home value $200K, mortgage is $350K: what would you do?
As the real-estate bubble implodes I wonder if we could see a lot of home-owners just hang on and try and wait it out. So long as a person can still make the payments wouldn't they just keep living in a house, even if it was worth substantially less than the mortgage? Or would a lot of people just walk away from their homes if they were under-water (even if they could still make the payments)?
Comments
3 Groups:
- Those that can hang on and do
- Those that can hang on and decide it's easier to walk
- Those that can't hang on
Due to changes in mortgage qualifications, recent buyers are weighted heavier in the latter two groups. For many, homeownership wasn't a long term plan or well thought out decision. Many will walk because it's the cheaper alternative.
If you were trying to identify the optimal financial outcome, the best choice is probably to stop making the mortgage payments immediately, put three months mortgage payments into savings while the lender begins foreclosure actions. Then they could contact the lender and hit them up for a payment to vacate the house without having to go through a full foreclosure sale. In a couple of years, the person's credit will be on the mend, and they've dodged the underwater equity.
However, since most people are emotional beings, they will stay put and make the payments as long as they can. When they run a couple of payments late, they'll continue to make partial payments even though it won't stall foreclosure proceedings. They'll waste their time trying (and probably failing) to work a short sale until the sheriff shows up on their doorstep. At this point, the person's credit will be ruined, he'll have no money saved for a rental deposit, and he'll have to move in with his folks.
The choice seems pretty clear from an impartial observer, but people get tied up in not losing the house and trying to get by as best they can.
People aren't coming home at night after a long day's work, checking their zillow zestimate, and saying to their spouse over dinner, "you know honey, our home value has dropped $150K so I've got this great idea: let's stop making the payments."
The average, random homeowner doesn't connect the dots that way. A house is more than just a payment and a value to many folks out there.
Most people, (perhaps the subprime homeowner even more so since now they know they're not gonna qualify for another home loan for about a decade) want to stay in the house they purchased, even if the value dips, because their plan never was to bail if all goes to hell.
Now let's look at a different scenario: the homeowner in financial distress. The two top reasons why people default are divorce and failure of a business with job loss coming in third. Now we have a completely different dinner table conversation, or NO conversation if it's a divorce. Sometimes people in financial distress go into denial because the emotions are overwhelming. They're dealing with fear, anger, sadness, maybe even some self-disgust; all powerful emotions.
They're trying to figure out all their options, people are trying to give them advice but they're not listening too well because they're in a high emotive state. If you want an example of what I mean, rent the movie "House of Sand and Fog." I assign this as extra credit when I teach at BCC.
Now, THESE folks, the ones in true financial distress end up usually putting off their final decision until it's too late to do much of anything except let the lender foreclose. They haven't thought out in advance to "keep 3 months worth of payments" because the logical side of their brain isn't in gear; they're in survival mode.
At that time, what these people need is legal advice. You might say, "Jillayne, how can someone afford an attorney if that person is in financial distress?" Well for that person, the Wa State Bar Assoc offers free legal aid.
If we want to get a line on an increase in foreclosures here or nationwide, all we need to do is to watch divorce rates, the rate at which small businesses are failing and economic job loss reports. Sometimes all three of these are inter-related. Foreclosures will follow increases in these areas.
While these are certainly the traditional reasons for people to go into foreclosure, I don't see any hard evidence that the recent foreclosure epidemic nationwide is the result of any of these factors.
If you have some recent evidence to back up this claim I'd certainly be interested to see it.
The credible sources I've read indicate that the reason for the current rise in foreclosures is that banks modeled their home loan performance probabilities based on the continued rise in home prices. The expectation was that people in unaffordable loans (and banks new the loans were unaffordable for many recent buyers) would refinance using equity gained through appreciation.
When appreciation stopped, people that had not increased their income/savings, improved their credit score or added value to the home through some other means had few options for extracting equity.
Countrywide's CEO stated rather frankly that they were issuing loans based on the assumption that people would use equity to make the payments and much of the deterioration in their business model is due to this failure.
If the rise in foreclosures is in fact due to a sharp rise in divorce rates, small business failures and job losses the MSM and all of the RE focused blogs seem to have missed this trend.
On a separate note, I think we're seeing a generation gap with regard to people's willingness to "hang on" to a home that is no longer a good investment. The older folks tend to believe that homeowners have a deep emotional attachment to their homes and will fight to keep them.
I'm not saying this doesn't exist, just that it's not as strong among the gen-X and Y crowds that have made up the majority of recent FTHB's. Realistically A LOT of the attraction to home ownership has been due to the wealth creation (or wealth transfer) effect these groups have come to expect from it. Many recent buyers would have had a take it or leave it attitude if it wasn't for the opportunity to earn instant equity just by buying a home. Take this away and the magic just isn't there.
