has dropped rom astellar 802 to 679, complicating the couples hopes to renance the LosGatos house where they now live.


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Other borrowers told our oce that they are remaining in or returning toproperties they have outgrown to avoid oreclosure.

I think its a horrible program, Dan, an active duty member o the Navy,said in an interview. Dan is headed or oreclosure because he rentedout his 820-square-oot condo at a loss ater getting married and having achild. Its almost like predatory lending. You expect something like thatrom Countrywide, but not rom (an entity) with the name Caliornia inthe title.

Not only does the policy disrupt the lives o the borrowers it costsCalHFA money. Each oreclosure, on average, translates into $38,000 inuninsured losses or the agency. Now that two CalHFA insurance undshave been wiped out by oreclosures, each new deault costs more than$50,000 in uninsured losses.

CalHFA ocials say they must adhere to the policy because o an opinionrom the bond counsel or many o its issuances. The bond counselinterpreted a section o the Internal Revenue Code as prohibiting renting.It advised CalHFA that ederal law requires a borrower whose loans comerom tax-exempt bonds to remain in the residence or the lie o the mortgage.

Most other states surveyed by our oce, acing the same wave o rentalrequests rom distressed homeowners, interpret the IRS code dierently.They say that its enough or borrowers to live in the property or areasonable time. Only two states Nevada and Georgia maintainpolicies o oreclosing on borrowers who rent but are current on theirpayments. A Georgia ocial said his agency has not had to resort to thattype o oreclosure or several years.

The IRS limits the number o loans that dont comply with the owner-occupancy requirement to 5 percent. CalHFA ocials believe thatexceeding the cap could threaten the tax-exempt status o the bonds thathave traditionally unded their single-amily loan program.

Yet, even i the agency granted a waiver to every property now beingleased without permission, the total would add up to only 1.68 percent oits loans well below the IRS limit.

Ocials or other state housing agencies say that another reason theydont oreclose is to avoid nancial losses. They also point out thatoreclosing on borrowers who are in a bind because o the upside downmarket runs counter to their mission.

Were not going to be oreclosing on homes i theyre making their


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mortgage payments in this market, said Lisa DeBrock, homeownershipprogram manager or the Washington state Housing FinanceCommission.

Minnesota is one o the states that take a more orgiving approach. Yearsago, the state decided not to oreclose on borrowers who moved out andrented because o a change in lie circumstances.

As a Minnesota Housing ocial told our oce, Lie happens down theroad.


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Good Deeds Punished: State-Run

Mortgage Lender Forecloses on

Caliornians Current on Their Loans

Marcia Wold worked three jobs so she could aord to rent an apartment

in Silicon Valley. She ended up with one that was smaller than theMountain View high school classroom where she taught math. Even thatwas a stretch. At the end o each month, when she ran out o cash, sheracked up more credit card debt to pay or ood and gas.

Ater years o nancial struggle, she still harbored hopes o owning herown place. So when she heard about a Caliornia program that wouldallow her to buy with no money down, she didnt hesitate. In 2005 shebecame the owner o a Sunnyvale condo.

Six years later, the bank oreclosed. Like so many others in the housing

bust, Wold ound it impossible to hold on.

The dierence: Wold never missed a mortgage payment.

Wold and others like her are losing their properties, trapped in dicultliving situations or selling at a loss as a result o a decision by the CaliorniaHousing Finance Agency to deny many borrowers permission to rent outtheir ormer homes. Wold moved out o her CalHFA-nanced condobecause she married a man with a child rom a previous marriage andconcluded the three could not live in her 724-square-oot condo. Rentingthe condo made sense since she could not sell without taking a huge

nancial hit.

A total o 235 CalHFA borrowers are currently renting out their propertieswithout permission rom the agency. CalHFA has oreclosed on 21 othese loans. The agency cannot say how many, like Wold, would havecontinued paying o their loans.

Another 49 loans are delinquent, putting them at high risk or oreclosure.A much larger number 186 are in limbo, renting without permissionbut current on their payments. These borrowers are receiving an


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ultimatum rom CalHFA: move back in, pay the loan in ull, apply ora rental waiver or ace oreclosure. Since the beginning o 2011, 218borrowers have been sent acceleration letters inorming them that they

owe the unpaid balance o their mortgages unless they take corrective action.

An unknown number have been denied rental waivers and either decidedto sell, stay in the property or move back in to avoid oreclosure. Manyo these borrowers have outgrown their CalHFA-nanced residences but,prohibited rom leasing the property, live in cramped quarters. As thehousing crunch continues, more will run aoul o CalHFAs policy.

These numbers palein comparison to thetally o homeownerswith mortgages romprivate lenders whohave gone throughoreclosure in a largercrisis that has nothing todo with CalHFA or itspolicies. But the CalHFAborrowers ace a highlyunusual situation notseen among privatelenders they want tokeep paying but havebeen told they cant.

