Just as buying a home is an emotional decision, defaulting on the mortgage and giving up a home is too. Any borrower who is deeply underwater and making payments in excess of a comparable rental would benefit financially from strategic default. That’s the math. 
However, defying the logic, very few loanowners are actually defaulting. People cloak their reasons with intellectual rationalizations, but it’s an emotional decision based on the desire to keep their family home and the ethical considerations that go along with the decision. As with any emotional decision, it may be right, or it may be wrong depending more upon the perceptions of the decision maker rather than some outside measuring stick.
Since this is an emotional decision, anything pertinent to the decision maker will have a profound impact on the number of people who actually decide to strategically default. Most people default because they can no longer take the emotional strain of trying to make payments they really can’t afford. Their willingness to endure this hardship is strongly impacted by what they perceive as the reward. Many potential strategic defaulters don’t because they cannot endure the loss of self respect that would go along with what they interpret as breaking a promise. Many others believe losing the family home would inflict more pain on themselves and their families than continuing to make the payments. For many, the additive impact of both of these factors compel them to endure the financial distress rather than seek the strategic default exit.
Another major weight on the decision-making scale is the perception of future financial reward. People bought houses during the housing bubble because they believed they would be rewarded with HELOC money or increasing value in their properties. The housing bust squelched most of these dreams, but hope springs eternal, and many are holding on with the belief the market will eventually make them whole again. The belief in this future reward can push a borrower in either direction depending on what’s happening with home prices. As home prices plummeted, so did borrower’s hopes of ever having equity again. Borrowers without hope of equity often strategically default. If it becomes a widespread perception that house prices are on the mend, the psychological impact on loanowners will be profound. Many who still may not have equity in many, many years will at least see the light at the end of the tunnel. Rising home prices give loanowners hope, and this hope will dramatically change the strategic default equation. In 2013, strategic default will become far less common.
Strategic Default Not Best Option for Underwater Mortgages, Say Economists and Homeowners
71 Percent of Surveyed Economists Would Not Strategically Default, According to June 2012 Zillow Home Price Expectations Survey
SEATTLE, July 26, 2012 /PRNewswire via COMTEX/
If faced with a deeply underwater mortgage, most economists and homeowners agree they would not strategically default, according to dual surveys from Zillow®.
Nearly three-quarters of economists surveyed in the June 2012 Zillow Home Price Expectations Survey (71 percent) said they would not strategically default, even if they owed on their mortgage at least 40 percent more than the current value of their home.
This can also be interpreted as further proof that economists are clueless and inept, and I won’t argue against that point because I believe many of them are.
The survey, sponsored by leading real estate information marketplace Zillow, Inc. and conducted by Pulsenomics LLC, was compiled from 114 responses from a diverse group of economists, real estate experts and investment and market strategists. The main portion of the survey, which captures respondents’ expectations concerning the future of home prices, was released last month.
In a separate Zillow survey conducted by Ipsos®, 59 percent of homeowners said they would not make the decision to strategically default if they were underwater on their home by more than 40 percent[i]. Nearly 75 percent of homeowners in the U.S. with an underwater mortgage are underwater by 40 percent or more, according to Zillow’s first quarter Negative Equity Report[ii].
That also says that 41% of loanowners would strategically default. That is a very high number.
“We were initially surprised that so few economists would be willing to strategically default, since when you do the math, it can often be the best economic choice, if you leave aside moral and ethical considerations,” said Zillow Chief Economist Stan Humphries. “Of course, strategic default is not just a mathematical decision. The most common reason for avoiding strategic default cited by homeowners was that it is a moral issue. That likely comes into play with economists and analysts, as well.”
I find it surprising that so many economists would chose to make the wrong financial choice. It shows just how emotional that decision really is.
Thirty-seven percent of homeowners who said they would not strategically default cited moral reasons, while 35 percent indicated it didn’t make sense given that they intended to live in their current home for a long time.
The “live in the house for a long time” response is the same as saying they expect to own long enough to have equity again. There is an embedded believe in a return to appreciation.
The Zillow Home Price Expectation Survey additionally asked the same group of economists and housing analysts their stance on the adoption of government-sponsored mortgage principal forgiveness initiatives for underwater borrowers. The survey found that 72 percent of respondents opposed any adoption of such programs, while 28 percent were in favor.
