Irvine Housing Blog

The Latest Lie about Strategic Default: Borrowers Are Emotional Fools

Posted: 01 Jun 2010 03:30 AM PDT

Lenders are trying to label strategic defaulters as hysterical fools in order to keep the hopeless paying a little bit longer.

Irvine Home Address ... 13711 SOLITAIRE Way Irvine, CA 92620
Resale Home Price ...... $675,000

And So Sally can wait, she knows it's too late and she's walking on by
My soul slides away, but don't look back in anger, don't look back in anger
I heard you say

At least not today.

Oasis -- Don't Look Back In Anger

Home debtors can wait, many know it's not too late and their walking away. The ones that stay watch their souls slide away one payment at a time. Paying on a hopeless mortgage checking Zillow Zestimates and NAr press releases for good news about their home's value. Those are the debtors who will look back in anger -- anger at the lies they were fed, the manipulations from realtors, lenders, and now our own government. How would you feel after a decade of being underwater?

Lenders are frightened about strategic default because it threatens to wipe out the remaining illusions about the value of the worthless loans on their balance sheets. If every underwater homeowner did what was in their best financial interest, our banks would be undeniably insolvent; therefore, lenders are coordinating a public relations campaign to appeal to false morality and now lenders are trying to stereotype strategic defaulters as hysterical fools.

There is so much about the manipulation of borrowers by lenders I find offensive. This one I find particularly offensive because lenders are trying to make the correct and rational decision of hopeless debtors look like the incorrect and irrational decision of overemotional lunatics.

If lenders were merely trying to bluff debtors with bullshit or foster fantasies of appreciation, their behavior would be consistent with the clueless shills of the National Association of realtors who lie by ignorance -- however, lenders know strategic default benefits many borrowers, and they are intentionally perpetrating a lie for their own advantage. Unintentional lies of bullshit are not as offensive as intentional deception for personal gain, which is what lenders are doing now.

Anger at the root of mortgage default problem, study finds

By Kenneth R. Harney

Saturday, May 22, 2010

Memo to the bank: Take this money-sucking, underwater house and shove it! Go ahead and wreck my credit for years to come. I'm walking away, no matter what.

Why?

That's the question posed by Brent T. White, a University of Arizona law professor whose academic paper last year on the fast-spreading "strategic default" phenomenon drew sharp criticism from lenders and Wall Street, who viewed him as the Pied Piper of the walk-away movement.

Now White has published a paper based on the personal accounts of 356 strategic defaulters and homeowners on the verge of doing the same. His finding: People who intentionally default on their loans are not as economically rational or calculating in their decision-making as widely thought.

The reporter is setting readers up with a false premise hidden in the language: rational and calculated decision making does not support strategic default. Unfortunately for lenders, the ability to do math clearly demonstrates that strategic default is wiser for those who are deeply underwater and paying far more in interest than they would in rent. It is a wise and rational decision for borrowers in that circumstance. Whether or not people get emotional about that fact is beside the point; strategic default is the best course of action for many home debtors.

In fact, he said, their decisions to pull the plug "may not turn out to be economically rational."

Here is where the lenders plant their insidious lie: it may not turn out in your favor. Fear of the bogeyman is all they have left. Deeply underwater homeowners who continue to pay bloated mortgages will consider their odds and chose the path with a much higher probability of a successful outcome: strategic default. What lenders fear most is that strategic default may turn out to be very economically rational. In fact, it will.

Perhaps if this bear rally goes on a bit longer lenders can appeal to residual kool aid intoxication as well -- "Don't default now, prices are coming back!" Yeah, right.

But they walk anyway, in large part because they are at the end of their emotional rope.

Sure, once people are pissed off enough, they get angry and make a decision. Anger is a wonderful motivator for change. Everyone who strategically defaults makes a very difficult decision, and either choice they make is fraught with difficulties.

They have transitioned from feelings of anxiety and hopelessness to outright anger at their lenders, the government and a financial system they consider unfair.

That's because borrowers have been screwed by lenders, the government and our financial system -- with a little help from their own greed. It is human nature for people to blame every responsible party other than themselves. Borrowers who strategically default are pissed at the perpetrators just as any victim would be. There might even be a few with the smallest modicum of introspection who realized they participated as well. Not many, but a few....

White published his latest paper in Arizona Legal Studies, the university law school's journal. After a study he did last year, which argued that far larger numbers of underwater borrowers should stick it to their lenders, White says he was inundated with e-mails and calls from homeowners saddled with negative equity. Many provided him with extensive details of their financial situations and difficulties dealing with their lenders.