Most other states contacted by the oversight oce are taking a morelenient approach. Although each state policy is unique, all but two o thestates contacted by the oversight oce said they are not oreclosing onborrowers or violating the owner-occupancy requirement, as long as theyare current on their payments. Only Nevada and Georgia have policiessimilar to Caliornias. Georgias agency said it had not oreclosed on aborrower who rented or several years.

Caliornia borrowers who go through oreclosures take a hit to theircredit rating, with implications or getting a job or renting an apartment.CalHFA insists on inorming credit reporting agencies o these borrowerstechnical deaults even though they continue making payments until theend. In addition, the borrowers lose out on the possibility o regainingequity in the property when the housing market bounces back.

But the ill eects are not limited to borrowers. CalHFA loses moneyon each oreclosure an average o $37,839 o uninsured losses per

Marcia Wold in ront o the Sunnyvale condo she lost to oreclosure.


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oreclosed property. As a result o oreclosures among all its borrowers,not just those who rented, CalHFA has burned through its mortgageinsurance und and a special gap insurance und, as well as some o

the reserves it had accumulated in its bond indenture. Thats driven upuninsured losses to $56,000 per oreclosure in the most recent quarter.

Foreclosures, in general, are well known to cause undesirable rippleeects. They drive down property values o nearby homes. The Centeror Responsible Lending estimated in 2009 that price declines on homeswithin an eighth o a mile o a oreclosed property averaged $7,200. Thedecreased value o the oreclosed property and nearby houses translatesinto reduced property taxes or schools and other public services.

CalHFA oreclosures can also lead to evictions o tenants who were livingin the borrowers property.

CalHFA itsel has emphasized the importance o preventing oreclosures.With its single-amily home loan business drastically reduced, CalHFAhas ocused on using ederal unds to minimize oreclosures in the overallhousing market.

Preventing oreclosures will not only benet the amilies directlyimpacted, it will help stabilize neighborhoods, communities and theentire Caliornia economy, Peter Carey, acting board chairman, and L.Steven Spears, then-executive director, wrote in an introductory messageto the agencys most recent annual report.

Borrowers Rent to Avoid Losses

Many o the CalHFA borrowers moved because o an unoreseen changein lie circumstances. They got married, had children, or needed tomove in with elderly parents to take care o them. In normal times, theywould simply have sold their CalHFA-nanced homes. But in the upsidedown housing market, they cant sell without absorbing substantial losses.They cant renance because the amount they owe is greater than thedepressed value o the property. Even though they are willing and able tocontinue paying o their loans, they are given an ultimatum by CalHFA:move back in, pay back the loan in ull, renance or ace oreclosure.

Ater getting married in 2010, Wold moved into a Los Gatos housethat her husband, Ken, owns jointly with his parents. She let thecondo vacant or several months beore she ound renters. Even then,ater paying a commission to a property management company andhomeowner association dues, she was losing $1,000 a month.


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Somehow, CalHFAs mortgage servicer ound out she was renting. Andon Valentines Day 2011, the condo was auctioned o in a oreclosure sale.

The weekend beore, I would be sitting on the couch Ken would lookat me and Id be crying, Wold recalls. They took away a part o mebecause I worked so hard or it. This represented that I had made it.

And they took that away rom me.

Other borrowers, intent on avoiding oreclosure, nd themselves trappedin places that are too small.

A San Diego law enorcement ocer told the oversight oce that hesoutgrown the 500-square-oot apartment conversion he bought witha CalHFA loan in 2005. He was engaged to be married at the time,and now lives in the one-bedroom, one-bath place with his wie and16-month-old child.

It puts a strain to the whole amily situation, especially with the little onerunning around, he said.

Hes now preparing to ask CalHFA or a rental waiver, but the researchhes done on the policy leaves him little hope.

The stipulation that youve got to live there the lie o the loan is notrealistic, he said.

CalHFA says that it is bound by ederal laws and regulations. CalHFAmortgages are underwritten by tax-exempt bonds. In return or thetax exemption, state housing nance agencies must adhere to restrictionson how the money is used. Years ago, beore the housing market collapsed,one o the agencys bond counsels concluded that the Internal RevenueCode, with some narrowly dened exceptions, requires borrowers to livein homes nanced by bond proceeds or the duration o their mortgages.I CalHFA allowed too many borrowers to rent, the bond counsel advised,the agency might jeopardize the tax exempt status o its bonds.

All o what were doing here is to make sure we can honor our obligationsto bondholders, Bruce Gilbertson, the agencys director o nancing,said in an interview with the oversight oce.