I am pleasantly surprised to see that 72% of Americans do not want to see their irresponsible brethren given free money. The other 28% are likely those who would receive the bailouts.
“These survey results suggest that economic and financial considerations are not the dominant drivers of behavior for even deeply underwater borrowers,” said Pulsenomics Founder Terry Loebs. “This underscores the challenges in valuing underwater mortgages and in determining the costs and benefits of principal forgiveness initiatives.”
To be coldly calculating about it, it makes no sense to forgive principal or reduce interest rates for that matter on underwater loanowners. Most of them simply won’t strategically default even if it’s the best financial decision. They are making an emotional decision, and what they really need is hope of a brighter future. Once they have that, they will hang on forever if necessary. It’s not logical, but it is how loanowners think. I fully expect to see strategic default decline considerably once the general public accepts the idea we are at the bottom of home prices — whether we really are or not.
Better late than never
The former owners of today’s featured property dutifully paid down their mortgage through the entire housing bubble. Right at the peak, the refinanced twice and took out every penny of their accumulated equity. In essence, they sold it to the bank at the peak, only the bank didn’t realize it at the time.
Total mortgage equity withdrawal was $383,756.
Wouldn't you be embarrassed to overpay by $100,000? Only fools buy houses without knowing neighborhood values. Don't be a fool. Don't suffer the pain of an underwater mortgage. The surest way to lose your house is to overpay for it. Our reports identify overvalued and undervalued neighborhoods. Use it to broaden or narrow your search area. Savvy buyers work with us to find bargains. We've saved thousands from financial ruin. Let us save you too. If you want peace of mind while shopping for your next home, sign up for our monthly market newsletter.
We're sorry, but we couldn't find MLS # S705989 in our database. This property may be a new listing or possibly taken off the market. Please check back again.
Proprietary OC Housing News home purchase analysis
8061 SAN MARCELLO Cir Buena Park, CA 90620
$480,000 …….. Asking Price
$145,000 ………. Purchase Price
3/14/1997 ………. Purchase Date
$335,000 ………. Gross Gain (Loss)
($11,600) ………… Commissions and Costs at 8%
============================================
$323,400 ………. Net Gain (Loss)
============================================
231.0% ………. Gross Percent Change
223.0% ………. Net Percent Change
7.8% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$480,000 …….. Asking Price
$16,800 ………… 3.5% Down FHA Financing
3.55% …………. Mortgage Interest Rate
30 ……………… Number of Years
$463,200 …….. Mortgage
$120,442 ………. Income Requirement
$2,093 ………… Monthly Mortgage Payment
$416 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$120 ………… Homeowners Insurance at 0.3%
$483 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
============================================
$3,111 ………. Monthly Cash Outlays
($313) ………. Tax Savings
($723) ………. Equity Hidden in Payment
$19 ………….. Lost Income to Down Payment
$140 ………….. Maintenance and Replacement Reserves
============================================
$2,235 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$6,300 ………… Furnishing and Move In at 1% + $1,500
$6,300 ………… Closing Costs at 1% + $1,500
$4,632 ………… Interest Points
$16,800 ………… Down Payment
============================================
$34,032 ………. Total Cash Costs
$34,200 ………. Emergency Cash Reserves
============================================
$68,232 ………. Total Savings Needed
The property above is available for sale on the MLS.
Contact us for a comparative market analysis, a cost of ownership analysis, or information on how you can make an offer today!
OC Housing News FREE Guides!
Click on the book cover for more information.
