Lingering debt from housing bubble still keeps housing supply off the market

Those who are no longer underwater but lack the equity for a move-up could sell if they wanted, but they are not listing their homes.

American-Gothic-House-UnderwaterFor many loanowners, the last eight years in borrower purgatory felt more like borrower hell. They’ve been trapped beneath their debts, and any remedies for their situation would carry negative consequences of their own. Many people opted to strategically default, and I openly encouraged this action for years because it immediately relieved the emotional distress and put people on a path toward building a new future. However, those that did strategically default had to pay a price of a lowered credit score and lingering debt collection issues. Many others borrowers opted to sell short, but this too had credit implications. A few even sold the house and paid the shortfall out of savings, but these sellers were the exception rather than the rule.

Nearly all these borrowers who escaped their debt prisons shared one common characteristic: They generally left their properties dead broke. Unfortunately, the same is true of most loanowners who finally sell and get out from under their burdensome mortgage debt.

Getting out of debt

Prior to my writing publicly about the housing bubble, my wife was close friends with a woman who lived in the Cottage neighborhoods in Woodbridge. This family bought their house for about $400,000 in 2001, and by 2006, it was worth about $725,000. When I told them houses can’t possibly appreciate that quickly and sustain the gains, they told me I didn’t understand California real estate. The woman’s mother was a real estate agent, and she knew this market better than I ever could — or so I was told. Despite my long conversations with them on the subject, I could not convince them there was a housing bubble. These conversations provided much of the early energy to write for the IHB. Maybe I couldn’t save them, but I could try to save everyone else.

The family who was my inspiration decided to execute a move-up in November of 2007. They only had $100,000 because the breadwinner borrowed the rest of their equity to start a successful business (the only use of HELOCs I can understand and endorse). They took their $100,000, borrowed $1,000,000 in a first mortgage, borrowed $100,000 in a HELOC second mortgage (maximized their tax write offs), and bought a $1,200,000 trophy home in Woodbridge. After launching their new business, they quickly took on an $8,000 per month mortgage payment on a property they could have rented for $4,000 a month.

They struggled with this payment for over six years. Finally, in May of 2013, values had come back to where they could sell the house, pay the commission and get out with a small profit. The traded down to a cottage home very similar to the one they left six years earlier. It couldn’t have been an easy decision. They had to pay $40,000 more than they sold their cottage for back in 2007, and they put about $100,000 down, so the last six years had no net loss, but no gain either. Their new mortgage payment is at least 60% less than their previous one.

My wife asked me if perhaps they did it right. They got to live in that beautiful house for six years and feel like they owned it. They got to impress their family, friends, and neighbors and live the good life — at least that’s what was seen from the outside. I pointed out to my wife what you didn’t see was the emotional cost the breadwinner of the family endured trying to make that $8,000 per month payment. Since they could have rented the house for $4,000 per month and since they ended up with no additional equity, the extra $4,000 per month they were spending was “throwing their money away on mortgage interest.” That $4,000 could have funded many family trips and vacations, possessions for their teenage daughters, savings for their retirement, savings for their children’s education, and a plethora of other benefits they gave up to “own” that house. Even after the tax breaks, this family flushed $200,000+ down the mortgage toilet.

I give this family credit for finally making the right financial decision. The discussions about selling their dream home to take a step down the property ladder could not have been easy, but it was clearly the right choice. They cut their housing costs by 60%, and now they will have the extra money to do all the things they gave up to own that huge home loan.

Many others will chose to hang on because the moment they rise above water, the stress of being a loanowner almost immediately turns to greed about making enough money to buy a nice move-up. Unfortunately for the broader housing market, this makes for a severe lack of available homes for sale. Between those who are still underwater and those who can’t make the move-up they desire, many homes that ordinarily would be for sale are not on the market.

Housing supply falls further, feeding prices

Diana Olick, Thursday, 30 Jul 2015how_far_underwater

Ask anyone trying to buy a home today, and the vast majority will launch into a story about a bidding war. Demand for housing has returned, but housing supply has not, and the numbers are only getting worse. …

The reasons for tight supply are manifold: Homebuilders are putting up single family homes at a far slower pace than historical norms. They cite a shortage of labor for at least some of that weakness, but they also are not seeing strong demand, due to their higher prices.

As it turned out, reflating the housing bubble hurts homebuilders, rather than helps them. Homebuilders celebrated when prices went up because their costs were fixed, and they made more when they sold the units; however, now when they go to buy lots to construct more homes, the cost of those lots reflects the increased value of the houses they plan to build on them. The higher prices mandated by their lot costs puts these homes out of reach of most buyers, so they still get their high prices, but they can’t sell volume at the higher price points.

In our new era marked by the absence of unstable affordability products, high prices mean low sales, and unlike the past, there is no way to suspend this law of supply and demand. Today’s high prices may benefit bankers and existing homeowners, but it’s a disaster for homebuilders because they simply won’t be able to sell enough homes to meet their financial projections. Further, this problem will only get worse as interest rates rise and prices become even less affordable.

Another reason is negative equity. Millions of homeowners still owe more on their mortgages than their homes are worth, or they don’t have enough equity in their homes to afford to move up, leaving them unable to list their homes for sale. Still other potential move-up buyers are afraid they won’t be able to find a home to buy, so they stay where they are.

Negative equity is the primary reason as Low housing inventory is an indicator of residual mortgage distress. To the reasons listed above, I would also add that millions of owners with little or no equity also aren’t listing and selling their homes because they don’t have the equity for a move-up deal.greedy_sellers

“Sellers tend to want to hang in and get the last juice out of the orange,” said Humphries. “If you think you might see 10 percent appreciation over the next year, is it rational to move where you might squeeze more out of the market? No.”

Yes, foolish greed is present as well.

That seller psychology is only feeding the problem in some of the hottest markets. Low inventory only pushes prices higher, and makes more sellers want to wait. That in turn pushes supply lower, as housing demand rises. In addition, higher rents are keeping more first-time buyers from saving for a down payment.

“If we can get additional increase in supply, then price increases will begin to flatten out, which will be good for the economy, good for many first time buyers, but as long as we have limited supply, and that’s what we have today, then prices inevitably will continue to rise,” said Lawrence Yun, chief economist for the National Association of Realtors.

As those who were underwater reach the surface of their debts, they could sell if they wanted to, but so far, most have not acted on this new freedom. Why is that?

Those who have equity, but not enough to put 20% down on a move-up are no listing their homes. If the debt is manageable, then they are content to wait for rising prices to help them out, and with millions of loan modifications, most aren’t feeling the financial pain, at least until their rate moves higher.

The people with less than 20% equity (the black bar above), is a large portion of the population, and what they do with their homes will determine when more supply comes to the market. For now, they can sell but chose not to, but as the terms of their loan modifications reset to higher rates, many more will list their homes because rising costs compels them.

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