Back in the olden days when buying a home required commitment, savings and dedication it was certainly harder to part with it. Buyers 2005+ didn't need any of that. No job? Buy a home. No savings? Buy a home! Not so good at paying your bills? No problem! Buy a home!
It's a bit of a stretch to think this group of homebuyers characterized by underemployment, lack of savings and poor credit are suddenly going to "get religion" and straighten up. Not going to happen on a wide scale.
Back in the olden days when buying a home required commitment, savings and dedication it was certainly harder to part with it.
What's old is new again. Instead of buying, though, it will take these things to HOLD ON to the home.
I don't think we're talking a generation gap. People of all age ranges nationwide are facing foreclosure, not just Gen X and Gen Y.
Last time I checked the stats, subprime and prime FIXED rate loans are doing relatively okay. It's the subprime and prime ARM loans where we're seeing dramatic increases in foreclosure.
When we combine an ARM loan with financial distress, now we REALLY see an increase in foreclosures.
Traditionally people with ARM loans who are doing okay financially HAD more options like trying to refinance or sell. Not everyone, no matter what their age, is going to arrive at a logical decision to just walk away.
So, it's not all just the lending climate over the past 9 years and it's not all just financial distress like I'm talking about, it's a combination of many factors. This includes the now present problem of the local real estate market slow down and prices no longer appreciating. The option to sell for these folks might not be there, the option to refi might not be there, which is why foreclosure stats have nowhere to go but slowly up for the next many years.
But they'll go up in relation to financial distress.
I'm with sniglet, I think people will keep living in their house as long as they can.
http://www.bloomberg.com/apps/news?pid= ... refer=home
This is an excellent point. Unlike previous real-estate cycles we have lots of home-owners today who used exotic financing (e.g. negative amortization, 100% finance, etc) to buy more home than they could afford. No one seemed to think this was a bad idea because "real-estate only goes up". Appreciation was the miracle drug that made everything work out.
In reality, the explosion of exotic financing (of which only a small part was sub-prime) has pretty much guaranteed that many home-owners will wind up under-water (i.e. with homes worth less than the mortgage), and in default: no divorces, illness, or unemployment required.
I don't believe I ever indicated that only the younger generation is walking away from their homes, just that they have a different attitude towards it, more "easy come, easy go" coupled with the fact that the "coming" part was particularly easy relative to how it was years ago.
Am I reading this wrong, or are you really implying that the credit bubble was masking the effects of divorce, business failure and job loss on foreclosures? I'd believe that, but if that's the case then tracking these indicators wouldn't tell you a whole lot about why foreclosures are rising now since the number of people losing homes was supressed artificially by easy credit.
I'm not arguing for the sake of it - It's just that when I see what seems like a highly unusual situation being explained in terms of normal trends with no evidence that's the case, I'm going to ask what's up.
After reading your post, I'm not even sure if you meant to say that because foreclosure rates on non adjustable loans are still low that this is because people that chose a fixed rate loan are also less likely to divorce, have their business fail or lose a job.
What I'd really like to see is some evidence that the rise in foreclosures is actually due to changing social trends. My hunch is we're just as likely to see divorce, business failure and job loss as a consequence to people being unable to pay their mortgage/refi and losing RE related jobs as the market contracts.
I'm not so sure that's the entire reality.
Here's what I experienced:
20% down,
10% down
5% down
0 down
0 down with seller paying closing costs.
Then we started adding on to that by selling people adjustable rate mortgages, interest only loans, and then interest only adjustables, and finally the pay option, interest only, negative am, ARM loans, along with zero down, seller-paid closing costs.
All the while, credit score requirements kept going down, down, as well as requirements for cash reserves, job stability or any income verification.
an unknown percentage of people will go through foreclosure and re-enter the market as renters....as they should.
Here's what bothered me during this time: The appraisers were pressured to hit the sales price that included seller paid closing costs. Now everyone's sales price and appraisal was based on that closed sale and we kept at it for several years.
Anyone with half a brain who's been in this industry longer than 15 years knew that it would not last, but nobody listens to reason when there's tons of money being made.
I still think people will irrationally try to stay in their home for as long as possible, and when we see an increase in financial distress situations, we'll see foreclosures slowly continue to rise nationwide for many years to come.
Yes, financial distress and toxic loans are inter-related, but that's not the ONLY thing that will keep foreclosure numbers slowy rising.
"Am I reading this wrong, or are you really implying that the credit bubble was masking the effects of divorce, business failure and job loss on foreclosures?"
Possibly. When faced with these situations, homeowners HAD the option of selling quickly and easily, and having some equity in there to pay the costs of selling like excise tax, escrow, Realtor commission, and so forth.
That option is slowly fading in many markets.
Good conversation. I'll be back later on tonight.