But housing nance ocials elsewhere have reached a dierent conclusion.Ocials in other states, chosen or our survey because o their size orhigh rates o underwater mortgages, said that, like their counterparts inCaliornia, theyre dealing with a wave o borrowers who rented out theirproperties. But most said they interpreted the Internal Revenue Code to


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require that the borrower intended in good aith to move into the propertyrather than setting out to be a landlord. They dont believe, in the currentmarket, that the IRS would crack down on states that allow distressed

homeowners who lived in the property or a reasonable time to lease.

Minnesota is one o the states that take a more orgiving approach thanCaliornias. It decided years ago not to oreclose on borrowers whomoved out because o a change in lie circumstances, as long as theystayed current on their loans.

Lie happens down the road, said Barb Spiess, a sta member atMinnesota Housing.

A Wave o Requests Led to CalHFA Policy in August 2010

Beore the housing market collapsed, CalHFA prohibited leasing ohomes by borrowers with very limited exceptions, according to a stamemo on August 8, 2010. The agency reasoned that the program was notmeant to set up borrowers as landlords.

With the recession, CalHFA started getting many more requests to allowrentals. Sta granted more exceptions than it had in the past, whenborrowers did not ace devastating losses rom selling homes that wereworth much less than they had paid.

But the agency ound itsel in a bind, according to the memo. It had basedits original policy not to grant most rental requests on advice rom its bondcounsel at the time, Orrick, Herrington & Sutclie. Orrick opined thatone section o the Internal Revenue Code prohibited commercial uses oproperties unded by tax-exempt bonds, a denition that included rentals.

In 2005, CalHFA hired another rm, Hawkins, Delaeld & Wood, tohandle its new single-amily issuances. Hawkins disagreed with Orrick onthe question o rentals. It advised the agency that the Internal RevenueCode section required only that the borrower intended to live in thehouse, not stay there or the lie o the mortgage.


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Faced with conficting opinions, CalHFA sta attempted to come up witha policy that would reconcile them and that both bond counsels couldendorse. The policy went into eect in August 2010. It prohibited rentals

unless the borrower could document one o the ollowing involuntarynancial hardships:

Reductioninincomebecauseofreducedhours,paycuts,oranewjob. Aninvoluntaryincreaseinlivingexpensesormedicalcosts. Aninvoluntaryjobtransfer,includingamilitaryposting,witha

possible return in one year. Beingforcedtolookforajoboutsidetheareawiththepossibilityof

return, or selling or renancing the home, within a year.

Several months ater this policy was approved, the agency added anothereconomic hardship exemption. Starting in 2005, CalHFA, in an attempt tokeep up with the private mortgage market, started oering unconventionalmortgages, such as a 35-year-loan with the rst ve years interest-only.These borrowers aced increased mortgage payments ater the rst veyears. CalHFA amended its policy to include those increased paymentsas an involuntary economic hardship qualiying the borrower or anexemption to the no-rental policy.

Even borrowers who met the criteria were allowed to rent out their homesor only a year, with the possibility ater that o extensions. The policy alsostipulated that under no circumstances could rental exceptions exceed 5percent o total single-amily loans, the cap cited in the Internal RevenueCode. I the number approached 5 percent, all requests would be denied.

It is driven by our desire to stay within what our bond counsel says is saeharbor, to stay under 5 percent, Charles McManus, the agencys directoro mortgage insurance, said in an interview with the oversight oce. Weuse hardship guidelines as our monitor or whats approved and whats notapproved. We try to be very consistent.

As o mid-September 2011, about 1.68 percent o residences paid orby CalHFA loans were occupied by renters. This number included 147properties that received rental waivers rom CalHFA and another 235that were being leased without permission. That means that even i theagency granted waivers to every borrower whose property was beingrented, the total would be 1.68 percent - well below the 5 percent cap.I CalHFA takes action against all o those who are renting withoutpermission orcing them to sell, move back in or ace oreclosure thetotal percentage o renters would be only 0.6 percent.

But the agency has chosen to take a conservative approach.


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In part, thats because other borrowers may be renting without CalHFAsknowledge, said Di Richardson, CalHFAs director o legislation. Therecould be another two percent we dont know about, she said pushingthe agency closer to the 5 percent limit.

I the agency hit the limit, she said, it would not be able to grant any morewaivers, regardless o each borrowers circumstances.

We wouldnt be able to accommodate those that did have a hardship,she said.

Internal Revenue Code Focuses on Borrowers Intentionto Move In

Internal Revenue Code Section 143 requires that 95 percent o borrowersoccupy the homes that were nanced by tax-exempt bonds. But thelanguage ocuses on borrowers intentions when they take out the houseloan rather than subsequent actions years later. Experts in the eld rely onthat language or their interpretation that borrowers who rent because o ahardship or change in circumstances are not in violation o the code.