According to CoreLogic, a real estate analytics firm, negative equity continues to be a massive and corrosive problem. During the first quarter, 11.2 million homeowners across the country owed more on their mortgages than the market value of their properties.

In Las Vegas, 75 percent of mortgaged homes and condos are underwater. In Phoenix, 550,000 homeowners have negative equity -- 58 percent of houses with loans. Florida's rate of negative equity is 48 percent, followed by Michigan at 39 percent and California at 34 percent. Nationwide, nearly one out of four mortgaged houses is in a negative equity position, according to CoreLogic.

There are a lot of borrowers who are underwater. Many of them would benefit from strategic default.

White and other academic researchers say that severe negative equity is the essential spark that prompts owners to consider walking away -- even those who think it's morally wrong to default.

We have about six more months of mileage out of the morality play. By the end of this year, many people will know someone they know and respect who strategically defaulted. Once that happens, it's over. When the hundreds of thousands of people who are deeply underwater see the benefits others gain by defaulting, they will all do it.

Based on the personal accounts shared by strategic defaulters, White said, they often have high credit scores, sterling payment histories and solid incomes. As one underwater homeowner said in an e-mail to White, "There isn't a lender out there who wouldn't give us a loan," based on credit performance.

Didn't this author argue earlier that these people were irrational and poor decision makers? Aren't people with high credit scores more savvy about debt?

But staring at hundreds of thousands of dollars of negative equity, owners become anxious, then pessimistic, about their financial futures. Older owners with severe negative equity worry about their ability to stay afloat in their retirement years if they keep paying their mortgage.

Why someone late in their career would take on a huge mortgage is beyond me. Other than the desire for a property they could not afford, senior borrowing is purely for the anticipated mortgage equity withdrawal to fuel their retirement spending. Seniors in particular should consider strategic default. What do they have to lose? If seniors get cut off from credit cancer it is the best thing that could happen to them.

Lenders and loan servicers often play crucial -- if inadvertent -- roles in motivating owners to walk away, White said. Of the 356 homeowners' situations he analyzed, 100 percent reported contacting their lenders to work out a solution before they defaulted.

Many say they were rebuffed by servicers who refused to discuss modifications with anyone current on loan payments. White quoted one deeply underwater homeowner: "So many times I have called my mortgage company to say that I have been a good-paying customer, who despite the difficult economic times, [has] continued to pay on time. I am told over and over again that they cannot do anything for me."

What is the bank's incentive? If people who are deeply underwater keep paying, the bank has no incentive to stop that. Only if borrowers actually default does a lender have any incentive to do anything. Nothing is going to change that.

Other owners told White that they tried to qualify for one of the Obama administration's foreclosure-prevention programs but either got snagged by rigid income-to-payment rules or non-responsive servicers, or were told they were too deeply underwater to obtain assistance of any sort.

Any borrower so far underwater as to fail to qualify for a government program should default. What are they waiting for? The government basically told them to.

In the end, anger pushes even the most reluctant defaulters over the line.

Some of the anger is directed at the federal government. One couple told White: "Frankly we are tired of getting the short end of the stick, while the government seems to rescue everyone but us."

That's because the government is bailing out the banks while letting borrowers flounder. Did borrowers really think it would turn out the other way?

White says there can be no effective answer to the walk-away trend as long as lenders and the government fail to intervene early and address underwater borrowers' needs and emotions.

Do borrowers need therapy to be convinced to keep paying when it is not in their best interest? I suggest a mass hypnosis. Maybe if debtors are hypnotized, they will suddenly believe paying the supersized mortgage is in their best interest.

One possibility: much deeper principal-reduction efforts for owners who have severe negative equity and see no way out. Another option offered by White: Create a "rent-based loan program" that would allow underwater owners the option of refinancing their balances to an interest rate that would bring their monthly payments in line with the rental cost for a comparable house.

Foreclosure is a superior form of principal reduction. If the government and lenders want to reduce balances, foreclose on people and reduce balances that way. I like the idea of rent-based payment cram downs. Underwater loan owners are renting from the bank anyway. If lenders believed their loans could get crammed down to rental equivalence levels, perhaps they wouldn't make so many stupid loans.