Nearby Foreclosures
Gain a competitive advantage over other buyers. By locating distressed properties -- before they hit the MLS -- you can discover where tomorrow's REOs and short sales will appear. Most of these properties are not listed on the MLS, but they will be soon. Research properties in advance and get a jump on your competition. Don't miss out on another deal because you couldn't act quickly. Use this tool to your advantage! The red properties are already bank owned. As soon as REO asset managers prepare them for sale, they will be on the MLS. Get ready! The green and blue properties have owners who are not paying their mortgages. They may be offered as short sales, or they may go through foreclosure and become REO. Either way, they will also likely be available on the MLS soon. Find your next home! Be prepared to offer on these properties by researching them in advance or risk losing out to buyers who are have done their homework. Start your research today! To find distressed properties, enter your desired location and press search. Scroll through list by pressing "next."  |
$350,000 8171 HOLDER St |
0.28 miles 3 bd / 1.75 ba 1,400 Sq. Ft. |
|
 |
$354,900 7817 LA CASA Way |
0.41 miles 3 bd / 1.75 ba 1,212 Sq. Ft. |
|
 |
$409,900 6740 BERRY Ave |
0.51 miles 3 bd / 1.75 ba 1,233 Sq. Ft. |
|
 |
$375,000 6069 MACARTHUR Way |
0.6 miles 3 bd / 1.75 ba 1,364 Sq. Ft. |
|
 |
$310,000 6700 HOUSTON St |
0.61 miles 3 bd / 1 ba 1,115 Sq. Ft. |
|
 |
$429,000 7107 SANTA RITA Cir |
0.63 miles 3 bd / 1.5 ba 1,300 Sq. Ft. |
|
 |
$399,000 6622 SAN HAROLDO Way |
0.69 miles 3 bd / 1.75 ba 1,460 Sq. Ft. |
|
 |
$389,900 7187 SANTA CATALINA Cir |
0.74 miles 3 bd / 2 ba 1,268 Sq. Ft. |
|
 |
$400,000 5702 THELMA Ave |
0.89 miles 3 bd / 1.75 ba 1,424 Sq. Ft. |
|
 |
$345,000 7285 FILLMORE Dr |
0.98 miles 3 bd / 2 ba 1,215 Sq. Ft. |
21 Responses to “Rising home values will halt strategic default”
Sorry, the comment form is closed at this time.
“…However, defying the logic, very few loan owners are actually defaulting…”
To wit, interesting related article:
Orange County Register
Published: July 26, 2012 Updated: July 31, 2012 10:57 a.m.
High housing payments the new ‘American nightmare’
Millions of Californians are paying close to half their income for housing – a level once considered foolish. Even as home prices have tumbled, the cost of homeownership has continued to rise.
link:
http://www.ocregister.com/articles/percent-365633-loan-income.html
Reality is, at current price levels, OC homedebtorship in general is FOOLISH because to obtain it, most households will have ‘all of their eggs in one basket’, which is an INVESTMENT 101 FAIL.
Nonetheless, despite lower prices, the cost of homeownership will always rise because:
1) RE is a fixed target. Thus, govt will always tax or even confiscate if need be, either directly or indirectly thru its proxies (banks).
2) Input/carry costs rise as time passes.
Unfortunately, for those who’re wishing prices-up with sustainability– US wages are not indexed to inflation, corporations are in the wage suppressing business and home prices are now being administered.
Stupid is as stupid does.
“UNHEEDED ADVICE
Cheryl Knight was in love.
She loved a townhouse across the street from her Fullerton condo in a garden complex lined with small lakes. And the price in mid-2006 just before the market peaked, $480,000, was within her reach, barely.
“I fell in love with it,” the editor and writer said, “which was why I went against my Realtor’s advice and bought it when she said it was overpriced.”
Knight, 43, also ignored the implicit advice of her lender, who rejected her first two loan applications.
The loan she finally got was a five-year, interest-only adjustable for $390,000. She borrowed the remaining $90,000 on a line of credit. The seller refused to wait for Knight to sell her condo. It would take Knight nearly a year to sell the condo.
Her monthly payments, including taxes, insurance and homeowner association fees, came to $2,510 – about 60 percent of her income at the time.
A few months after moving in, the company where she worked as an editor sent her to a conference in Omaha, Neb. She attended a session on financial planning and heard the speaker say that no one should spend more than 30 percent of his or her income on housing.
“And I was paying double that,” Knight said. “I almost started laughing. It was a shock.”
A single mother with a son in high school, she was spending virtually all her money on the house and her son.”
That feed bar and the food pellet that follows is pretty strong. 50 years of Southern California Real Estate Conditioning.
Sad but true. Despite the deep and destructive crashes, people still insist on believing the fantasy.
Why Rise in Home Prices May Not Mean Much—Yet
Average home prices through May increased for the second month in a row, according to the latest S&P/Case-Shiller Home Price Indices, which measure both the top ten and top twenty housing markets in the US.
Prices are still down from a year ago, but those annual drops are improving.