Section 143 requires those who issue tax-exempt mortgage bonds, such asCalHFA, to make a good aith attempt to assure that borrowers intend tooccupy properties as their primary residences. Ninety-ve percent o thebond proceeds must go to residences that met the requirement o owneroccupancy at the time the mortgages were executed. Residences intendedto be used as investment properties or vacation homes do not qualiy ormortgages unded by the tax-exempt bonds. Any deviations rom theserules must be corrected within a reasonable time ater being discovered,according to the ederal law.

U.S. Department o Treasury regulations urther speciy that to meet therequirement o good aith, bond issuers or their loan servicers must spellout the owner occupancy requirements in mortgage documents. Bondissuers such as CalHFA must also establish reasonable procedures, such

as investigations, to assure compliance with the owner-occupancy andother requirements.

The regulations themselves describe what this looks like in practice.Say that a bank acting as loan servicer or a state housing nance agencygets signed adavits rom borrowers that they intend to move into theproperty within 60 days and to maintain it as their primary residence.

The state, according to Treasury regulations, has met the test o a goodaith eort. I this occurs in 95 percent o cases, the state is in compliancewith Internal Revenue requirements.


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But what i a borrower moves out and leases the property? Borrowerstranserred by their employers to another part o the country or orced bymarket conditions to rent out their ormer homes would not be consideredout o compliance, according toABCs of Housing Bonds by Joseph P.Rogers, Jr. and Howard Zucker, recognized as a leading publication in theeld. (The two authors are bond counsels or Hawkins, Delaeld, the lawrm hired by CalHFA in 2005 to handle its single-amily issuances.)

Since the test is whether the residence can reasonably be expected tobecome the principal residence o the mortgagor, a loan should not betreated as an unqualied loan where unoreseen circumstances orce amortgagor to lease the residence, the authors wrote.

Treasury regulations speciy that such borrowers, i they are gone ormore than a year, cannot claim the deduction or mortgage interest.But even then, Treasury is authorized to allow the deduction i theailure to meet the residence requirement resulted rom circumstancesbeyond the mortgagors control.

Sujyot Patel, a partner in the law rm Peck, Shaer & Williams inCincinnati, told the oversight oce that he advises clients that they mustdevelop consistent procedures to show that the homeowner intendedto move into the property and did live there or a period o time. Peck,Shaer is the bond counsel or Georgia, Louisiana and Ohio andunderwriters counsel in Kentucky.

We say home ownership has to be there, Patel said. I the person movesout ater three months, then the housing agency didnt do a good enoughjob o screening.

But the rms advice also takes into account the reality o current times,Patel said a perect storm in the housing market that can leaveborrowers acing severe losses i they are orced to sell. As long as thehousing agency has done its due diligence when the loan was made,Patel said, it has the fexibility to look at rental requests case-by-case,

taking into account whether the mortgage is underwater. Such waiverscan be reviewed or possible renewal every year, he said.

Patels rm advises clients that there has to be real economic hardshipor a homeowner to qualiy or a rental waiver. An example would bea borrower who no longer could aord the mortgage payments but wasunable to sell without taking a huge loss.

The rm has not ormulated an opinion about borrowers who movedout because they got married or had children or experienced another


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change in lie circumstance. But as long as an agency has a clear policyand applies in consistently, Patel said, there is little chance o the InternalRevenue Service investigating and almost no chance that it would strip a

bond issuance o its tax-exempt status.

I just cant see that the service would ever declare these bonds taxable,he said.

L. Steven Spears, CalHFAs chie deputy director, nds little comort insuch assurances: I the IRS does not intend to enorce the rule in thedepressed housing market, why hasnt it issued a clarication?

That would be really, really helpul, Spears said.

The oversight oce contacted the Internal Revenue Service seekingsuch a clarication. Through a spokeswoman, the IRSs Compliance andProgram Management section responded that a residence must be onethat can be reasonably expected to become the principal residence othe mortgagor within a reasonable time ater the nancing is provided.

Among the actors that go into this assessment is the good aith o themortgagor. A residence may not be used as an investment property.Bond issuers such as CalHFA are given the latitude to resolve violationsas long as they made a good aith eort to comply with the law, havea 95 percent compliance rate overall, and correct violations within a

reasonable time. The IRS declined to make anyone available or aninterview.Most States in Our Survey Take a More Lenient ApproachThan Caliornia Does

The oversight oce surveyed 20 states covering more than two-thirds othe U.S. population, including large states and those with a high rate ounderwater mortgages, to nd out how they were handling borrowers wholeased out their properties.

Several said that the problem has become acute since the housing bubbleburst.

Were seeing so much more o that now, its unortunate, said SandyGaver, single amily program manager o the Florida Housing FinanceCorporation.

