May172013

Loanowners are in no hurry to list and sell their houses

I postulated that loanowners would begin listing their homes as soon as prices reached near-peak levels when they could get out without completing a short sale. Upon further reflection, I’ve concluded that we may not see many more MLS listings once loanowners are above water. We will certainly see some, and we are seeing some of these WTF listing prices now, but the cloud inventory may remain in the clouds until rising housing costs force these over-extended borrowers to leave.

Conversation with a loanowner

I recently had an extended conversation with a loanowner who doesn’t make enough money to afford the house he currently owns. We talked about his situation and options, and here is what he told me.

First, like most loanowners, he and his family are emotionally attached to their property. They want to stay because it’s a nice home they’ve decorated and customized to their tastes. They don’t want to move, and if given the chance, they will stay in their family home.

One of the reasons many loanowners don’t want to sell is because they will endure the unceremonious fall from entitlement. People who can’t afford their homes are living beyond their means. If they sell and find a rental, they will be forced to live within their means in a property they can afford. For most loanowners, that means taking a step down the property ladder, and nobody wants to do that. So unless they are forced to, people won’t voluntarily sell a nice house to move into one they consider substandard. When combined with the emotional attachments of home ownership, most people will chose to struggle and fight rather than capitulate and sell.

Another reason this loanowner doesn’t currently plan to sell his house is because he couldn’t buy another one. His credit is trashed because in order to get his loan modification, he had to stop making regular payments. The missed payments ruined his credit score. If you extrapolate that circumstance to the millions of borrowers who applied for a loan modification, and you begin to understand why owner-occupant loan applications have been so low for so long.

This from a recent Calculated Risk post:

MBA National Delinquency Survey Loan Count
Q2 2007 Q1 2013 Change Q1 2013 Seriously Delinquent
Prime 33,916,830 28,008,431 -5,908,399 1,134,341
Subprime 6,204,535 4,169,970 -2,034,565 849,006
FHA 3,030,214 7,194,524 4,164,310 574,842
VA 1,096,450 1,645,556 549,106 68,291
Survey Total 44,248,029 41,018,481 -3,229,548 2,626,480

There are 2,626,480 seriously delinquent borrowers who have suffered a lowering of their FICO score. Plus, there were many more in prior years. Keep in mind, this is not ordinary credit problems that typically keep potential homebuyers out of the market. This issue is directly caused by the housing bust, and each of these delinquent borrowers is unlikely to have a good enough credit score to qualify for a home loan.

I thought many loanowners were keeping their properties off the market to avoid the negative credit implications of a short sale. Perhaps not. They already have low credit scores, so the short sale won’t make that much of a difference. A big reason these listings aren’t coming to market is because these sellers won’t be able to buy again.

Second, this loanowner wasn’t being compelled to sell due to the cost. With his loan modification, his monthly cost of ownership is lower than a comparable rental. With his 2% temporary teaser rate, his payment is very low. As long as his monthly costs are lower than a comparable rental, it doesn’t make sense for him to sell and rent.

When I asked him what happens when his interest rates starts to rise back up to the contract rate, he said one of two things would happen. Either he would be offered another loan modification, or he would be able to refinance into a low-interest rate mortgage. I didn’t press him on the how realistic that was.

It’s not very likely he would be offered another loan modification unless the property were still severely underwater. The serial refinancing of one teaser rate to another died with the collapse of the housing bubble. Banks are willing to deal now because the property has no collateral backing, but the loan modification entitlement will be rescinded as prices near the peak.

If a loanowner has equity again, even a tiny amount of it, and the terms of the loan modification increases the borrowers costs, the borrower can ask for another loan modification, but it’s unlikely they would receive one. Why would the bank cut them a deal once they bank can get paid in full from a sale? It would be better for the bank to force the old owners out in favor of a new one who will pay the full current rate on a home loan.

This loanowner also thought he could get a low-rate mortgage. Given his bad credit, it’s unlikely he will be given any mortgage much less a low-rate one.

Basically, he is in denial. He is living on borrowed time, renting from the bank, and reacting to temporary circumstances and hoping something will work out. Right now his incentive is not to sell, so he doesn’t. However, his cost of living will continue to escalate over the next few years, and as the value of his property is nearing the amount he owes, the rising cost of his housing will ultimately push him out. Either that, or he will endure a lifetime of bank servitude with every available penny going toward debt service on a house he really can’t afford.

My conclusion is that inventory will be slow to come back to the market. It will be predicated less on loanowners getting above water and more on them facing increasing borrowing costs due to changes in the terms of their loan modifications. That will happen slowly and be staggered over time, which is what the banks want. Perhaps some of these borrowers will hold out long enough to recover their credit scores or even obtain equity, but since many of these borrowers got in trouble with excessive mortgage equity withdrawal, a sale and repurchase will not be a move up.

Expect low MLS inventory to be the new normal.