People form strong attachments to their homes. Walking away is never a decision they take lightly. We can discuss the pros and cons and come up with our own beliefs and attitudes about it, but the turnover of our housing stock caused by the housing crash will be very painful for those who go through it.
Ruthless default or accelerated default?
I write often about hidden premises buried within the arguments writers make. These distinctions are important, and unless we uncover our fallacious beliefs, we make erroneous judgments and carry false beliefs. I have written many times about strategic default, and in my last post on the subject, I uncovered something new.
There is no accepted definition of strategic default. Lenders have tried to define the issue as any borrower who is capable of making a payment and chooses not to. On the surface that sounds reasonable, but that misses a very important distinction. Some people chose to default because they know they can’t afford the home and they are merely choosing the timing of the inevitable.
When I think about strategic default, I think about people who chose the timing of their default when there is little reasonable hope of having equity and they are facing escalating payments. The only thing strategic about the default is the timing, not whether or not they will lose the home.
True strategic default — a default by a non-distressed homeowner who can afford the payment on a fixed-rate amortizing mortgage — is rare. In cases where the owner is severely underwater and they can rent for far less than their current payment, the incentive certainly exists, but most borrowers in that circumstance with a fixed-rate mortgage will chose to ride out the collapse. The borrowers with most incentive to default are those with toxic financing or temporary loan modifications that know they are facing an increased debt and an increasing payment. When those borrowers default on their own schedule, is their default truly strategic or merely accelerated?
Although attitudes toward strategic default are changing quickly, for now most borrowers still think it’s a bad idea.
By Carmen Nobel 06/10/10
SILVER SPRING, Md. (TheStreet) — Among the lousy home-foreclosure reports comes encouraging news from the National Foundation for Credit Counseling: Most Americans at least think that foreclosing on their homes is a bad idea.
The NFCC’s Financial Literacy Survey found that only 23% of respondents consider it justifiable to default on a mortgage even if the property value is now lower than the amount of money owed on the mortgage. When asked if they would be more likely to keep their mortgage or their credit cards current, 91% said they would pay their mortgage first.
They should ask that same question to people who are underwater and see if they get a different response. I suspect they would.
Americans continue to prioritize their obligation to service their mortgage loan, and this is indeed good news for homeowners, mortgage lenders and the housing market overall,” NFCC spokeswoman Gail Cunningham said in a statement.
But the reality seems less rosy. The delinquency rate for mortgage loans on one- to four-unit residential properties increased to a seasonally adjusted rate of 10.1% of all outstanding home loans at the end of the first quarter, an increase of 59 basis points from the fourth quarter, according to the Mortgage Bankers Association. The percentage of loans on which foreclosure processes started in the first quarter was 1.23%, up three basis points from the previous quarter. The total percentage of loans in foreclosure at the end of the first quarter was a record 4.63%.
The serious delinquency rate, including both foreclosures and loans more than 90 days past due, was 9.54% at the end of March, a slight decrease from the previous quarter but an increase of 2.3% over the first quarter of 2009.
This is strong evidence that most of the defaults are not strategic but out of necessity. Most people are delinquent because they cannot make the payments not because they choose to default. However, as more in the media question this choice, many more will continue to chose accelerated default.
I never thought I would write something like this. I used to believe that it was wrong to just walk away from a home. I am not talking about taking the dog for a walk — I am talking about not paying the mortgage and leaving.
Yes we all signed legal documents that say we have to pay back our mortgages, but some people can’t, and as we all know, many owe more on their homes then they can be sold for. In the past I have represented sellers who sold their homes because they could no longer afford the payments due to a change in their life circumstances, like divorce or the death of a spouse.
When that happens some home owners can’t afford the mortgage on one income. Loan modifications are few and far between and so are short sales. Some home owners have tried everything and every program and there isn’t any help and they can not pay. It seems that the bank would rather take the loss than modify the payment or entertain a short sale, and even if they do say yes to the short sale they may not say yes to an offer so that the sale can take place.