Each state housing nance agency has its own way o dealing with thedilemma. But only two o the states we contacted have policies similarto Caliornias. They, too, oreclose on borrowers who are current on


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STATEHOUSING FINANCE AGENCY POLICY

ON BORROWERS WHO WANT TO RENTACCEPTABLE REASONS

Arizona reviews case by case, still ormulating policy n/a

Florida allows i mortgage is underwater mortgage is underwater

Oregon no policy - hasnt seen the problem n/a

Washington does not oreclose on current loans because o renting any

New York allows i mortgage is underwaterinclude job transers or

increase in amily size

New Jersey allows i borrower cannot pay back outstanding loaninclude outgrowing house,

needed to care or parent or

moved or job

Nevadadoes not allow except or military tours o duty;

borrowers must sell, move back in or ace oreclosuremilitary deployment

Michigan allows as long as mortgage insurer approvesinclude death in amily,

decrease in income,

change in marital status

Texasallows, but borrower must not claim mortgage

interest deduction

any, as long as borrower

doesnt claim mortgageinterest deduction

Marylandhas not seen the problem much; any cases would

be reerred to housing agency committee

n/a

Massachusettsallows i loan underwater, borrower is not making a

proft on renting and can show hardship

include increase in amily size,

medical problems, relocationor job, loss o income

Virginia allows any

Colorado allows

any, as long as borrowerintended to occupy and not

renting would pose a hardshipor the amily

Utah has had a moratorium on oreclosures or two years any

Ohio allows any

Illinois still working out a policy n/a

Georgia does not allow except or military deployment military deployment

Minnesota allows any

Idaho

allows i borrower intends eventually to moveback in; even i not, allows borrower to rent out

while arranging a saleany

How Other States Deal with Renting


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payments but have violated their mortgage agreements by renting outtheir properties. A Georgia ocial said his agency has not oreclosed onanyone in those circumstances or a ew years. A Nevada ocial could

not say how many oreclosures have occurred because owners rented.

Most o the other states we contacted ollow much more orgivingpolicies. Florida, which like Caliornia has been hit hard by the housingdownturn, allows renting on a case-by-case basis i an appraisal showsthat the mortgage is underwater. Washington does not oreclose onany borrowers who rent. New York allows renting i the mortgage isunderwater regardless o the reason the borrower is moving out. It couldbe something as simple as the homeowners having a child.

New Jersey has a similar policy. The borrower must document a loan-to-value ratio o 95 to 97 percent. Even though the house in this caseis worth slightly more than the outstanding mortgage - and so is nottechnically underwater - state ocials took into account closing coststhat borrowers would incur i they were orced to sell. As long as the loanmeets this test, New Jersey allows renting or any change in circumstances the borrower may have outgrown the house, moved to care or a sickparent, or been transerred by an employer.

Michigan allows renting i the mortgage insurer approves. Massachusettsallows it i the mortgage is underwater and the borrower can show hardshipsuch as growth in amily size, medical issues, job relocation or loss oincome. The borrower is not permitted to make money on the rental.

Virginia has been permitting rentals or two decades ater a ederal courtruled that it could not oreclose on a soldier who was transerred andleased his property. The court ruled that once the borrower complied withthe terms and conditions o his loan, what he did aterwards could not begrounds or oreclosure, said Michele Watson, director o homeownershipprograms at the Virginia Housing Development Authority.

The minute we had our hand slapped, we changed our policy, Watson said.

Utah has had a moratorium on oreclosures or two years. Ohio sendsborrowers a letter pointing out that the state has a legal right to oreclose,but allows renting i the borrower can produce real estate listings showingthat the mortgage is underwater, a lease agreement and renters insurance.Minnesota stopped oreclosing 17 years ago on those who violated theowner-occupancy requirement. The housing nance agency had beencalling second mortgages due in these cases, but recently decided todiscontinue that policy as well.


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Other States Take Diferent View o Internal Revenue Code

Several o the states contacted by the oversight oce said they interpreted

the Internal Revenue Code to mean that a borrower must make theproperty his or her primary residence within a reasonable amount o time,not that the borrower must stay there or the lie o the mortgage. Coloradois one o the states that take that view. It now has 908 properties on rentalwaivers, which adds up to 5 percent o its portolio. Ocials admit thatmany more homes may be rented without the agencys knowledge. Yetthe IRS is not challenging the tax-exempt status o the agencys bonds.

Other state housing agencies say one reason they dont oreclose is that itwould cost them money.

In Washington, or instance, the Housing Finance Commission wouldlose the money owed on second mortgages each time it oreclosed, saidLisa DeBrock, homeownership program manager.

Financially, its not a good decision, she said. Were out thousands o dollars.

DeBrock was one o several state housing ocials who emphasizedanother point: Their operations are meant to promote homeownership.Foreclosing on borrowers who are in a bind because o the upside-downmarket runs counter to their mission.

Were not going to be oreclosing on homes i theyre making theirmortgage payments in this market, DeBrock said.

