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The other (borrowed) shoe ready to drop

The major media takes notice of what Middle America has known for a couple of years:

Americans owe a staggering $1.1 trillion on home equity loans — and banks are increasingly worried they may not get some of that money back.

To get it, many lenders are taking the extraordinary step of preventing some people from selling their homes or refinancing their mortgages unless they pay off all or part of their home equity loans first.

Well. Sharon and I appear to have been trend-setters.

Consider Randy and Dawn McLain of Phoenix. The couple decided to sell their home after falling behind on their first mortgage from Chase and a home equity line of credit from CitiFinancial last year, after Randy McLain retired because of a back injury. The couple owed $370,000 in total.

After three months, the couple found a buyer willing to pay about $300,000 for their home — a figure representing an 18 percent decline in the value of their home since January 2007, when they took out their home equity credit line. (Single-family home prices in Phoenix have fallen about 18 percent since the summer of 2006, according to the Standard & Poor’s Case-Shiller index.)

CitiFinancial, which was owed $95,500, rejected the offer because it would have paid off the first mortgage in full but would have left it with a mere $1,000, after fees and closing costs, on the credit line.

Citi pulled the same stunt on us when we moved from St. Louis to Columbia. We listed our home just after the peak of the real estate market. We asked about 8% less than it’s recent appraised value, and even that was obviously too high.

After a couple of months, we received two “short sale” offers that required Citi’s approval. (Countrywide held the first mortgage and would have been paid in full.) Had Citi agreed, they would have recovered about half of what we owed.

Both times, however, the decision-makers at Citi dithered until the buyers walked. Ultimately, we were forced to let the house go to foreclosure. It ultimately sold for about 12% less than the offers we’d received and nearly 30% below the value for which it was appraised less than a year earlier.

Citi got nothing.

So the Times article is a bit misleading. CitiFinancial may think they’re preventing sales until they’re paid in full, but they’re only forcing the sales to take place after foreclosure. Instead of recovering a percentage of a bad investment, Citi devalues the home even further by dragging out the process, eliminating the homeowner’s incentive to maintain it, and ultimately putting a vacant house back on the market at a lower price.

Maybe that’s why even the wealth of Middle Eastern oil sheiks may not be enough to save Citi from collapse. And as this pattern repeats for different lenders around the country, the bank crisis and the economy will get worse before they get better.

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