“On a monthly basis, all 20 cities and both composites posted positive returns and 17 of those cities saw those rates of change increase compared to what was observed for April. Seventeen of the 20 cities and both Composites also saw improved annual rates of return,” notes S&P’s David Blitzer.
“We have observed two consecutive months of increasing home prices and overall improvements in monthly and annual returns,” he added. “However, we need to remember that spring and early summer are seasonally strong buying months so this trend must continue throughout the summer and into the fall.”
This is not the first time since the initial home price collapse in 2006 that we have seen prices rise, only to fall again. We saw large price gains in 2009, thanks to the home buyer tax credit, and we saw slight gains last spring due to some seasonality and a big run on distressed properties by investors.
So how do we know if the latest gains we are seeing are here to stay?
Much of the answer lies in foreclosures. Many markets have seen their supply of foreclosed properties fall dramatically, due to huge investor demand.
Take Phoenix, for example, where investors claim there is just not enough to buy. Home prices there are up 11.5 percent from a year ago.
Miami and Tampa are also seeing solid gains. But Atlanta continues to be the weakest spot; as foreclosure supplies there surge, prices are down 14.5 percent.
Foreclosures are falling nationwide, but the crisis is far from over, and the concern is that all the delays in foreclosure processing will continue to wreak havoc on home prices for at least another year, if not longer.
There were 1.4 million homes in some stage of foreclosure in June, down slightly from 1.5 million in June of 2011, according to a new report from CoreLogic.
Completed foreclosures, however, fell more dramatically, down 24 percent from a year ago. This is likely due to renewed loan modification efforts by lenders, as well as new state legislation, that are keeping many homes from final foreclosure.
California’s U-6 or underemployment and unemployment rate is 20.3%.
Fundamentally, I don’t see how real estate price can improve while income & jobs are languished. And I don’t see how American jobs can improve while global living expenses haven’t reach equilibrium yet at the same time laws & regulations in America are all against small businesses but for global multi-national corps.
They don’t call people of country as sheeple for no reason.
There the greater fool model. We just have to find enough FBC to buy all the overpriced RE with cash and not to later finance.
Mike, do you know the economy is improving with all the pre-election stimulus?
The economists that don’t view strategic default at this time as an option may also view the monthly payments as keeping an option open for any future profit. If you think of losing a “home” that is family, there’s greater reluctance to default. If you think of losing a house, moving and saving your family, the odds will be greater for a strategic default.
I buy real estate — not people and not homes.
45% of Nevadans see nothing wrong with strategic default
Nevada homeowners are equally divided over the ethics of “strategic default” or not paying their mortgage even though they can afford to, a report released Thursday by the Nevada Association of Realtors shows.
Forty-five percent of adults surveyed said there’s nothing wrong with strategic default, while an equal percentage said homeowners have a legal and ethical obligation to pay their mortgage.
The 52-page “Face of Foreclosure” report, conducted by Gainesville, Fla.-based SGS Research, surveyed 500 Nevada adult residents and 500 individuals who had received at least one foreclosure filing, lead researcher Joel Searby said.
The most significant finding is the one-to-one split over strategic defaults and whether it’s a financial decision or an ethical decision, Searby said.
A second noteworthy finding is that 40 percent of those who had gone through foreclosure were advised by financial experts to default on the loan to receive government assistance, he said.
“In order to have any recourse, they have to default. That creates incredible instability in the market when they’re advised to default,” Searby said Thursday. “Despite all of that, there’s still a fundamental belief in home ownership in Nevada. As a researcher, I would expect that to take a major hit given all the negative news in Nevada.”
Nevadans expressed a dim view of government programs such as the Home Affordable Modification Program, or HAMP. Only 9 percent of those facing foreclosure and 10 percent of all Nevadans said foreclosure prevention programs have helped. Still, 55 percent believe government has a role in addressing the problem.
Despite frustration with government programs designed to assist distressed homeowners, Nevadans place a high value on home ownership. The survey found that 79 percent of those who faced foreclosure still believe owning a home is part of the American dream.
Also, 55 percent of survey respondents said owning a home is a better value than renting, compared with 39 percent who said renting was better.
Last year’s “Face of Foreclosure” report found that 23 percent of Nevadans who lost their homes to foreclosure admitted they simply walked away from mortgage payments they could otherwise afford to make. That percentage climbed to 27 percent this year.