What about all those people who were given loans on terms under which they couldn’t sustain ownership? Loan modifications are just Option ARMs in disguise. The people who can’t afford their homes are going to sell eventually. Banks are hoping that not all of them decide to sell at one time, so they are doing whatever they can to drag out the liquidation process and hopefully get prices up a bit to increase their recovery. When the people chose to default when an unsustainable loan modification is available, I argue that default is accelerated and not strategic.
Walking away may be the only option, but keep in mind that the foreclosure process is slow. It can take a year from the last payment until the bank owns the home. A person could live rent free for six months to a year before they had to leave – giving them some time to pack and to save some money. It may mean the difference between years of struggling to come up with enough money and having little money for anything else like home repairs or food, and being able to make a fresh start and have a life again.
The more banks allow delinquent owners to squat the greater this incentive becomes.
Like I said when I started, I never thought I would write anything like this but now I get it. I have talked to people who have tried everything. They have called the bank many times, they have checked into various programs designed to help distressed home owners and there isn’t any help. There is help for some but not for all. Programs that teach money management are nice, but there are some who simply don’t have enough money to manage.
This may all sound wrong, but there have been so many foreclosures that I don’t think it has the stigma it used to have. It may hammer a credit rating, but again — with so many foreclosures – I suspect the time will come when lenders will need to loan money to people who have gone through a foreclosure. I understand that a home loan is a legally binding contract but if there is no money, there is no money, and banks could modify loans or be more cooperative with short sales.
With the way things are today I don’t think it is a good idea to try and save a home at any cost. It just doesn’t make sense anymore. On the other hand I have no respect for people who walk away just because they owe more on the home than it is worth when they can afford to make the payments. I made payments on my home for at least three years when the value was less than what we owed and never would have considered walking away because it is my home. We bought it so that we would have a place to live and raise our children.
It is a difficult distinction to make between the truly ruthless default and the merely accelerated one. It is certainly much easier to feel empathy for the accelerated default because these people could never sustain home ownership. There is a dignity in choosing your own time rather than being subject to the whims of bankers and legislators. In contrast, the ruthless defaulters won’t get much sympathy from anyone. What criteria separates the two groups? Who decides? It is possible to embrace one and reject the other?
Do you see a distinction between ruthless (strategic) default and accelerated default?
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Proprietary OC Housing News home purchase analysis
$375,000 …….. Asking Price
$184,500 ………. Purchase Price
12/28/1995 ………. Purchase Date
$190,500 ………. Gross Gain (Loss)
($30,000) ………… Commissions and Costs at 8%
$160,500 ………. Net Gain (Loss)
103.3% ………. Gross Percent Change
87.0% ………. Net Percent Change
4.3% ………… Annual Appreciation
Cost of Home Ownership
$375,000 …….. Asking Price
$13,125 ………… 3.5% Down FHA Financing
3.45% …………. Mortgage Interest Rate
30 ……………… Number of Years
$361,875 …….. Mortgage
$112,217 ………. Income Requirement
$1,615 ………… Monthly Mortgage Payment
$325 ………… Property Tax at 1.04%
$83 ………… Mello Roos & Special Taxes
$94 ………… Homeowners Insurance at 0.3%
$377 ………… Private Mortgage Insurance
$405 ………… Homeowners Association Fees
$2,899 ………. Monthly Cash Outlays
($239) ………. Tax Savings
($575) ………. Equity Hidden in Payment
$14 ………….. Lost Income to Down Payment
$67 ………….. Maintenance and Replacement Reserves
$2,167 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$5,250 ………… Furnishing and Move In at 1% + $1,500
$5,250 ………… Closing Costs at 1% + $1,500
$3,619 ………… Interest Points
$13,125 ………… Down Payment
$27,244 ………. Total Cash Costs
$33,200 ………. Emergency Cash Reserves
$60,444 ………. Total Savings Needed