In New Jersey, i theyre paying, we pretty much think we have a goodcustomer, said Jerome Keelen, director o single amily programs atthe state Housing and Mortgage Financing Agency. The agency tellsborrowers who are renting that it wants them to sell or renance as soonas possible. It reviews the rental waivers periodically. But as long as theborrowers would ace a nancial hit by selling, Keelen said, Well giveit or as long as the hardship truly exists.

Floridas agency takes a similar view.

We dont want to create a hardship, Gaver said. Its not our mission. Itsdenitely not what were here orWe dont like to see oreclosures at all.

The Ohio Housing Finance Agency believes that it will remain withinthe IRS guidelines as long as it keeps track o the 200 to 300 borrowerswho have received rental waivers.


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Its hard or me to swallow, to say that Im going to oreclose on thembecause theyre not living in the property, especially i theyre current ontheir loan payments, said Tom Walker, homeowner operations manager.

Told o Caliornias policy, Walker responded, Thats pretty harsh.

Two States Have Policies Like Caliornias

Nevada is one o the two states we ound whose policy resembles Caliornias.It may be no coincidence. The Nevada Housing Division ormulated itspolicy several years ago on the advice o bond counsel Orrick, Herrington& Sutclie the same law rm that served as the Caliornia agencyscounsel when it came up with its rst policy on rentals.

We dont have any choice, in our opinion, said Lon DeWeese, chienancial ocer o the Nevada Housing Division.

Nevada does an annual survey o borrowers to determine i any havemoved out. I they have, the borrowers must either move back in, put thehouse up or sale or deault. The housing division recognizes that manyborrowers are dealing with a dicult market Nevada has consistentlyranked as the state with the highest percentage o underwater mortgages.But negative equity is no more a hardship or borrowers than makingmoney on a property during a housing market surge should be consideredan unwarranted windall, DeWeese said.

DeWeese said he could not estimate the number o oreclosures that haveresulted rom technical deault because o renting. Nevadas housingnance agency pulled out o the whole mortgage business in 2006 andhas been ocusing just on down payment assistance.

Georgia is the other state with a strict no-rental policy.

We may let them do it or a short period o time, but not very long, saidPhil Cottone, director o homeownership at Georgia Housing & Finance

Authority.

But Cottone could not recall a recent case o the authority oreclosingon a borrower because o a violation o the rental policy. Its happened acouple o times in years past, he said. More common is a homeownerwho moves out under nancial duress and stops making payments, whichleads to oreclosure.

It hasnt been that big an issue or us, Cottone said.


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CalHFAs Policy Puts Borrowers in a Fix

Marcia Wold has always adored Tigger. The bouncy tiger rom the

Winnie-the-Pooh books adorns her cell phone cover. Her personalizedlicense plate announces her devotion to him to the world. It makes sense Tigger is a good totem o Wolds sunny outlook.

Twelve years ago, shedecided to live inCaliornia while visitingrom Illinois or ateachers conerence.The drive rom the SanFrancisco airport to thecity was enough to winher over a ew weekslater, she moved.

She worked three jobs:one teaching math, oneteaching a night class orGED students, and thelast as a nanny. Aterschool, she would pickup her clients kids and drop them o in Milpitas, and then head straightto the night school class.

Ater buying her condo through CalHFA in March 2005, she was sodelighted to nally have her own washer and dryer that she actuallylooked orward to doing laundry. She completely remodeled the place,starting with the bathroom, which or some reason had carpet on thefoor. She put in a new rerigerator, a stove, a garbage disposal andcountertops.

Wold loved living in an oasis sheltered rom highway noise. To burn ostress, she swam laps in the pool a ew yards rom her door, and walkedin the shade o massive redwoods in the developments park. She saw thehumble condo as a symbol o how she had managed to nd a toeholdin one o the priciest communities in the nation. When she inherited$10,000 rom her grandmother, she used it to pay down her mortgage.In retrospect, she wishes she had gone on a cruise.

Ater she met Ken on Match.com and the couple married, they thoughtor a long time about trying to live in the 784-square-oot condo.Ultimately, they decided it would be too hard on Kelley, Kens 5-year-old

Marcia Wold takes a break rom grading math homework to chat

with her mother-in-law, Nancy Wold.


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son rom a previous marriage. And so they moved into the house in acanyon outside Los Gatos that Ken owned with his parents.

All was well until Wold received a letter rom CalHFA in April 2010, tellingher that she had to move back into her house or pay o her loan in ull.

I honestly thought it was a joke, Wold recalled. Her second thought wasthat it was a minor misunderstanding that would easily be cleared up witha phone call. Indeed, the CalHFA representative she talked to told herthat there were many borrowers like her who got married or had a changein lie circumstance, and advised her to apply or a one-year waiver o theowner occupancy clause.

She said in her experience, it would be no problem, Wold said.

Several months later, in July, CalHFA returned one o her mortgagepayments. Wold called CalHFA again. The same representative saidCalHFA was getting a lot more requests than usual. She suggested that

Wold send the mortgage payment back to CalHFA and it would be takencare o.