Bought at bottom, milked it, and squatted

Today's featured property was purchased for $372,000 on 11/6/1998. The owner used a $297,600 first mortgage and a $74,400 down payment.
On 11/22/1000 he opened a $50,000 stand-alone second.
On 8/22/2001 he opened a $100,000 HELOC.
On 7/29/2004 he opened a $150,000 HELOC.
On 4/13/2005 he refinanced with a $600,000 Option ARM with a 1% teaser rate and obtained a $120,000 stand-alone second.
Total property debt is $720,000.
Total mortgage equity withdrawal is $422,400
Total squatting is at least 20 months.

Foreclosure Record
Recording Date: 06/04/2009
Document Type: Notice of Sale

Foreclosure Record
Recording Date: 01/23/2009
Document Type: Notice of Default

Uncomfortably numb

After writing about this for over three years, when I see someone who stole $422,400 and squatted for almost 2 years, I am rather numb to it all.

If someone robs a bank and gets $20,000, it makes headlines and someone goes to jail, but when someone steals nearly half a million dollars through a mortgage, nobody notices.

If someone breaks into a vacant house and squats for a couple days, the police are called out to remove them. If someone quits paying their mortgage and squats for a couple years, nobody notices.

If someone had told me these would be commonly accepted actions a few years ago, I wouldn't have thought it possible. Yet here we are. I am uncomfortably numb.

Irvine Home Address ... 13711 SOLITAIRE Way Irvine, CA 92620

Resale Home Price ... $675,000

Home Purchase Price … $372,000
Home Purchase Date .... 11/6/1998

Net Gain (Loss) .......... $262,500
Percent Change .......... 81.5%
Annual Appreciation … 5.1%

Cost of Ownership
-------------------------------------------------
$675,000 .......... Asking Price
$135,000 .......... 20% Down Conventional
4.87% ............... Mortgage Interest Rate
$540,000 .......... 30-Year Mortgage
$137,704 .......... Income Requirement

$2,856 .......... Monthly Mortgage Payment

$585 .......... Property Tax
$0 .......... Special Taxes and Levies (Mello Roos)
$56 .......... Homeowners Insurance
$0 .......... Homeowners Association Fees
============================================
$3,497 .......... Monthly Cash Outlays

-$694 .......... Tax Savings (% of Interest and Property Tax)
-$665 .......... Equity Hidden in Payment
$253 .......... Lost Income to Down Payment (net of taxes)
$84 .......... Maintenance and Replacement Reserves
============================================
$2,476 .......... Monthly Cost of Ownership

Cash Acquisition Demands
------------------------------------------------------------------------------
$6,750 .......... Furnishing and Move In @1%
$6,750 .......... Closing Costs @1%
$5,400 ............ Interest Points @1% of Loan
$135,000 .......... Down Payment
============================================
$153,900 .......... Total Cash Costs
$37,900 ............ Emergency Cash Reserves
============================================
$191,800 .......... Total Savings Needed

Property Details for 13711 SOLITAIRE Way Irvine, CA 92620
------------------------------------------------------------------------------
Beds: 5
Baths: 3 full 1 part baths
Home size: 2,590 sq ft
($261 / sq ft)
Lot Size: 5,500 sq ft
Year Built: 1970
Days on Market: 173
Listing Updated: 40297
MLS Number: S598459
Property Type: Single Family, Residential
Community: Northwood
Tract: Rc
------------------------------------------------------------------------------
According to the listing agent, this listing may be a pre-foreclosure or short sale.

This large home has 5 bedrooms and 3.5 baths. Two of the bedrooms have private baths with showers and tubs. Both of these bedrooms also boast cathedral ceilings. As you enter this home you walk into a large livingroom diningroom combination. Off to the left you have a cozy familyroom with a brick fireplace. As you move to the right of the home you have a comfortable kitchen with a breakfast nook and breakfast counter. All three of these rooms have sliding glass doors that lead to a fantastic backyard that is complete with a pool. This home is very open, making it perfect for entertaining.

Sub 5% interest rates are stabilizing prices

The markets are signaling continued deflation and a double-dip recession. As a result, money is flowing into government backed home mortgages. The historic spreads between the 10-year Treasury and a GSE MBS are now meaningless because a mortgage-backed security from a GSE is now backed by the full faith and credit of the US Government -- it is a government security. Between the flight to quality and the government guarantee, interest rates are very low.

As a result of very low interest rates, payment affordability is very high. Today's featured property would likely save an owner money versus a comparable rental, and that is what is driving our market. Of course, the actual price paid is still very high, and the stability of record low interest rates is suspect to say the least, but the affordability of monthly payments is undeniable. If lenders were smart, they would be selling more of their REO into this temporary affordability.