Cash For Keys

Jon Daurio, chief executive officer of mortgage investor Kondaur Capital Corp., recently offered a $4,000 check to Barry Culver for the deed to his Bryan, Ohio house.

With the exchange, and a pay-off to a second-lien holder, Culver was freed of $120,000 in crushing mortgage debt on the house, said Daurio, who had bought the right to cut the deal when he purchased the mortgage months earlier. The house, after repairs, is now on the market for $47,500.

“It got me out of a bind,” said Culver, a former Kmart employee who has since relocated near his in-laws in Tennessee where job prospects are better. “I got a little cash out of it and was able to pay off other stuff I owed.”

Such ‘cash-for-keys’ offers are common for Orange, California-based Kondaur, one of the largest players in the business of buying and resolving distressed loans for profit. The business is growing more popular, with volumes of loans for sale at their highest since the founding of Kondaur in July 2007, said Daurio, a veteran of the subprime lending industry.

At DebtX, a Boston-based loan exchange, the number of bidders on pools of loans is up 25 percent since last quarter.

DEALS ARE INCREASING

Owners of bad loans are increasingly making deals with borrowers to avoid a foreclosure, which tends to reduce returns for investors and place a black mark on the homeowner’s credit. Lawmakers and regulators are becoming more accepting of these solutions even though they mean the borrower loses the home.

The trend comes after more than two years of loan modification programs and foreclosure moratoriums that have produced mixed results, with many homeowners ineligible or defaulting again.

Where a modification isn’t feasible, the U.S. Treasury in April will begin paying borrowers who agree to a deed-in-lieu of foreclosure or short sale, where a home is sold for less than outstanding debt. Unlike most modifications, those actions erase excess debt and reset home values, solving the problem of underwater loans that are a top cause of defaults.

U.S. modification efforts to date have been “tragic” in delaying housing and economic recovery, Daurio said.

“All you are doing is delaying depreciation of the houses,” Daurio said. “You are not preventing it by keeping people in a house that they can’t afford.”

More than 11 million properties with mortgages are “underwater,” according to First American CoreLogic. Efforts to expand use of principal forgiveness haven’t caught on.

DELAYING THE INEVITABLE

Foreclosures have been stalled on more than 1 million bad loans since the U.S. Home Affordable Modification Program was announced a year ago, resulting in higher costs and losses to investors, according Moody’s Investors Service.

This is delaying an inevitable clearing of the housing market that is needed for a lasting rebound, analysts said. A pent-up “shadow inventory” from failed modification efforts could destabilize the market in 2010, they worry.

“You are preventing the orderly transfer of a home from those that can’t afford it to those that can afford it,” said Rod Dubitsky, a global structured finance specialist at Pacific Investment Management Co. in Newport Beach, California.

The ability to customize loan workouts and earn potentially huge profits are enticing investors to the market, where loans are commonly sold at 40 cents to 60 cents per dollar of principal. Discounts give investors more room to work with borrowers than banks working to mitigate their loss, said Kingsley Greenland, chief executive officer at DebtX.

Investors generally look for a quick workout since it costs them to carry the loan or the property, said Jeff Freud, founder of LoanMarket.net, in Irvine, California.

Distressed whole loans are just a slice of the total mortgage market, however. Many loans are tied up in securities, and banks now with adequate reserves are arranging deed-in-lieu and short sale agreements themselves.

Mountains of cash chasing a limited field of loans has buoyed prices, but that is reducing opportunity for funds, said Louis Lucido, a principal at Los Angeles-based DoubleLine. But that could change if the Federal Deposit Insurance Co. more rapidly unwinds the assets of its failed banks, he said.

New entrants to the market tend to be small investors, who hold less than 100 loans at any one time, analysts said.

Among a pool of loans acquired by Dean Engle, a real estate investor in San Francisco who teaches others how to get a start in the business, was a foreclosed home in Greenwood, Missouri. It was still occupied by the former owner, who had no money to find a new place to live.

Engle told Ellen Brewood, a local agent to offer the former owner $5,000 to move out, and avoid a lengthy eviction. The house was vacated within five days. After 15 days on the market, it had offers above the $139,000 asking price.

“He wouldn’t believe it, that investors wanted to pay him,” Brewood said of the former owner.