Mar302009

Responsible Homeowners are NOT Losing Their Homes

Many of the sob stories in the mainstream media have been focused on what are characterized as “responsible homeowners” who are in danger of losing their homes. Several articles of this type have been posted here, and many commenters have noted the extravagances and poor decisions that often make these homeowners look less than completely responsible. Let’s be clear about one thing:pay_mortgage_or_children_rental

Responsible homeowners are NOT losing their homes.

To see the truth in this statement, one needs to have a clear definition of “responsible homeowner.”

A “responsible homeowner” is a buyer who, if they utilized financing, did not stray from the conservative parameters set forth by lenders (prior to the bubble) and financial planners. This includes using a maximum 28% debt-to-income ratio on the mortgage, at least a 20% downpayment and fixed-rate conventionally amortizing financing.

Few who fit this definition are going to lose their homes; although, some of them may chose to walk away from the debt because they are hopelessly underwater. The only ones who fit the above definition who are in danger of losing their homes are those who lose jobs; they are the truly sad casualties of the housing bubble. Unfortunately, this is becoming more common due to the financial crisis caused by all the homeowners who borrowed irresponsibly.

Responsible borrowers are not the ones defaulting on their mortgages; irresponsible homeowners are.

If “responsible homeowner” is defined as a buyer who believed they could manage their monthly payment and did so until the loan terms changed, then by this definition, many responsible homeowners are going to lose their homes.

Almost everyone who signed up for a toxic loan thought they could make the payment; most did for a while. Many were convinced they could make the payments by a predatory lender out to make a few bucks on the origination. Many more believed they could supplement their incomes with the rapid appreciation they would enjoy as their house values rose to infinity. Does ignorance to their inability to sustain their housing payments make them responsible?

In the political debate surrounding foreclosure moratoriums and homeowner bailouts, the politicians are using the latter definition of “responsible homeowner.” The ignorant and those who knowingly took excessive risk are being rewarded with a government bailout. The prudent are the ones paying the bill.

To see the truth in the importance of these definitions, we need to look no further than the astute observations on this blog. One of our frequent commenters is a responsible homeowner. He purchased near the peak, but he did so with terms that his family can afford. He meets the parameters in the first definition. He is in no danger of losing his house in foreclosure. Yes, he is annoyed that the values have dropped–who wouldn’t be–but he is not going to become a foreclosure statistic.

If you want to know what the lenders really worry about it is that guys like him may chose to go into foreclosure and walk away from the debt. There are already enough irresponsible homeowners on their way to the meat grinder. A wave of walkaways would make sausage of the entire banking industry.

The reality is responsible homeowners are not losing their homes; some may lose their houses because of a job loss, and some may chose to walk away, but very few truly responsible homeowners are endangered. The foreclosure crisis is caused by the irresponsible.

I want you to contemplate how much trouble our market is in. I will use the analogy of drinking and partying and compare the Irvine experience to that of Minnetonka, Minnesota.

Let’s say you are a Minnetonka resident. You make just as much money as residents in Irvine, but your median house price at the peak was $305,000. This is higher than historic norms, but as far as kool-aid partying goes, you had only a few social drinks. If you take an aspirin and drink a big glass of water, you will feel fine in the morning. The Federal Reserve is providing the aspirin in the form of 4.5% mortgage interest rates and the guaranteed ability to refinance your conforming mortgage. You as a Minnetonka resident did not party too hard; your hangover is manageable.

Now imagine you are an Irvine resident. You make a decent living, but instead of paying $305,000 for a median home, you paid $723,000 (or borrowed that much on your HELOC). You had a great time: you bought cars, took vacations, and impressed all your friends and neighbors with how rich you are. You did more than take a few social drinks of kool-aid. You downed the bottle; when that wasn’t enough, you found a bigger bottle, and as the party went on, you finally went intravenous. You are now dependant upon kool-aid (HELOC money), and there is no amount of medicine that can save you from a wicked hangover, delerium termens, and the worst withdrawal pains possible. The Federal Reserve’s medicine is not going to help you; your mortgage is not conforming, and you not going to be allowed to refinance. You are screwed.

People bidding on Irvine real estate in the new financing environment simply cannot bid prices as high as they used to, and they are not going to be able to raise their bids for quite some time. It is very unlikely that prices will rise enough to bail out all the homeowners facing ARM resets. There are too many people who drank too much kool aid (see examples above). All of these overextended homedebtors must be flushed from the system. Based on available data, (1) we know that refinancing is not going to be possible, (2) we know these people cannot afford the payments, and (3) we know that their are not enough buyers who really do make that much money to take over these people’s debts and bail them out. There are no other viable alternatives.

I used to think that Turtle Rock would be spared the worst of the housing correction. Most residents are long-term owners, so there is relatively little toxic financing on purchases. The only thing that could flatten Turtle Rock–other than big declines in neighboring communities–is mortgage equity withdrawal. I didn’t think it could be that bad; perhaps I was wrong.