In October, Wold got a letter that her request or a rental waiver had beendenied. Unless she paid o the loan or moved back in, CalHFA wouldpursue oreclosure.

Wold owed about $35,000 more than the condos estimated value. Sellingwould mean a huge nancial hit, and moving back in was not an option.

And so she prepared or the inevitable.

She asked a CalHFA ocial i she would rerain rom reporting theoreclosure to the credit-reporting agencies. The ocial said no. Knowingthat her credit score would plummet, Wold bought a car a month beorethe oreclosure sale. Sure enough, her credit score has dropped rom 802to 679. With Kens parents planning to move to a retirement community,Ken and Marcia had hoped to renance the mortgage under their names.But with the sagging credit score, Marcia realizes that she will have to paya higher rate or rely on Kens parents to help renance.

Wold wasnt the only one to suer nancial consequences. She boughtthe condo or $335,000 and still owed $320,000. CalHFA sold the condoin June or $235,000. I the agency had allowed Wold to rent out thecondo until the market turned around and she was able to sell it, it mighthave recovered the entire amount it was owed, as well as avoiding thecosts o selling the property.


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CalHFAs losses rom oreclosures o all kinds have stressed the agencysbooks during the housing crisis. As o the end o August 2011, the agencyhad oreclosed on 2,972 properties. It has been able to recover about 87

percent o outstanding loans and expenses. But in doing so, it exhaustedits mortgage insurance und, which consisted o premiums paid byborrowers. It also burned through a gap insurance und that it had set up.The remaining 13 percent - $112.5 million has been covered by reservesaccumulated by the bond indentures.

Agency Has a Hard Time Producing Numbers DocumentingSize o Problem

The agency itsel seems to be having a hard time quantiying the number oborrowers aected by its policy. The oversight oce in May asked CalHFAor the number o borrowers who had been denied permission to rent. Overthe course o the next ve months, the agency gave our oce three dierentsets o widely varying statistics. The agency attributed the discrepancies tothe development o a new system or tracking renter-occupied propertiesprompted by our oces inquiries. Ocials said that, beore the housingdownturn, there was never a need or such a system.

We believe we are near completion with this system, and the numbersprovidedare mostly accurate, the agency said in a written response to ourquestions.

But the system ocuses on the number o CalHFA residences that areoccupied by renters. It does not track the number o rental requests that havebeen denied.

CalHFA would not give our oce names or any other inormation aboutborrowers who lost their properties as the result o technical deault orviolating the no-rental policy. The agency argued that, as condentialconsumer inormation, the inormation is exempt rom public disclosure.

We were only able to nd others like Wold by searching on-line orums orpeople acing oreclosure.

Many o the stories sounded similar. The borrowers said they had beenunaware o the owner-occupancy provision or thought nothing o it,assuming that in a normal housing market they would simply be able to sellthe CalHFA property i they wanted to move elsewhere. As their amiliesgrew or they went through other changes, they moved and rented out theproperty, oten at a considerable loss. Even so, they were willing to keeppaying o their mortgages until the market turned around and they couldsell or renance. Then they got the ultimatum rom CalHFA: move back in,pay o the loan or ace oreclosure. With rental agreements in place, some


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were unable to move back in. Selling would mean wiping out their 401(k)sor other savings. And so they let the properties go.

I can assure you that many people aected by this policy were unaware othis restriction when they signed their mortgage paperwork, Dan, an activeduty member o the Navy, wrote in an email to our oce. The wording isquite hard to understand, especially or the new homeowner who many othese loans were targeting.

He said that his mortgage broker explained that the clause just meant that hecouldnt use the property as a place o business.

Looking back, I was incredibly nave and or lack o a better word stupid,Dan wrote. However, I do believe that CalHFA, my agent and my brokerwere disingenuous and contributed to an enormously serious problem somany Caliornians and Americans now ace.

Dan bought an 820-square-oot San Diego condo in 2007 using a CalHFAloan. He got married the ollowing year. The couple had a child in 2010.

When Dan spoke to the oversight oce, he and his wie were expecting asecond one. About a year ago, pressed or space, they bought a house a ewmiles away and rented out the condo. They were losing $800 every month.

When Dan contacted the loan servicer to ask about renancing, he disclosedthat he was no longer living in the condo. CalHFA initiated the oreclosureprocess, which takes about three months.

I think its a horrible program, Dan said in an ensuing interview withour oce. Its almost like predatory lending. You expect something like thatrom Countrywide, but not (rom an entity) with the name Caliornia in thetitle. Countrywide Financial, bought by Bank o America in 2008, was thetarget o lawsuits by state attorneys general alleging deceptive and predatorylending practices.

