Why strategic defaults benefit the dialog on housing. Strategic defaults moving faster than HAMP modifications. The movement for stronger mortgage requirements.
- 0 Comments
I know many of you have strong opinions regarding strategic defaults. People have a hard time blending in moral and financial obligations. It really is a fine balance and public discourse gets muddied with emotional arguments to a somewhat obvious economic issue. The housing market has not been normal for over a decade. Even today there is this assumption that since the market has purged the bulk of subprime and option ARM loans (at least on the origination front) that lending standards are now good. They are not. In fact, the big problems now in the housing market stem from prime mortgages going bad. Recent data showed that for every four foreclosures, one person would deliberately stop paying on their home. This is such a foreign concept but it strikes at the core of the problem.
The strategic default problem is probably bigger than many would have expected. The number one reason for strategic defaults involves negative equity:
Source: Census, Zillow
Now being underwater is the number one reason that sets people up for strategic defaults. After all, if you weren’t underwater and wanted to get rid of your home you would presumably just sell at market value. Yet with one-third of mortgages underwater, many are making the conscious decision to walk away from their mortgage obligation. Keep in mind that this is one fraction of the foreclosure market. The vast majority of people in or entering foreclosures get there because of their actual inability to pay for their monthly obligation. This comes from job losses, wage cuts, or mortgage adjustments.
Strategic defaults have never been seen to this level because never had so many people purchased homes with little to no money down. If there is really this anger out in the market, then people should move toward a mass movement of massively increasing down payments to at least 10 percent or even higher. In this regards, strategic defaults are good because they bring forward the root problems of what led us into the housing bubble. If someone had to put in say 10 percent of their own money, walking away would involve skin in the game. Let us run this scenario with a 10 percent price decline:
Old method
Price of home: $500,000
Mortgage: $500,000
Current market value: $450,000
Negative equity: $50,000
New method
Price of home: $500,000
Mortgage: $500,000
Current market value: $450,000
Negative equity: 0
It is clear that the second case not only provides a buffer for real estate price decreases, but it will also make people think twice about walking away from their hard saved down payment. In the first case, the owner is now underwater by $50,000 with little money at play. They either decide to keep paying and hope prices go up or walk away. And many are deciding to pursue the latter option. Some may seek out a payday loan resource if things become too difficult to manage.
In fact, more people are strategically defaulting than getting help from HAMP:
“(UPI) Last quarter, more homeowners voluntarily defaulted on their mortgages and chose to walk away from their homes than the total number of mortgages permanently modified to date under the Administration’s year-old Home Affordable Modification Program (HAMP).
According to new data from the team of researchers at the University of Chicago and Northwestern University that first identified the scope of “strategic default” behavior last year, the number of homeowners willing to default when the value of a mortgage exceeds the value of their house, even if they can afford to pay their mortgage, has dramatically increased compared to just a year ago.
The percentage of foreclosures that were perceived to be strategic was 31 percent in March 2010, compared to 22 percent in March 2009. RealtyTrac reported foreclosure filings on 932,234 properties in the first quarter, a 7 percent increase from the previous quarter and a 16 percent increase from the first quarter of 2009.
Some 288,992 foreclosures per quarter are strategic defaults. Under the Home Affordable Modification Program, through March, 227,922 mortgages had been permanently modified since the program began March 4, 2009.”
The good news is the solution for future problems is rather straightforward. We need to increase down payments by a large amount. With FHA insured loans only requiring 3.5% down, this would mean a near tripling of cost out of pocket for a purchase of a home. And this would in fact slow down the housing market but is this necessarily bad? Let us run the numbers:
Home price: $200,000
FHA down payment today: $7,000 (3.5%)
Run these numbers with a new scenario:
Home price: $200,000
New down payment: $20,000 (10%)
This benefits the buyer since they have more skin in the game but also, they have a buffer for a 10 percent price decrease instead of a 3.5 percent buffer. And we already know that selling costs amount to 5 to 6 percent so technically that person buying with a 3.5% down payment is underwater the day they sign the mortgage.
We really need to think about the future of mortgages or we are simply setting up another housing crisis in the near future.
If you enjoyed this post click here to subscribe to a complete ad free feed.
Popularity: 1% [?]