When a mortgage holder gets behind on payments, they often “cure” the deficiency — well, at least they used to. The cure rate in early 2007 was 45%; It recently fell to 6.6%.The cure rate is the ratio of the number of loans cured divided by the number of delinquent loans in the system. It is a measure of the percentage of loans each month that leave Shadow Inventory. It is a direct measurement of one of the methods of exiting the system — the other being foreclosure. When a property goes delinquent, what isn’t cured is a foreclosure.
Cure rates are very low right now because there is so much shadow inventory in the system that has no chance of curing. This makes the denominator of the calculation larger than it should be (Loans Cured / Total Delinquent) because delinquent loans are not becoming REO on time. There are about 15,000 loans in Preforeclosure Inventory that should be REO but due to foreclosure moratoria and other policies, Shadow Inventory (Preforeclosure Inventory plus REO) has been growing. This is consistent with anecdotal reports I have heard.
Today, I want to take a closer look at cure rates and relate the micro-economic decisions of individuals to the macro-economic statistics.
Cure Rate and Equity
Defaults are loan disease. There are many causes of the disease, from unemployment to loss of market value, but there is only one symptom that lenders care about — defaults. There are two important dates concerning defaults; (1) the date when lenders consider a borrower to be a default problem which is 60 days after payment was due, and (2) the date when the Notice of Default is permitted to be filed which is 90 days after payment was due.
The lenders do not control the first date — when the borrowers actually quit paying — but they do control the second date — when they file a notice of default. What is customarily a 30 day gap has extended by months. Part of our famed Shadow Inventory is trapped in this moratoria gap.
Patients who are in good health cure from disease better than those in poor health. Borrowers whose finances are strong — have equity — will cure at better rates than those who are underwater or facing a rental savings enticement. Many who see better futures in different circumstances will walk away from the debts and succumb to the loan disease. In borrowers terms, the cure for loan disease is to quit paying.
There are many factors that influence who will cure their loan and who will not. One of the most important of these factors is their equity position.
When people have equity in their homes, they cure at very high rates. Either the loan officer will modify the loan, or they will force sale. The owner generally will choose to sell and obtain their equity to live on. If you have a borrower in default with a low Loan-to-Value (LTV), they will cure either by loan modification or open market sale at nearly 100% rates.
As LTVs get higher, percent equity or Equity Position gets lower. As the equity position gets smaller a number of negative factors work together to lower cure rates quickly:
- Lenders feel less security extending credit.
- Loan modifications are more difficult to obtain.
- Success of loan modifications declines.
- It becomes more difficult to sell, particularly when equity falls to zero.
- Absent faith in appreciation, borrowers have little incentive to cure.
- If savings by renting is reasonable, borrowers have incentive not to cure.
The combination of these factors means that cure rates fall off to nearly zero as homeowners go underwater. (BTW: We will have stories of people who bought in 2006 who paid their mortgages for 25 years to get back to the value they paid. These loan (lone?) survivors will be like the Japanese WWII veterans who come out of the jungle after all these years, and they are still fighting the war.)
The equity position changes as prices change. The more prices fall in a market, the more people default and fail to cure. This adds inventory which further depresses prices; a downward spiral ensues. Have you taken a careful look at the Case-Shiller Index for Las Vegas? You see exactly what happens when you hit the downward spiral.
If there is a reason for lender collusion to withhold inventory, it is their collective fear of recreating Las Vegas in every market in America. They have not begun to face the staggering losses they will take in Orange County.
Default rates would also graph very much like cure rates because the same reasons that people may not cure a loan are also reasons they may wish to default. Going underwater and having rent savings available will push and pull people out of their homes. Financially, it is often the right thing to do.
This means that house prices get a double whammy; when property owners go negative-equity, they (1) default and (2) fail to cure. They become ruthless incurable defaulters adding inventory to the downward spiral — like today’s featured property owner.