“People were not admitting to it a couple years ago,” said Blane Johnson, president of Nevada Association of Realtors in Incline Village. “Now more people are willing to say they did it. They’re never going to get their money back. It’s easier and cleaner to walk away.”
Mortgage Rates Climb After Months of Record Lows
Freddie Mac announced Thursday that after more than three months of record-low drops, mortgage rates slid up this week.
Freddie Mac’s Primary Mortgage Market Survey showed that the 30-year fixed-rate mortgage (FRM) averaged 3.55 percent (0.7 point) for the week ending August 2, up from 3.49 percent the previous week. Before this week, the average 30-year FRM had fallen to or matched record-low levels for 13 of the past 14 weeks.
The 15-year FRM also slid up, averaging 2.83 percent (0.6 point) from 2.80 percent last week.
In addition, the 5-year adjustable-rate mortgage (ARM) averaged 2.75 percent (0.6 point), a slight increase from the last survey’s finding of 2.74 percent. On the other hand, the 1-year ARM fell a bit, averaging 2.70 (0.4 point) from 2.71 percent a week ago.
“Recent announcements of additional debt relief for the Eurozone and mixed domestic economic indicators added upward pressure on Treasury yields as well as mortgage rates this week,” said Frank Nothaft, VP and chief economist at the GSE. “The U.S. economy grew at a 1.5 percent annualized rate in the second quarter, slower than the 2.0 percent growth in the first quarter with consumer spending in June unchanged from May. However, consumer confidence rose in July for the first time in five months, according to The Conference Board.”
Meanwhile, Bankrate reported mixed results, with the 30-year fixed averaging 3.77 percent (up from 3.75 percent the previous week). The 5-year ARM also inched up to 2.91 percent (from 2.89 percent); however, the 15-year FRM dropped from 3.00 percent to a new low of 2.99 percent.
“Comments from the President of the European Central Bank helped reverse some of the recent flight to quality that had brought bond yield and mortgage rates consistently lower. Mortgage rates are closely related to the yields on government bonds. When investors are nervous and piling into safe haven investments, it serves as a catalyst for lower rates. But the reverse is also true, and when any of those trades gets unwound, it pushes rates higher,” said Bankrate in a release.
A great read… and only $33 US.
2015 – The big fall of Western real estate
http://www.leap2020.eu/Book-2015-The-big-fall-of-Western-real-estate-By-Sylvain-Perifel-and-Philippe-Schneider_a10782.html
Shouldn’t this post be titled something more like “Strategic Default and the Fantasy of Rising Home Values”? I know several people who are very well-paid/successful and “plan to live in their house for a long time” because they have to! Even though they make bank they still don’t have 6 figures of cash lying around to bring to the table if they were to sell. So they keep paying the mortgage, thinking occasionally that maybe they should stop. But they’re trapped by a combination of habit and fantasy that their homes will dramatically rise in value. I think general inertia and not wanting to deal with painful financial decisions is what’s keeping these people paying for their over-priced prisons, I mean houses…
The belief in rising prices does not have to be rooted in reality in order for it to have a strong psychological impact. People bought homes for appreciation at every point during the crash. Most thought they were getting a bargain or buying at the bottom.
The best part is, all of these people I know who are deep underwater are still paying their mortgages and still spending their remaining earnings on toys. Rather than save, they lease new cars every couple years, live an expensive lifestyle, even renovate kitchens in their underwater houses! There is no logic to the average American’s financial behavior, which is what got us to where we are today.
Their fall from entitlement is inevitable. It’s only a matter of when it happens and how painful it is.
Home prices may rise.
Home values will not.
Excellent post.
I would like to expand upon that just a bit……..
Price does NOT equate to value because price is something you charge people for. Value is what something is worth.
That seems like an astute observation.
When adjusted for inflation — something we all know is coming — any rise in prices will be lost by value in the currency.
[...] The market-has-bottomed meme currently touted by every major media outlet is a concerted effort to improve buyer sentiment and induce people to enter into a transaction that may not be in their best interest. Affordability is currently quite good in nearly every housing market due to the low interest rates — and that is a good reason to buy — but sheeple are so accustomed to buying for appreciation that the market-has-bottomed meme must be pounded into the public’s heads to knock people off the fence. A secondary benefit of a widespread belief in future appreciation is a reduction in strategic default. [...]