Andrea and Joshua Bernard received what Andrea described as a shockingletter rom CalHFA in late September 2011. The couple moved to the

Inland Empire rom Portland, Oregon, ater a ca they had been operatingwent belly up and Joshua got an attractive job oer in Caliornia. They livedat rst in a travel trailer. But when they ound out they were expecting asecond child, they started looking or a more suitable place. In 2007, theyound an 880-square-oot house in San Jacinto near the end o a cul de sacwith a view o a nearby ridge or $245,000, and arranged a loan through CalHFA.

Andrea recalls that the loan servicer, Countrywide, told the couple that theircontract required them to live in the house or at least three years. An escrowocer later conrmed the three-year gure.


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Andrea started a photo business, and in 2010, the couple had a third child.They looked into adding to their house, but realized the monthly paymentswould grow beyond what they could aord. Assuming they had met the

three-year residency requirement, they rented out the house at a loss o$840 a month and bought a bigger, cheaper one that would accommodatethe children and Andreas growing business.

The CalHFA-nanced house was now worth about $70,000 - $175,000less than they had paid. The Bernards knew other people who were simplywalking away rom their underwater homes.

We just absolutely did not eel like that was the right thing to do, Andrea said.We wanted to continue to meet that obligation not wanted to, but needed to.

Ater getting the deault letter rom CalHFA, the Bernards contacted theloan servicer, Bank o America. Andrea said the bank could tell her littleabout CalHFAs requirements, but said that i she contacted CalHFAdirectly, the agency would send her back to Bank o America. The Bernardshave a 35-year mortgage, and were required to pay interest only in the rstve years. Their monthly payment is scheduled to increase in 2012. Andreasaid that the workers she talked to at Bank o America did not inorm herthat under CalHFAs policy, increased payments in the sixth year o a 35-year loan could be grounds or a rental waiver. She only learned about theexemption when told by our oce.

The Bernards plan to ask or an exemption, but ear that a one-year extensionwouldnt resolve their problem, since the mortgage would still be deeplyunderwater and the house still too small or their amily and Andreas business.

I denitely eel like were being punished or trying to do the right thing,Andrea said. I dont know what the ethical thing to do is right now. Wehave been orced into a situation that was in part our ault, but not throughany purposeul eort to be deceitul or raudulent. I dont think oreclosurewould be a correct or just punishment.

Theyre Just Hurting Themselves, One Borrower Says

Stephen and Britt Reiman have been trying to no avail to honor theircommitment to CalHFA. Stephen bought a Palmdale house in 2007, beorethe couple met. They ound each other on eHarmony it turned out thatthey were both engineers at dierent locations o the same company. AterBritt moved rom Arizona to Caliornia, the two decided to buy a biggerhouse so they could start a amily, and rented out the CalHFA property.Stephen didnt remember reading the no-rental clause. When CalHFApointed it out to him, he gured he must have assumed that, i it came to it,he could just sell the house.


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Stephens mortgage was ve years o interest only, so he has no equity in thehouse. Ater those rst ve years, the monthly payments are due to increaserom $2,500 to $3,000. The tenants are paying only $1,450 a month, less

than hal the mortgage.

The original purpose o the owner-occupancy clause was to make sure thatborrowers didnt buy property to make money. The Reimans, like otherborrowers in the same x, are clearly not doing that.

We were making up the dierence out o our own pockets to honor theloan, Britt Reiman said in an interview with the oversight oce. We weretrying to make it work.

The Reimans request or a rental waiver was denied, and in June, they weretold to move back in, renance or sell the house.

We cant move back in because we have the renters there, Britt Reiman said.

Now theyre resigned to oreclosure and the hit to Stephen Reimans credit.They hope that Britts credit score will be spared in case they need to borrowor anything. They have a hard time understanding why CalHFA would bewilling to lose money on their loan when they wanted to keep current untilthey could sell and repay the mortgage in ull.

Theyre just hurting themselves, Britt Reiman said.

Other borrowers, intent on avoiding oreclosure, nd themselves trapped inresidences that are too small.

A borrower in Southern Caliornia told the oversight oce he bought histwo-bedroom condominium shortly beore he got married. His wie hada previous child, and now theyve had two more. They decided to moveinto her athers spacious house ater he passed out on the driveway, spenta couple o months in intensive care, and returned home needing help.The borrower rented out his CalHFA property to his aunt. He told CalHFAthat he had moved out, and received a letter this summer demanding ullpayment o the outstanding balance or proo that he had moved back in. Hesaid that despite the condos limitations, he plans to return with his amily ove to the condo.

One borrower described her situation in an on-line orum. She and herhusband were also reused a rental waiver by CalHFA. They live in a640-square-oot condo in San Diego.

Even though I wasnt supposed to be able to have children, we are blessed


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with a rambunctious 2-year-old and, unortunately, downstairs neighborswho demand complete silence or they are up banging on our door, shewrote. I havent slept well in months because they wont let the baby cry at

night, so he has to sleep with us.


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