Oct292013

Emerging loanowners stepping down the housing ladder

I feel bad for loanowners (AKA underwater borrowers). When I started blogging in February of 2007, I felt a sense of urgency to convince as many people as I could they shouldn’t buy a house. I knew the impending price collapse was going to have serious long-term consequences on people’s lives. Many would succumb to the weight of their debts and lose their homes in foreclosure. Many more would endure years of owing more on their mortgage than their home was worth. Mortgage debt is always a heavy burden, but when it greatly exceeds the value of the house it’s attached to, the crushing weight is almost too much to bear (remember Swiller’s bizarre rants?)

For many loanowners, the last seven years in borrower purgatory felt more like borrower hell. They’ve been trapped beneath their debts, and any remedies for their situation would carry negative consequences of their own. Many people opted to strategically default, and I openly encouraged this action for years because it immediately relieved the emotional distress and put people on a path toward building a new future. However, those that did strategically default had to pay a price of a lowered credit score and lingering debt collection issues. Many others borrowers opted to sell short, but this too had credit implications. A few even sold the house and paid the shortfall out of savings, but these sellers were the exception rather than the rule.

Nearly all these borrowers who escaped their debt prisons shared one common characteristic: They generally left their properties dead broke. Unfortunately, the same is true of most loanowners who finally sell and get out from under their burdensome mortgage debt.

The celebration among the financial media about the underwater borrower problem going away ignores another serious problem directly related to it. When they finally get far enough above water to sell, pay commissions and closing costs, and not take a loss, these loanowners still end up penniless. These borrowers do not end up executing a move up trade. Many must wait and save for down payment to sell again.

My loanowner inspiration

Prior to my writing for the IHB, my wife was close friends with a woman who lived in the Cottage neighborhoods in Woodbridge. This family bought their house for about $400,000 in 2001, and by 2006, it was worth about $725,000. When I told them houses can’t possibly appreciate that quickly and sustain the gains, they told me I didn’t understand California real estate. The woman’s mother was a real estate agent, and she knew this market better than I ever could — or so I was told. Despite my long conversations with them on the subject, I could not convince them there was a housing bubble. These conversations provided much of the early energy to write for the IHB. Maybe I couldn’t save them, but I could try to save everyone else.

The family who was my inspiration decided to execute a move-up in November of 2007. They only had $100,000 because the breadwinner borrowed the rest of their equity to start a successful business (the only use of HELOCs I can understand and endorse). They took their $100,000, borrowed $1,000,000 in a first mortgage, borrowed $100,000 in a HELOC second mortgage (maximized their tax write offs), and bought a $1,200,000 trophy home in Woodbridge. After launching their new business, they quickly took on an $8,000 per month mortgage payment on a property they could have rented for $4,000 a month.

They struggled with this payment for over six years. Finally, in May of 2013, values had come back to where they could sell the house, pay the commission and get out with a small profit. The traded down to a cottage home very similar to the one they left six years earlier. It couldn’t have been an easy decision. They had to pay $40,000 more than they sold their cottage for back in 2007, and they put about $100,000 down, so the last six years had no net loss, but no gain either. Their new mortgage payment is at least 60% less than their previous one.

My wife asked me if perhaps they did it right. They got to live in that beautiful house for six years and feel like they owned it. They got to impress their family, friends, and neighbors and live the good life — at least that’s what was seen from the outside. I pointed out to my wife what you didn’t see was the emotional cost the breadwinner of the family endured trying to make that $8,000 per month payment. Since they could have rented the house for $4,000 per month and since they ended up with no additional equity, the extra $4,000 per month they were spending was “throwing their money away on mortgage interest.” That $4,000 could have funded many family trips and vacations, possessions for their teenage daughters, savings for their retirement, savings for their children’s education, and a plethora of other benefits they gave up to “own” that house. Even after the tax breaks, this family flushed $200,000+ down the mortgage toilet.

I give this family credit for finally making the right financial decision. The discussions about selling their dream home to take a step down the property ladder could not have been easy, but it was clearly the right choice. They cut their housing costs by 60%, and now they will have the extra money to do all the things they gave up to own that huge home loan.

Many others will chose to hang on because the moment they rise above water, the stress of being a loanowner almost immediately turns to greed about making enough money to buy a nice move-up. Unfortunately for them, many others will not keep enduring the high monthly payments when they emerge, and these newly-equitied owners will get out as soon as they can and execute a move-down trade. These new listings and move-down trades will pressure higher price points and create more demand at lower ones. That’s why I believe The move-up market will suffer for another decade.

Eight years to recycle this property

Have you ever wondered why we used to have rules that require lenders to resolve their bad loans? We suspended those rules when we instituted mark-to-fantasy accounting, but prior to that, lenders used to have to write down their bad loans. This usually prompted them to foreclose on the property and sell it to recover their capital so they could recycle that money into a more productive use. It’s the concept of productive use that drives the need to recycle bad loans. Failure to liberate money tied up in bad loans lead to the lost decade in Japan, and it’s responsible for the economic malaise we experienced over the last six years.

Today’s featured property has been non-performing for the better part of eight years. It was originally purchased as a flip in 2005. Zovall at the IHB profiled this property back in November of 2006. Since then it’s been in and out of foreclosure and listed on and off for the last seven years. Nobody has made any payments on this mortgage since 2006 at least. This non-performing note kept getting can-kicked. Finally, it was bought by the bank late last year, but they sat on it for another year hoping to make some of the lost interest from eight years of non-performance.

Should it really take eight years to resolve a bad loan?

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[idx-listing mlsnumber=”OC13216903″ showpricehistory=”true”]

108 CORAL ROSE Irvine, CA 92603

$619,900 …….. Asking Price
$620,000 ………. Purchase Price
5/9/2005 ………. Purchase Date

($100) ………. Gross Gain (Loss)
($49,592) ………… Commissions and Costs at 8%
============================================
($49,692) ………. Net Gain (Loss)
============================================
0.0% ………. Gross Percent Change
-8.0% ………. Net Percent Change
0.0% ………… Annual Appreciation

Cost of Home Ownership
——————————————————————————
$619,900 …….. Asking Price
$123,980 ………… 20% Down Conventional
4.24% …………. Mortgage Interest Rate
30 ……………… Number of Years
$495,920 …….. Mortgage
$140,211 ………. Income Requirement

$2,437 ………… Monthly Mortgage Payment
$537 ………… Property Tax at 1.04%
$200 ………… Mello Roos & Special Taxes
$129 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$319 ………… Homeowners Association Fees
============================================
$3,622 ………. Monthly Cash Outlays

($472) ………. Tax Savings
($684) ………. Principal Amortization
$189 ………….. Opportunity Cost of Down Payment
$97 ………….. Maintenance and Replacement Reserves
============================================
$2,752 ………. Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$7,699 ………… Furnishing and Move-In Costs at 1% + $1,500
$7,699 ………… Closing Costs at 1% + $1,500
$4,959 ………… Interest Points at 1%
$123,980 ………… Down Payment
============================================
$144,337 ………. Total Cash Costs
$42,100 ………. Emergency Cash Reserves
============================================
$186,437 ………. Total Savings Needed
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