May212012

Strategic default paid off as defaulters repurchased at lower prices

Many borrowers chose not to struggle with onerous house payments early in the housing bust and strategically defaulted. Most of these borrowers recognized their payments were greater than the cost of a comparable rental, and with falling prices, there was no return for this added investment. The wise choice then as now was to strategically default. Many did.

Early strategic defaulters are being rewarded with much lower ownership costs due to lower house prices and lower interest rates. By the time prices recover to the peak when many of their cohorts will just be emerging from the depths, the early defaulters will have lower payments and significant equity. Strategic default was the best possible decision, and today’s buyers are making the most of it.

Foreclosed Americans find way back to homeownership

By Jilian Mincer — NEW YORK | Wed May 16, 2012 3:00pm EDT

(Reuters) – When Jennifer Anderson’s family could no longer afford their mortgage and lost their home, she expected many years to pass before they would again become property owners.

But less than two years later, in March, they purchased a $297,000 house outside Phoenix, Arizona, after qualifying for a loan backed by the U.S. government.

They joined a small but growing number of Americans who are making a surprisingly quick return to homeownership after defaulting on their loans or being forced into short sales that cost their banks money.

“We didn’t really expect it,” said Anderson, 40. “We were resigned to the fact that we were going to be in a rental property for a while.”

From the beginning of the housing bust, I predicted the government would relax its standards on the waiting period following a foreclosure because they were going to need those recycled buyers to mop up their REO. Not long thereafter, Fannie Mae announced they were reducing the waiting period after a foreclosure from five years to two years despite the obvious incentives to strategically default.

… Data is not available, but interviews with more than 30 lenders, builders, Realtors and consumers suggest that a growing number of Americans are getting back into the housing market, even though they went through a foreclosure, bankruptcy or short sale in recent years.

“Most are not ashamed or bashful about what happened because so many people were forced into that reality in the last six years,” says Graham Epperson, vice president of sales in Arizona for the PulteGroup, a leading U.S. homebuilder.

They want to escape rising rents and take advantage of home prices, which are down by about a third from an April 2006 peak.

Rising rents and prices below rental parity are a strong inducement to buy a home.

…Federal Reserve Chairman Ben Bernanke stressed the point last week, saying banks have become so restrictive that many worthy homebuyers are being frozen out of the market, and lending practices are not likely to loosen any time soon.

What exactly is a “worthy homebuyer?” Isn’t a worthy homebuyer someone who will repay the debt as promised? Does it seem logical that banks, institutions that make money from making loans, would be turning away anyone who will repay the debt as promised? Isn’t is far more likely that banks are prudently avoiding making loans to borrowers who won’t repay them? Therefore, isn’t Bernanke’s statement complete bullshit intended to placate his critics? The real truth in his statement is that lending practices are not likely to loosen any time soon.

… Most of these reentering buyers are using FHA-insured loans, which at the end of 2011 accounted for about 30 percent of loans for home purchases, compared with 4.5 percent in 2005.

The resurgence of FHA loans is primarily due to the fact that FHA insured loans only require 3.5% down.

A conventional mortgage typically carries a lower interest rate than does an FHA-backed loan, but it also requires a credit score of at least 720, proof of income and a significant down payment. In contrast, FHA loans historically have been available to help low and moderate-income families buy homes.

FHA borrowers typically need a credit score of at least 620 and a 3.5 percent down payment. The FHA charges an upfront mortgage insurance premium of 1.75 of the loan (which can be rolled into the mortgage) and an annual 1.25 percent premium on the outstanding loan.

A 620 FICO score is hardly an onerous credit hurdle.

BAD MEMORIES

For some economists, alarm bells are ringing.

… “FHA is putting people back into situations that still have high risk of default,” Pinto said.He noted that a lot of these loans are made to consumers with credit scores well below 720 — the median national score for all households– and that about 15 percent of loans made to people with scores of 620 to 659 are likely to fail.

If the lowest segment of approved FICO scores has a historic default rate of 15%, how much lower should we go? The notion that credit standards are too tight is nonsense. Since we are all backing these loans as taxpayers, I want those standards even tighter.

A SECOND CHANCE

There have been about 4.2 million foreclosures in the United States since 2007, according to data firm RealtyTrac. It expects that number to climb to 6 million by early 2014.

A bankruptcy remains on a consumer’s record for seven years, but that consumer can start raising his or her credit score in several months by decreasing debt, not borrowing more and paying bills on time.

The GSEs and the FHA will both insure loans three years out of bankruptcy. I have heard anecdotal accounts from homebuilders that many transactions are timed to close three years and one day from a buyer’s bankruptcy date.

“Most of the loans that are getting done are for people who have really rebuilt their credit,” says Frank Donnelly, president of the Mortgage Bankers Association of Metropolitan Washington, D.C. “They have to prove (to the lender that) it was something like a job loss that caused this and not chronic delinquency.”

In other words, Ponzis have to lie. With training from lenders in stated-income loan programs, many Ponzis are experienced liars.

Many people did not strategically default early in the bust because they thought it was immoral. That nonsense faded away by 2011.

By 2008 it was obvious to most underwater borrowers that strategic default was the best financial decision, but many held on with false hope of some massive government bailout program designed to help them. Instead, any bailout money was sent to the banks.

Those who strategically defaulted between 2008 and 2010 are re-entering the housing market at a good time. It’s  not too late to benefit from strategic default, but as the market turns the corner and prices begin to rise, the benefit of strategic default diminishes. In fact, this is one of the myriad of reasons lenders are so intent on engineering a market bottom. False hope induced many not to strategically default before, and if they can generate the hope of a recovery — even a false hope — that is nearly as valuable as a real recovery because fewer debt slaves will seek freedom.